1. Copyright 2008 The McGraw-Hill Companies 9-1 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 The Aggregate Expenditures Model O 9.1

2. Copyright 2008 The McGraw-Hill Companies 9-2 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Chapter Objectives Economists Combine Consumption and Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy –AE = Output –Saving = Investment –No Unplanned Changes in Inventories How Changes in Equilibrium Real GDP Occur and Relate to Multiplier Integrate Government and Foreign Sectors into AE Recessionary and Expansionary Expenditure Gaps

3. Copyright 2008 The McGraw-Hill Companies 9-3 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Consumption and Investment Simplifications –Private Closed Economy –Planned Investment –Investment Schedule r and i (percent) Investment (billions of dollars) ID 20 8 Real GDP (billions of dollars) 20 Investment (billions of dollars) IgIg Investment Demand CurveInvestment Schedule 20 Investment Demand Curve Investment Schedule

4. Copyright 2008 The McGraw-Hill Companies 9-4 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Consumption and Investment Equilibrium GDP: C + I g = GDP Real Domestic Output Aggregate Expenditures –Aggregate Expenditures Schedule Equilibrium GDP Disequilibrium W 9.1

5. Copyright 2008 The McGraw-Hill Companies 9-5 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Consumption and Investment (1)40 (2)45 (3)50 (4)55 (5)60 (6)65 (7)70 (8)75 (9)80 (10)85 $375 390 405 420 435 450 465 480 495 510 $-5 0 5 10 15 20 25 30 35 40 20 $395 410 425 440 455 470 485 500 515 530 $-25 -20 -15 -10 -5 0 +5 +10 +15 +20 Increase Equilibrium Decrease $370 390 410 430 450 470 490 510 530 550 (2) Real Domestic Output (and Income) (GDP=DI) (3) Con- sump- tion (C) (4) Saving (S) (1-2) (5) Investment (I g ) (6) Aggregate Expenditures (C+I g ) (7) Unplanned Changes in Inventories (+ or -) (8) Tendency of Employment Output and Income (1) Employ- ment Graphically… …in Billions of Dollars

6. Copyright 2008 The McGraw-Hill Companies 9-6 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 530 510 490 470 450 430 410 390 370 45° 370 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) Consumption (billions of dollars) Consumption and Investment Equilibrium GDP C I g = $20 Billion Aggregate Expenditures C = $450 Billion C + I g (C + I g = GDP) Equilibrium Point G 9.1

7. Copyright 2008 The McGraw-Hill Companies 9-7 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Equilibrium GDP Other Features… –Saving Equals Planned Investment Leakage Injection –No Unplanned Changes in Inventories

8. Copyright 2008 The McGraw-Hill Companies 9-8 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 510 490 470 450 430 45° 430 450 470 490 510 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Changes in Equilibrium GDP …and the Multiplier Increase in Investment (C + I g ) 0 Decrease in Investment (C + I g ) 2 (C + I g ) 1

9. Copyright 2008 The McGraw-Hill Companies 9-9 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show International Trade Net Exports and Aggregate Expenditures Net Exports Schedule Net Exports and Equilibrium GDP –Positive Net Exports –Negative Net Exports International Economic Linkages –Prosperity Abroad –Tariffs –Exchange Rates

10. Copyright 2008 The McGraw-Hill Companies 9-10 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Real GDP +5 0 -5 Net Exports X n (billions of Dollars) Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) 510 490 470 450 430 45° 430 450 470 490 510 International Trade Net Exports and Equilibrium GDP Aggregate Expenditures with Positive Net Exports C + I g Aggregate Expenditures with Negative Net Exports C + I g +X n2 C + I g +X n1 X n1 X n2 Positive Net Exports Negative Net Exports 450470490

11. Copyright 2008 The McGraw-Hill Companies 9-11 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show -700 200 150 100 50 0 50 100 150 200 250 International Trade Net Exports of Goods - Select Nations, 2004 Positive Net ExportsNegative Net Exports Canada France Germany Italy Japan United Kingdom United States +37 +195 +111 -17 -2 -117 -707 Source: World Trade Organization GLOBAL PERSPECTIVE

12. Copyright 2008 The McGraw-Hill Companies 9-12 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Adding the Public Sector (1)$370 (2) 390 (3) 410 (4) 430 (5) 450 (6) 470 (7) 490 (8) 510 (9) 530 (10) 550 $375 390 405 420 435 450 465 480 495 510 $-5 0 5 10 15 20 25 30 35 40 $20 20 10 20 $415 430 445 460 475 490 505 520 535 550 10 (1) Level of Output and Income (GDP=DI) (2) Consump- tion (C) (3) Saving (S) (4) Investment (I g ) (5) Net Exports (X n ) (6) Government (G) (7) Aggregate Expenditures (C+I g +X n +G) (2)+(4)+(5)+(6) Exports (X) Imports (M) Government Purchases and GDP …in Billions of Dollars

13. Copyright 2008 The McGraw-Hill Companies 9-13 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 45° 470 550 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Adding the Public Sector Government Spending and GDP C Government Spending of $20 Billion C + I g + X n C + I g + X n + G $20 Billion Increase in Government Spending Yields an $80 Billion Increase In GDP

14. Copyright 2008 The McGraw-Hill Companies 9-14 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 45° 490 550 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Adding the Public Sector Lump-Sum Tax Increase and GDP $15 Billion Decrease In Consumption From a $20 Billion (MPC=.75) Increase in Taxes C d + I g + X n + G C + I g + X n + G $20 Billion Increase in Taxes Yields a $60 Billion Decrease In GDP

15. Copyright 2008 The McGraw-Hill Companies 9-15 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Adding the Public Sector C d + I g + X n + G = GDP Leakages Injections No Planned Inventory Changes S d + M + T = I g + X + G G 9.2 W 9.2

16. Copyright 2008 The McGraw-Hill Companies 9-16 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Equilibrium Versus Full-Employment GDP Recessionary Expenditure Gap Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) 550 530 510 490 470 45° 490 510 530 AE 0 AE 1 Full Employment Recessionary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change

17. Copyright 2008 The McGraw-Hill Companies 9-17 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Equilibrium Versus Full-Employment GDP Inflationary Expenditure Gap Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) 550 530 510 490 470 45° 490 510 530 AE 0 AE 2 Full Employment Inflationary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change

18. Copyright 2008 The McGraw-Hill Companies 9-18 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Equilibrium Versus Full-Employment GDP Application: –U.S. Recession of 2001 Inflationary Expenditure Gap –U.S. Inflation in the Late 1980s –Full-Employment Output with Large Negative Net Exports Negative Net Exports W 9.3

19. Copyright 2008 The McGraw-Hill Companies 9-19 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Equilibrium Versus Full-Employment GDP Limitations of the Model –Does Not Show Price Level Changes –Ignores Premature Demand- Pull Inflation –Limits Real GDP to the Full- Employment Level of Output –Does Not Deal with Cost-Push Inflation –Does Not Allow for “Self- Correction”

20. Copyright 2008 The McGraw-Hill Companies 9-20 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Say’s Law - The Great Depression and Keynes Classical School – Automatic Self- Adjustment to Full Employment – Mill, Ricardo Views Based Upon “Say’s Law” - J.B. Say (1767-1832) – Supply Creates its Own Demand Great Depression Caused Questions Keynes Answered in his General Theory of Employment, Interest, and Money Income and Saving Discrepancies Volatility in Investment Spending Cyclical Unemployment Can Occur Government Should Be Active in the Recovery Process Last Word O 9.2

21. Copyright 2008 The McGraw-Hill Companies 9-21 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Key Terms planned investment investment schedule aggregate expenditures schedule equilibrium GDP leakage injection unplanned changes in inventories net exports lump-sum tax recessionary-expenditure gap inflationary-expenditure gap

22. Copyright 2008 The McGraw-Hill Companies 9-22 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show Next Chapter Preview… Aggregate Demand and Aggregate Supply