The Aggregate Expenditures Model

Copyright 2011 The McGraw-Hill Companies17-1

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

17The Aggregate ExpendituresModel

17.1

Copyright 2011 The McGraw-Hill Companies17-2

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast 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 Public sector and Foreign Sectors into AE

• Recessionary and Expansionary Expenditure Gaps

Copyright 2011 The McGraw-Hill Companies17-3

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Consumption and Investment• Simplifications

– Private Closed Economy– Planned Investment– Investment Schedule

ran

d i

(p

erc

en

t)

Investment (billions of rand)

ID

20

8

Real GDP (billions of rand)

20

Inve

stm

ent

(bil

lio

ns

of

ran

d)

Ig

Investment Demand Curve Investment Schedule

2020

Investment Demand Curve

Investment Schedule

Copyright 2011 The McGraw-Hill Companies17-4

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Consumption and Investment• Equilibrium GDP:

C + I = GDPY = C + I Y = Co +cYd + I

• Real Domestic Output (Yd)• Aggregate Expenditures (Y)

– Aggregate Expenditures Schedule

• Equilibrium GDP• Disequilibrium 17.1

Copyright 2011 The McGraw-Hill Companies17-5

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Consumption and Investment

R377.5

392.5

407.5

422.5

437.5

460.0

467.5

482.5

497.5

512.5

R-7.5

-2.5

2.5

7.5

12.5

20

22.5

27.5

32.5

37.5

20

20

20

20

20

20

20

20

20

20

R397.5

412.5

427.5

442.5

457.5

480

487.5

502.5

517.5

532.5

R-27.5

-22.5

-17.5

-12.5

-7.5

0

+2.5

+7.5

+12.5

+17.5

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

R370

390

410

430

450

480

490

510

530

550

(1)Real

DomesticOutput

(andIncome)

(GDP=Yd)

(2)Con-

sump-tion(C)

(4)Saving

(S)(1-2)

(5)Investment

(I)

(6)Aggregate

Expenditures(C+I)

(7)UnplannedChanges inInventories

(+ or -)

(8)MPC

Graphically…

…in Billions of rand

(3(Co)

R100

100

100

100

100

100

100

100

100

100

Copyright 2011 The McGraw-Hill Companies17-6

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Consumption and Investment• Mathematical Calculations

48025.0

120

12025.0

12075.0

2075.0100

Y

Y

Y

YY

YY

IcYCY

ICY

d

d

dO

Copyright 2011 The McGraw-Hill Companies17-7

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

530

510

490

480

450

430

410

390

370

45°

388 400 420 440 460 480 500 520 540 560

Disposable Income (billions of rand)

Co

nsu

mp

tio

n (

bill

ion

s o

f ra

nd

)

Consumption and InvestmentEquilibrium GDP

C

I = R20 Billion

AggregateExpenditures

C = R460 Billion

C + IC + I = GDP)

EquilibriumPoint

17.1

Copyright 2011 The McGraw-Hill Companies17-8

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Equilibrium GDP

• Other Features…–Saving Equals Planned

Investment

•Leakage

• Injection

–No Unplanned Changes in Inventories

Copyright 2011 The McGraw-Hill Companies17-9

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Savings and Investment• Mathematical Calculations

48025.0

120

2010025.0

2025.0100

20)75.01(100

)1(

Y

Y

Y

Y

Y

IYcC

IS

d

d

dO

Copyright 2011 The McGraw-Hill Companies17-10

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

510

490

470

450

45°

440 460 480 500 520

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s (b

illio

ns

of

ran

d)

Changes in Equilibrium GDP…and the Multiplier

Increase inInvestment

(C + Ig)0

Decrease inInvestment

(C + Ig)2

(C + Ig)1

Copyright 2011 The McGraw-Hill Companies17-11

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public Sector

C + Ig + G = GDP

• Leakages

• Injections

• No Planned Inventory Changes

S + T = Ig + G

17.2

17.2

Copyright 2011 The McGraw-Hill Companies17-12

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public Sector

R377.5

392.5

407.5

422.5

437.5

460.0

467.5

482.5

497.5

512.5

520

R-7.5

-2.5

2.5

7.5

12.5

20

22.5

27.5

32.5

37.5

40

20

20

20

20

20

20

20

20

20

20

20

R417.5

432.5

447.5

462.5

477.5

500

507.5

522.5

537.5

552.5

560

R370

390

410

430

450

480

490

510

530

550

560

(1)Real

DomesticOutput

(andIncome)

(GDP=Yd)

(2)Con-

sump-tion(C)

(4)Saving

(S)(1-2)

(5)Investment

(I)

(6)Exogenous

Public sectorSpending

(G)

(7)Aggregate

Expenditure(C+I+G)

Graphically…

…in Billions of rand

(3(Co)

R100

100

100

100

100

100

100

100

100

100

100

Public sector Purchases and GDP

20

20

20

20

20

20

20

20

20

20

20

Copyright 2011 The McGraw-Hill Companies17-13

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

45°

470 550

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s (b

illio

ns

of

ran

d)

Adding the Public SectorPublic sector Spending and GDP

C

Public sectorSpending ofR20 Billion

C + I

C + I + G

R20 Billion Increasein Public sectorSpending Yields anR80 Billion IncreaseIn GDP

Copyright 2011 The McGraw-Hill Companies17-14

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public sector• Mathematical Calculations

560

25.0/140

14025.0

14075.0

202075.0100

Y

Y

Y

YY

YY

GIcYCY

GICY

d

d

do

Copyright 2011 The McGraw-Hill Companies17-15

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public sector (S=I+G)• Mathematical Calculations

560

25.0/140

14025.0

202010025.0

2020)75.01(100

)1(0

Y

Y

Y

Y

Y

GIYcC

GIS

d

d

d

d

Copyright 2011 The McGraw-Hill Companies17-16

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding G and the Multiplier• Mathematical Calculations

560

80480

80

20*4

decreased I becausedown move line eexpenditur totalThe 4.3

500 = 50 - 550 = Y Nuwe

5) * (10 - Y = Y Nuwe

5 = 1/0.8 = 1/MPS =k 4.2

550 = Y

110 = Y 0.2

110 = 0.8Y-Y

0.8Y + 110

0)-(0+ 40 + 20 + 0)-0.8(Y + 50

Z)-(X+G+I+ T)-c(Y+ Co

Z)-(X +G + I + C = Y 4.1475.0/1

1

*

4801

1

Y

NewY

Y

Y

kMPS

k

IkY

Y

YYNewY

lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllll

Copyright 2011 The McGraw-Hill Companies17-17

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

560

80480

80

20*4

decreased I becausedown move line eexpenditur totalThe 4.3

500 = 50 - 550 = Y Nuwe

5) * (10 - Y = Y Nuwe

5 = 1/0.8 = 1/MPS =k 4.2

550 = Y

110 = Y 0.2

110 = 0.8Y-Y

0.8Y + 110

0)-(0+ 40 + 20 + 0)-0.8(Y + 50

Z)-(X+G+I+ T)-c(Y+ Co

Z)-(X +G + I + C = Y 4.1475.0/1

1

*

4801

1

Y

NewY

Y

Y

kMPS

k

IkY

Y

YYNewY

lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllll

Adding G and the Multiplier

• Mathematical Calculations

Copyright 2011 The McGraw-Hill Companies17-18

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public Sector

R362.5

377.5

392.5

407.5

422.5

445.0

452.5

460

467.5

482.5

497.5

505

R-12.5

-7.5

-2.5

2.5

7.5

15.0

17.5

20

22.5

27.5

32.5

35.0

20

20

20

20

20

20

20

20

20

20

20

20

R402.5

417.5

432.5

447.5

462.5

485.0

492.5

500

507.5

522.5

537.5

545.0

R370

390

410

430

450

480

490

500

510

530

550

560

(1)Real

DomesticOutput

(andIncome)

(GDP=Yd)

(3)Con-

sump-tion(C)

(5)Saving

(S)

(6)Investment

(I)

(7)Exogenous

Public sector

Spending(G)

(8)AggregateExpenditu

re(C+I+G)

Graphically…

…in Billions of rand

(4)(Co)

R100

100

100

100

100

100

100

100

100

100

100

100

Public sector Taxes and the GDP

20

20

20

20

20

20

20

20

20

20

20

20

(2)Taxes

(T)

20

20

20

20

20

20

20

20

20

20

20

20

Copyright 2011 The McGraw-Hill Companies17-19

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

45°

500 560

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s (b

illio

ns

of

ran

d)

Adding the Public SectorLump-Sum Tax Increase and GDP

R15 Billion DecreaseIn Consumption Froma R20 Billion (MPC=.75)Increase inTaxes

C + I + G (with T)

C + I + G

R20 Billion Increasein Taxes Yields aR60 Billion DecreaseIn GDP

Copyright 2011 The McGraw-Hill Companies17-20

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public sector• Mathematical Calculations

500

25.0/125

12525.0

12575.0

20201575.0100

2020)20(75.0100

)(0

Y

Y

Y

YY

YY

YY

GITYcCY

GIcYCY

GICY

d

do

Copyright 2011 The McGraw-Hill Companies17-21

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding the Public sector (S+T=I+G)• Mathematical Calculations

500

25.0/125

12025.0

854025.0

4025.085

4020525.0100

202020)20)(75.01(100

2020))(75.01(100

)1(0

Y

Y

Y

Y

Y

Y

Y

TTY

GITYcC

GITS

d

Copyright 2011 The McGraw-Hill Companies17-22

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Adding T and the Multiplier• Mathematical Calculations

500

60560

60

15*4

475.0/1

1

*

5601

1

Y

NewY

Y

Y

kMPS

k

IkY

Y

YYNewY

Copyright 2011 The McGraw-Hill Companies17-23

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End ShowRealGDP

+5

0

-5

Net

Exp

ort

s X

n(b

illio

ns

of

ran

d)

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s(b

illio

ns

of

ran

d)

540

520

500

480

46045°

460 480 500 520 540

International TradeNet Exports and Equilibrium GDP

AggregateExpenditureswith PositiveNet Exports

C + I +G

AggregateExpenditureswith NegativeNet Exports

C + I + G +Xn2

C + I +G +Xn1

Xn1

Xn2

Positive Net Exports

Negative Net Exports

480 500 520

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Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast 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

Copyright 2011 The McGraw-Hill Companies17-25

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast 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

Copyright 2011 The McGraw-Hill Companies17-26

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Equilibrium Versus Full-Employment GDP

Recessionary Expenditure Gap

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s(b

illio

ns

of

ran

d)

550

530

510

490

47045°

490 510 530

AE0

AE1

FullEmployment

RecessionaryExpenditureGap = R5 Billion

R5 BillionGap YieldsR20 Billion

GDPChange

Copyright 2011 The McGraw-Hill Companies17-27

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Equilibrium Versus Full-Employment GDP

Inflationary Expenditure Gap

Real GDP (billions of rand)

Ag

gre

gat

e E

xpen

dit

ure

s(b

illio

ns

of

ran

d)

550

530

510

490

47045°

490 510 530

AE0

AE2

FullEmployment

InflationaryExpenditureGap = R5 Billion R5 Billion

Gap YieldsR20 Billion

GDPChange

Copyright 2011 The McGraw-Hill Companies17-28

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast 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”

Copyright 2011 The McGraw-Hill Companies17-29

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast 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• Public sector Should Be Active in the

Recovery Process

Last

Word

17.2

Copyright 2011 The McGraw-Hill Companies17-30

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Key Terms• planned investment• investment schedule• aggregate expenditures schedule• equilibrium GDP• leakage• injection• unplanned changes in inventories• lump-sum tax• net exports• recessionary-expenditure gap• inflationary-expenditure gap

Copyright 2011 The McGraw-Hill Companies17-31

Consumption and InvestmentEquilibrium GDPEquilibrium GDP and the MultiplierPublic sector Spending and GDPLump-Sum Tax Increase and GDPAdding the foreign sectorRecessionary Expenditure GapInflationary Expenditure GapLast Word

Key Terms

End Show

Next Chapter Preview…

Aggregate Demand andAggregate Supply