1. Chapter 28: The Aggregate Expenditures Model Keynes – “In the long run, we are all dead.” Textbook Graphs and Tables Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 1

2. Assumptions of Model 1.Prices (goods, services, and resources) are stuck. → In the immediate short run, prices can’t react to market changes. 2 Average time between price changes for 350 categories of goods was 4.3 months.

3. Assumptions of Model: Prices are Stuck Reasons: – Most markets are not perfectly competitive, which leads to some degree of price-setting (and sticking) by producers. – Firms: Know that consumers prefer stable prices. Are afraid of competitive price wars. – Changing prices can be costly - “changing the menu price”. 3

4. Assumptions of Model 2.Since prices are stuck, economic feedback to firms is in the form of unplanned inventory changes. 3.The economy has excess production capacity and unemployed labor. 4

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7. Equilibrium: Private, Closed Economy 7

8. Equilibrium (private, closed economy): AE = C + I g = GDP → Planned spending equals total production (income) 8

9. Equilibrium: Private, Closed Economy By definition, actual spending always equals GDP (income): (C + I g + unplanned inventory changes) = GDP But only in equilibrium does aggregate planned spending equal GDP (income): AE = C + I g = GDP → No unplanned inventory changes in equilibrium. 9

10. Equilibrium: Private, Closed Economy 10

11. The Multiplier effect 11 Increase in investment spending = $5 billion + Second-round increase in consumer spending = MPC × $5 billion + Third-round increase in consumer spending = MPC 2 × $5 billion + Fourth-round increase in consumer spending = MPC 3 × $5 billion Total increase in real GDP = (1 + MPC + MPC 2 + MPC 3 +...) × $5 billion = 1/(1 – MPC) * $5 billion = 1/(1 – 0.75) * $5 billion = $20 billion

12. The Multiplier effect – changes in I g 12

13. Two Net Exports Schedules 13

14. Aggregate Expenditures with Net Exports 14

15. Aggregate Expenditures with Government Purchases 15

16. Equilibrium: Mixed, Open Economy 16

17. Taxes and Equilibrium GDP 17