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MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

CONCEPT: AGGREGATE EXPENDITURES MODEL AND MACROECONOMIC EQUILIBRIUM

● Aggregate expenditures (AE) represent the total _________________ in an economy

□ The aggregate expenditures model describes the relationship between _____________ and ______________

> Key Assumption: Prices are _____________

> Key Idea: In any particular year, the level of _______ is determined by the level of aggregate expenditure

𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋

𝐴𝐸 = _______________________________

Macroeconomic Equilibrium occurs when ________________________

□ In the AE model, think like this:

> AE = ________________

> GDP = ________________

AE =

Consumption

Investment

Government Purchases

Net Exports

EXAMPLE: Find macroeconomic equilibrium using the information in the following table:

Real GDP (Y)

Consumption (C)

Investment (I)

Government Purchases (G)

Net Exports (NX)

Aggregate Expenditure

(AE)

Unplanned Changes in Inventories

$16,000 $12,400 $3,500 $3,200 – $1,000

$18,000 $13,700 $3,500 $3,200 – $1,000

$20,000 $15,000 $3,500 $3,200 – $1,000

$22,000 $16,300 $3,500 $3,200 – $1,000

$24,000 $17,600 $3,500 $3,200 – $1,000

□ If AE = GDP Inventories _________________ the economy is _________________

- Everything produced is purchased

□ If AE < GDP Inventories _________________ GDP and employment _________________

- Purchases are ___________ than production

□ If AE > GDP Inventories _________________ GDP and employment _________________

- Purchases are ___________ than production

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: GRAPHING MACROECONOMIC EQUILIBRIUM

● The aggregate expenditures model describes the relationship between _____________ and ______________

□ In the AE model, think like this:

> AE = ________________

> GDP = ________________

AE =

Consumption

Investment

Government Purchases

Net Exports

Aggregate Expenditures Model

□ Macroeconomic Equilibrium occurs where the AE (C + I + G + NX) line crosses the _______________________

Amount (in billions)

Consumption 2 + 0.5Y

Investment 1

Government Purchases

0.5

Net Exports 0.5

C + I

C + I + G

C + I + G + NX

2 4 6 8 10

10

8

6

4

2

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: AGGREGATE EXPENDITURES MODEL IN A PRIVATE CLOSED ECONOMY

● The aggregate expenditures model describes the relationship between _____________ and ______________

□ A private closed economy is a country that ______________ have government or international trade

□ In the AE model, think like this:

> AE = ________________

> GDP = ________________

AE =

Consumption

Investment

Government Purchases

Net Exports

Private Closed Economy

□ Macroeconomic Equilibrium occurs where the AE (C + I) line crosses the _______________________

Amount (in billions)

Consumption 2 + 0.5Y

Investment 1

C + I

2 4 6 8 10

10

8

6

4

2

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: AGGREGATE EXPENDITURES MODEL IN A PRIVATE OPEN ECONOMY

● The aggregate expenditures model describes the relationship between _____________ and ______________

□ A private open economy is a country that ______________ have government

□ In the AE model, think like this:

> AE = ________________

> GDP = ________________

AE =

Consumption

Investment

Government Purchases

Net Exports

Private Open Economy

□ Macroeconomic Equilibrium occurs where the AE (C + I+ NX) line crosses the _______________________

Amount (in billions)

Consumption 2 + 0.5Y

Investment 1

Net Exports 0.5

C + I

C + I + NX

2 4 6 8 10

10

8

6

4

2

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: AGGREGATE EXPENDITURES MODEL AND THE MULTIPLIER EFFECT

● The multiplier effect describes how an initial boost in spending leads to a much higher increase in __________

□ In the AE model, think like this:

> AE = ________________

> GDP = ________________

AE =

Consumption

Investment

Government Purchases

Net Exports

Aggregate Expenditures Model

Multiplier Effect

𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝐺𝐷𝑃 =1

1 − 𝑀𝑃𝐶∗ 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑆𝑝𝑒𝑛𝑑𝑖𝑛𝑔 𝐵𝑜𝑜𝑠𝑡

Amount (in billions)

Consumption 2 + 0.5Y

Investment (old) 1

Government Purchases

0.5

Net Exports 0.5

C + I + G + NX (old)

Investment (new)

C + I + G + NX (new)

2 4 6 8 10

10

8

6

4

2

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: COMPONENTS OF AGGREGATE EXPENDITURE

● The level of aggregate expenditures is determined by the level of each of C + I + G + NX

□ Determinants of Consumption:

Disposable Income (refer to Consumption Function videos)

Household wealth Expected future income

Price level Interest rate

□ Determinants of Planned Investment:

Expectations of Future Profitability

Interest Rate Taxes Cash Flow

□ Determinants of Government Purchases:

Government Policies and Decision Making (Fiscal Policy)

□ Determinants of Net Exports:

Price Level in USA vs. other countries GDP Growth in USA vs. other countries Exchange Rate between USD and

other currencies

High US Inflation more __________

Low US Inflation more __________

High US Growth ____________

Low US Growth ____________

USD value rises ______________

USD value falls ______________

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: QUANTITATIVE ANALYSIS OF AGGREGATE EXPENDITURE MODEL

● We can use linear equations to solve for macroeconomic equilibrium where ____________________

□ Recall the calculation of Aggregate Expenditures:

AE =

Consumption

Investment

Government Purchases

Net Exports

□ Macroeconomic Equilibrium can be stated as the point where:

𝑌 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋

□ The trickiest part of the solution is that the formula for consumption uses the variable for GDP (Y)

> Consumption, C = A + MPC(YD), is dependent on GDP (Y) because:

- Higher GDP leads to higher disposable income

- Higher disposable income leads to higher consumption

EXAMPLE: Use the following information to solve for macroeconomic equilibrium:

C = 2,000 + 0.65Y I = 3,200 G = 2,800 X = 500 M = 1,500

PRACTICE: Use the following information to solve for macroeconomic equilibrium (T is a lump-sum tax):

C = 1,500 + 0.75(Y-T) I = 3,400 G = 2,600 + T X = 750 M = 2,000 T = 500

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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CONCEPT: DERIVING THE MULTIPLIER ALGEBRAICALLY

● We can use a simplified aggregate expenditures model to show how the multiplier is derived:

□ The multiplier signifies the multiple increase in GDP based on an initial increase in spending

□ Recall the calculation of the multiplier:

𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 =1

1 −𝑀𝑃𝐶

□ To derive it algebraically we start with a private closed economy (no government and no international trade)

𝐴𝐸 = 𝐶 + 𝐼

𝐴𝐸 = 𝐴 +𝑀𝑃𝐶(𝑌𝐷) + 𝐼

Since there are no taxes or government transfers in this model, then GDP (i.e. national income) = Disposable Income

In equilibrium, GDP = AE

Rearrange the formula algebraically and solve for GDP

Analysis: A $1 increase in spending (from a change in A or I) will result a 1/(1-MPC) increase in equilibrium GDP

MACROECONOMICS - CLUTCH

CH. 16 - DERIVING THE AGGREGATE EXPENDITURES MODEL

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