1. The Aggregate Expenditures Model Chapter 28 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 28-2 Chapter Objectives Aggregate expenditures for a private closed economy Characteristics of equilibrium real GDP in a private closed economy Changes in equilibrium real GDP and the multiplier Adding the government and international sectors Recessionary and inflationary expenditure gaps

3. 28-3 Model Simplifications Private closed economy Consumption and investment only Prices are fixed Excess capacity exists Unemployed labor exists Disposable income = real GDP –No taxes

4. 28-4 Model Simplifications Investment demand vs. 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 Curve Investment Schedule 20 Investment Demand Curve Investment Schedule

5. 28-5 Equilibrium GDP Real GDP = C + I g Aggregate expenditures –Equal to C + I g –Aggregate expenditures schedule Quantity goods produced = quantity goods purchased Disequilibrium –Only 1 equilibrium level of GDP

6. 28-6 (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 …in Billions of Dollars Equilibrium GDP In millions

7. 28-7 530 510 490 470 450 430 410 390 370 45° 370 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) Consumption (billions of dollars) C I g = $20 Billion Aggregate Expenditures C = $450 Billion C + I g (C + I g = GDP) Equilibrium Point Equilibrium GDP

8. 28-8 Equilibrium GDP Saving equals planned investment –Leakage –Injection No unplanned inventory changes

9. 28-9 510 490 470 450 430 45° 430 450 470 490 510 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Changes in Equilibrium GDP Increase in Investment by 5 (C + I g ) 0 Decrease in Investment by 5 (C + I g ) 2 (C + I g ) 1 The Multiplier Effect

10. 28-10 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

11. 28-11 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 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

12. 28-12 -700 200 150 100 50 0 50 100 150 200 250 Net Exports of Goods Select Nations, 2006 Positive Net ExportsNegative Net Exports Canada France Japan Italy Germany United Kingdom United States +31 +70 +203 -45 -27 -171 -881 Source: World Trade Organization

13. 28-13 Adding the Public Sector GDP = C d + I g + X n + G Lump sum taxes –Taxes affect disposable income –Consumption and the MPC Leakages = S d + M + T Injections = I g + X + G S d + M + T = I g + X + G

14. 28-14 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) …in Billions of Dollars

15. 28-15 45° 470 550 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Government Spending Effect 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

16. 28-16 45° 490 550 Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) Lump Sum Tax Effect $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

17. 28-17 Recessionary Expenditure Gap GDP is below full employment 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

18. 28-18 Inflationary Expenditure Gap GDP is above full employment 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

19. 28-19 The Complete Model GDP and full employment Multiplier effects –Government spending –Lump sum taxes Recessionary gap –Policy options Inflationary gap –Demand pull inflation

20. 28-20 Application U.S. economy late 1990’s –Too much investment –Stock market bubble –Consumer debt –Fraudulent business practice Aggregate expenditure falls U.S. recession of 2001 Terror attacks prolonged recession

21. 28-21 The Great Depression Classical economics –Mills and Ricardo –Prices adjust to maintain full employment Say’s Law –Supply creates its own demand Depression challenged the theory New theory developed –Keynes –Aggregate expenditure model

22. 28-22 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

23. 28-23 Next Chapter Preview… Aggregate Demand and Aggregate Supply