The Aggregate Expenditures Model

28

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Assumptions and Simplifications

• Use the Keynesian aggregate expenditures model

• Prices are fixed

• GDP = DI

• Begin with private, closed economy

• Consumption spending

• Investment spending

LO1 28-2

Equilibrium GDP

C

Ig = $20 billion

Aggregateexpenditures

C = $450 billion

C + Ig

(C + Ig = GDP)

Equilibriumpoint

LO1 28-3

Other Features of Equilibrium GDP

• Saving equals planned investment

• Saving is a leakage of spending

• Investment is an injection of spending

• No unplanned changes in inventories

• Firms do not change production

LO2 28-4

Changes in Equilibrium GDP

Increase ininvestment

(C + Ig)0

Decrease ininvestment

(C + Ig)2

(C + Ig)1

LO3 28-5

Adding International Trade

• Include net exports spending in aggregate expenditures

• Private, open economy

• Exports create production, employment, and income

• Subtract spending on imports

• Xn can be positive or negative

LO4 28-6

Net Exports and Equilibrium GDP

Aggregate expenditureswith positivenet exports

C + Ig

Aggregate expenditureswith negative netexports

C + Ig+Xn2

C + Ig+Xn1

Xn1

Xn2

Positive net exports

Negative net exports450 470 490

LO4 28-7

International Economic Linkages

• Prosperity abroad

• Can increase U.S. exports

• Exchange rates

• Depreciate the dollar to increase exports

• A caution on tariffs and devaluations

• Other countries may retaliate

• Lower GDP for all

LO4 28-8

Adding the Public Sector

• Government purchases and equilibrium GDP

• Government spending is subject to the multiplier

• Taxation and equilibrium GDP

• Lump sum tax

• Taxes are subject to the multiplier

• DI = GDP

LO4 28-9

Government Purchases and Eq. GDP

C

Government spendingof $20 billion

C + Ig + Xn

C + Ig + Xn + G

LO4 28-10

Taxation and Equilibrium GDP

45°

490 550

Real domestic product, GDP (billions of dollars)

Ag

gre

gat

e ex

pen

dit

ure

s (b

illio

ns

of

do

llars

)

$15 billiondecrease inconsumptionfrom a$20 billion increasein taxes

Ca + Ig + Xn + G

C + Ig + Xn + G

LO4 28-11

Equilibrium versus Full-Employment

• Recessionary expenditure gap

• Insufficient aggregate spending

• Spending below full-employment GDP

• Increase G and/or decrease T

• Inflationary expenditure gap

• Too much aggregate spending

• Spending exceeds full-employment GDP

• Decrease G and/or increase TLO5 28-12

Equilibrium versus Full-Employment

Real GDP(a)

Recessionary expenditure gap

Ag

gre

gat

e ex

pen

dit

ure

s(b

illio

ns

of

do

llars

)

530

510

490

45° 490 510 530

AE0

AE1

Fullemployment

Recessionaryexpendituregap = $5 billion

LO5 28-13

Equilibrium versus Full-Employment

AE0

AE2

Fullemployment

Inflationaryexpendituregap = $5 billion

LO5 28-14