Ch 9.Ch 9. The Aggregate The Aggregate Expenditures ModelExpenditures Model

(a) The investment demand (a) The investment demand curve and (b) the investment curve and (b) the investment

scheduleschedule

a) The level of investment spending ($20 bill) is determined by the interest rate (8%)together with the investment demand curve (ID).

b) The investment schedule (Ig) relates the amount of investment ($20 bill) determinedin (a) to the various levels of GDP (set amount/constant).

A.A. Equilibrium GDP: (GDP = C + Ig). Equilibrium GDP: (GDP = C + Ig). Savings equals planned Savings equals planned

investment investment (S=Ig).(S=Ig).

B.B. Planned investment – amount firms Planned investment – amount firms plan to invest.plan to invest.

C.C. Investment schedule – shows Investment schedule – shows amount amount firms plan to invest at firms plan to invest at possible possible values of real GDP.values of real GDP.

D.D. Aggregate expenditures schedule – Aggregate expenditures schedule – shows shows total amount spent on final total amount spent on final goods/ goods/ services at diff. levels services at diff. levels of real GDP.of real GDP.

Aggregate Expenditure is a measure of national income. It is a way to measure the total GDP or Gross Domestic Product (A measure of the level of economic activity). It is defined as the value of planned goods and services produced in an economy.

GDP is calculated by the formula C + I + G + NX C = Consumption Expenditure (Also written as CE) I = Investment (Ip + Iu planned + unplanned) G = Government spending NX = Net exports (Exports-Imports)

Aggregate Expenditures is defined as C + Ig.

-- John Maynard Keynes (pronounced Caines) developed the Aggregate Expenditures Model, aka the ‘Keynesian Model’ or ‘Keynes Cross.’-- The amount of goods & services produced and therefore the level of employ-ment depend directly on the level of aggregate expenditures (total spending).

John Maynard Keynes – British economist favored the heavy John Maynard Keynes – British economist favored the heavy gov’t spending during a recession, even running a deficit, to gov’t spending during a recession, even running a deficit, to jumpstart the economy (Keynesian economics).jumpstart the economy (Keynesian economics).

Keynes appeared on Dec 31, 1965 edition of TIME magazine.

Keynes ideas, called Keynesian economics,had a major impact on the Great Depresison andmodern economic / political theory as well as on

many gov’ts' fiscal policies. He advocated Interventionist gov’t policy, by which the gov’t would use fiscal and monetary measures to

mitigate the adverse effects of economic recessions, depressions and booms.

He is one of the fathers of modern theoretical macroeconomics.

Keynes argued that the solution to depression was to stimulate the economy ("inducement to invest") through some combination of two approaches : A reduction in interest rates. Government investment in infrastructure.

Consumption and Consumption and InvestmentInvestment

(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

20

20

20

20

20

20

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20

20

$395

410

425

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455

470

485

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515

530

$-25

-20

-15

-10

-5

0

+5

+10

+15

+20

Increase

Increase

Increase

Increase

Increase

Equilibrium

Decrease

Decrease

Decrease

Decrease

$370

390

410

430

450

470

490

510

530

550

(2)Real

DomesticOutput

(andIncome)

(GDP=DI)

(3)Con-

sump-tion(C)

(4)Saving (S)

(1-2)

(5)Investment

(Ig)

(6)Aggregate

Expenditures(C+Ig)

(7)UnplannedChanges inInventories

(+ or -)

(8)Tendency ofEmploymentOutput and

Income

(1)Employ-

ment

Graphically…

…in Billions of Dollars

The tableshows 10 possiblelevels of

production.

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)

Co

nsu

mp

tio

n (

bill

ion

s o

f d

olla

rs)

Consumption and Consumption and InvestmentInvestmentEquilibrium GDP

C

Ig = $20 Billion

AggregateExpenditures

C = $450 Billion

C + Ig(C + Ig = GDP)

EquilibriumPoint

The Keynesian

Model(KeynesCross)

showing theAggregate

ExpenditureModel

Equilibrium GDP: C + Ig = GDPEquilibrium GDP: C + Ig = GDP

Aggregate expenditures – in a closed economy, AE consists of C Aggregate expenditures – in a closed economy, AE consists of C (col 3) + I (col 5) = sum in col 6. Col 2 makes the AE schedule (col 3) + I (col 5) = sum in col 6. Col 2 makes the AE schedule (GDP=DI).(GDP=DI).

The schedule shows the amount (C+Ig) that will be spent at each The schedule shows the amount (C+Ig) that will be spent at each possible output or income level.possible output or income level.

Equilibrium GDP where GDP (DI) & AE columns are equal (col. 2 Equilibrium GDP where GDP (DI) & AE columns are equal (col. 2 and 6, are each $470 bill).and 6, are each $470 bill).

Changes in the equilibrium GDP caused by Changes in the equilibrium GDP caused by shifts in the aggregate expenditures shifts in the aggregate expenditures

schedule and the investment scheduleschedule and the investment scheduleA

ggre

gate

expend

iture

s

Real domestic product, GDP

Increase in investment

Decrease ininvestment

Equilibrium Graph

Equilibrium pointC+Ig C

470450

●

450

470The

KeynesCross

showing theAggregate

ExpenditureModel

If the amount invested increased by $5 billion, that If the amount invested increased by $5 billion, that increase will shift the graph upward.increase will shift the graph upward.

$5 billion $5 billion ΔΔ in investment spending leads to $20 in investment spending leads to $20 billion billion ΔΔ in output & income (income is Y). in output & income (income is Y).

Multiplier is 4 (= $20/$5).Multiplier is 4 (= $20/$5). MPS is .25MPS is .25

E. Multiplier: ΔΔ in output & income in output & incomeΔΔ in investment spending in investment spending

In an open-mixed economy, In an open-mixed economy, equilibrium GDP occurs where: equilibrium GDP occurs where: CCaa+I+Igg+X+Xnn+G=GDP+G=GDP

Net exports andequilibrium GDP

Net exports are exports minus imports.

Gov’t spending and equilibrium GDPGov’t spending and equilibrium GDP

Aggre

gate

expend

iture

s

Real GDP

Gov’t spendingincrease

a

b

c

●d

●e

-- In a private closed economy, the APC is equal to 1 at what income level?-- If AE are Ca+Ig+Xn+G, the amount of savings at $225 are what points?

Point ‘a’

Points ‘c and d”

Equilibrium Versus Equilibrium Versus Full-Employment GDPFull-Employment GDPRecessionary Expenditure GapRecessionary Expenditure Gap

Real GDP (billions of dollars)

Ag

gre

gat

e E

xpen

dit

ure

s(b

illio

ns

of

do

llars

)550

530

510

490

47045°

490 510 530

AE0

AE1

FullEmployment

RecessionaryExpenditureGap = $5 Billion

$5 BillionGap Yields$20 Billion

GDPChange

Equilibrium Versus Equilibrium Versus Full-Employment GDPFull-Employment GDPInflationary Expenditure GapInflationary Expenditure Gap

Real GDP (billions of dollars)

Ag

gre

gat

e E

xpen

dit

ure

s(b

illio

ns

of

do

llars

)550

530

510

490

47045°

490 510 530

AE0

AE2

FullEmployment

InflationaryExpenditureGap = $5 Billion $5 Billion

Gap Yields$20 Billion

GDPChange

F.F. Lump-sum tax – tax that’s a Lump-sum tax – tax that’s a constant constant amount at all levels of GDP.amount at all levels of GDP.

G.G. Recessionary gap – amount the aggRecessionary gap – amount the aggexpenditures schedule must shift expenditures schedule must shift

upward upward to increase real GDP to full-to increase real GDP to full-employment.employment.

H.H. Inflationary gap – amount the agg Inflationary gap – amount the agg expenditures schedule must shift expenditures schedule must shift downward to decrease real GDP to full-downward to decrease real GDP to full-employment.employment.

Opp

osite

s