ch9equilibrium
TRANSCRIPT
Chapter 9
Demand Side Equilibrium
Aggregate Expenditures
Ag
gre
gate
Exp
en
dit
ure
s =
AE
Real Income = Real GDP = Y
I =
10
00
I =
10
00
AE = C+I+G+NX
AE
G =
5
00
G =
5
00
NX =
30 0
NX =
30
0
Y = 5,000
C = 100 + 0.9Y
C =
9,1
00
I =
10
00
G =
5
00
NX =
30
0
Y = 10,000
C =
17
,20
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 19,000A
E =
10
,90
0
AE =
19
,00
0
C =
46
00
AE =
6,4
00
C =
22
,60
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 25,000
AE =
24
,40
0
Aggregate Expenditures
Real Income = Real GDP = Y
I =
10
00
I =
10
00
AE = C+I+G+NX
AE
G =
5
00
G =
5
00
NX =
30 0
NX =
30
0
Y = 5,000
C = 100 + 0.9Y
C =
9,1
00
I =
10
00
G =
5
00
NX =
30
0
Y = 10,000
C =
17
,20
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 19,000A
E =
10
,90
0
AE =
19
,00
0
C =
46
00
AE =
6,4
00
C =
22
,60
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 25,000
AE =
24
,40
0
100
100+ I+G+NX100+ 1000+500+300
1900
4
C = 100+0.9Y
5,000 10,000 19,000 25,000
4,600
9,100
17,200
22,600
Find the value of consumption for each of these values of Y:
5
I+G+NX
5,000 10,000 19,000 25,000
I =1,000G = 500
NX = 300
1,800
Find the value of I+G+NX for each of these values of Y:
Building Aggregate Expenditures
AE = C + I + G + NXC = 100 + 0.9YI = 1,000G = 500NX = 300
I + G + NX = 1,800
Purchases of buildings and
equipment PLUS planned inventories
Planned Investment
7
C = 100+0.9Y
5,000 10,000 19,000 25,000
4,600
9,100
17,200
22,600
Find the value of consumption for each of these values of Y:
Find the value of AE for each of these values of Y:
AE = 1,900+0.9Y
5,000 10,000 19,000 25,000
6,400
10,900
19,000
24,400C = 100+0.9Y
AE = 1,900 + 0.9 Y
5,000 10,000 19,000 25,000
6,400
10,900
19,000
24,400
Sold
Produced
Produced 5,000Sold 6,400
Inventories fallFirms increase Production
Produced 10,000Sold10,900
Inventories fallFirms increase Production
Produced 19,000Sold19,000
Inventories do not changeFirms do not change Production
Produced 25,000Sold 24,400
Inventories riseFirms decrease Production
AE
Y
5,000 10,000 19,00025,000
6,400
10,900
19,000
24,400
Produced 19,000Sold19,000
Inventories do not changeFirms do not change Production:
Equilibrium: Y = 19,000
AE
Y
AE
Y = 5,000 Y = 10,000 Y = 19,000
AE =
10
,90
0
AE =
6,4
00
AE =
19
,00
0
If total production Y = 5,000
an
d A
gg
reg
ate
Exp
en
ditu
res A
E =
6,4
00
Change in Inventories = 5,000 - 6,400 = -1,400 (Inventories decrease)
If total production Y = 10,000
an
d A
gg
reg
ate
Exp
en
ditu
res A
E =
10
,90
0
Change in Inventories = 10,000 – 10,900 = -900 (Inventories decrease)
If total production Y = 19,000
an
d A
gg
reg
ate
Exp
en
ditu
res A
E =
19
,00
0Change in Inventories = 19,000 – 19,900 = 0 (no change)
AE =
24
,40
0
an
d A
gg
reg
ate
Exp
en
ditu
res A
E =
24
,40
0
If total production Y = 25,000
Change in Inventories = 25,000 – 24,400 = 600 (increase)
Y = 25,000
Firms will increase productionFirms will increase production
Firms will not change productionFirms will decrease production
AE
The Keynesian Cross45 degree line
1000
1000
The 45 lineConverts HorizontalDistances into VerticalDistances.
Income
100
C
D
100 BA
Output
AE
Y = 5,000 Y = 10,000 Y = 19,000
AE =
10
,90
0
AE =
6,4
00
AE =
19
,00
0
AE =
24
,40
0
Y = 25,000
450
AE
Y = 5,000 Y = 10,000 Y = 19,000 Y = 25,000
Tota
l Pro
duct
ion
Total Sales=Aggregate Expenditures
AE
Y = 5,000 Y = 10,000 Y = 19,000 Y = 25,000
Inventories Decrease
Inventories Decrease
No change in InventoriesAE
Total Sales=Aggregate Expenditures
Tota
l Pro
duct
ion
Inventories Increase
If firms end only with WANTED inventories: their actual investment and their planned investment are the same.
With inventories only at the planned level
Total Production
=C + I + G + NX
45A
ggre
gate
Exp
en
dit
ure
s
Real GDPY
No unwanted change inInventories
Y
YC
+I+
G+
NX
C+I+G+NX
AE
45A
gg
reg
ate
Exp
en
dit
ure
s
Real GDPY
Firms will decreaseOutput
Firms will decreaseOutput
Equilibrium Y
C+I+G+NX
AE
Too High Y
Y
C+
I+G
+N
X
Unwanted increase inInventories
Unwanted increase inInventories
45
Ag
gre
gate
Exp
en
dit
ure
s
Real GDPY
Firms will increaseOutput
Firms will increaseOutput
YC+
I+G
+N
X
Equilibrium Y
Low Y
AE
Unwanted
decrease in
Inventories
Unwanted
decrease in
Inventories
6,000 is the equilibrium output
Real Income = Real GDP = Y
I =
10
00
I =
10
00
AE = C+I+G+NX
AE
G =
5
00
G =
5
00
NX =
30 0
NX =
30
0
Y = 5,000
C = 100 + 0.9Y
C =
9,1
00
I =
10
00
G =
5
00
NX =
30
0
Y = 10,000
C =
17
,20
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 19,000A
E =
10
,90
0
AE =
19
,00
0
C =
46
00
AE =
6,4
00
C =
22
,60
0I
= 1
00
0G
=
50
0
NX =
30
0
Y = 25,000
AE =
24
,40
0
When C, I, G or NX decrease
The AE line shifts down
When C, I, G or NX increase
The AE line shifts up
AE
Y = 5,000 Y = 10,000 Y = 25,000
If AE line
shifts down
Equilibrium
Y = 19,000
AE
Y = 5,000 Y = 25,000
Equilibrium
Y = 19,000
Y = 10,000
Equilibrium
If AE line shifts down
Inventories increase
Firms decrease output
Equilibrium output
decreases
AEEquilibrium
Y = 19,000Y = 25,000
Inventories Decrease
Equilibrium output increases
Firms Increa
se Output
If AE line shifts up
Determining Output
In the short run, Aggregate Expenditures determine
output.
Firms adjust production to the level of
sales
Potential GDP
The real gross domestic product (GDP) the economy would produce if its labor force were fully employed
Equilibrium output occurs below Potential GDP
A Recessionary Gap = 5,000 – 4,000
Equilibrium output occurs above Potential GDP
An Inflationary Gap = BE
B
Potential GDP
At Y = 3000
a) Total Spending > Outputb) Inventories fallc) Total Spending < Outputd) Inventories risee) Total Spending = Outputf) There is no change in Inventoriesg) The economy experiences a
recessionary gaph) The economy experiences a
recessionary gap
At Y = 4,000 At Y = 5000
i) Economy is at equilibriumj) Economy is not at equilibrium
Potential GDP
C+I+G+NX
3. If the economy is at equilibrium, is total spending greater, less than or equal to Output? Do Inventories fall, rise or remain unchanged? Does the economy experience a recessionary gap or an inflationary gap? If an inflationary (recessionary) gap exists, how can the gap be closed?
4. If the economy is at equilibrium, is total spending greater, less than or equal to Output? Do Inventories fall, rise or remain unchanged? Does the economy experience a recessionary gap or an inflationary gap? If an inflationary (recessionary) gap exists, how can the gap be closed?
Which AE line will cause a recessionary
gap?Which AE line will cause an Inflationary
gap?
Condition for Equilibrium
Total Sales = Total Production(Otherwise inventories either increase
or decrease and we need inventories to remain the same for equilibrium)
Hypothetical Economy: No government and no foreign sector (closed economy)
In such economy, total sales are sales to consumers and firms only.
AE = C + I Only these two groups purchase
total production.
Condition that must be satisfied for equilibrium:
Y = C + ISince: Y = C + S (Income is
either consumed or saved)We can rewrite the equilibrium condition
as: C + S = C + I
S = I leakages = InjectionsIn a closed economy without
government the equilibrium condition is that Savings must be
equal to Investment
HouseholdsFirms
S
I
C
Total Incom
e
Total Producti
onTo
tal
Spendin
g
Closed Economy without Government
C+I
45
SI
Y Equilibrium
Y Equilibrium
AE
I=S
Leakages =
Injections
Y above equilibrium
Inventories increase
Inventories fall
Y below equilibrium
What is the equilibrium GDP?
For what value of GDP is:Y = AE?
For what value of GDP is:S = I?
At Y = 5,000 are inventories rising? Falling? Unchanged?For what value of GDP is:Y = AE?
At Y = 3,000 are inventories rising? Falling? Unchanged?
Investment
Hypothetical Economy: Trades with the rest of the world (open economy) but no government
In such economy, total sales are sales to consumers, firms and foreing countries only.
AE = C + I + NX Only these three groups purchase
total production.
Condition that must be satisfied for equilibrium:
Y = C + I + X-MSince: Y = C + S We can rewrite the equilibrium condition
as: C + S = C + I +X-MS = I + X-
MS+M = I + XS = I +(X-M)
leakages = Injections
In an open economy without government the equilibrium condition says that our
savings must be enough to finance private Investment plus the trade deficit.
Rest of World
Firms
S
I
C
Total Incom
e
Total Producti
on
Total S
pending
NX
Households
Open Economy without Government
C+I+NX
45
S+M
I+X
Y Equilibrium
Y Equilibrium
AE
I+X=S+M
Leakages =
Injections
Y above equilibrium
Inventories increase
Inventories fall
Y below equilibrium
What is the equilibrium GDP?
For what value of GDP is:Y = AE?
For what value of GDP is:S = I+(X-M)?
At Y = 5,000 are inventories rising? Falling? Unchanged?For what value of GDP is:Y = AE?
At Y = 3,000 are inventories rising? Falling? Unchanged?
Real World Economy: With government and foreign sector
In such economy, total sales are sales to consumers, firms, foreigners and the government.
AE = C + I+ G + NX These four groups purchase total
production.
Condition that must be satisfied for equilibrium:
Y = C + I + G + X-MSince: Y = C + S + T (Income is
used to consume, save and pay taxes)
We can rewrite the equilibrium condition as: C + S + T= C + I + G +X-M
S = I + (G – T)+(X-M)
leakages = Injections
Rest of World
HouseholdsFirms
S
I
T
G
G
C
Total Incom
e
Total Producti
on
Total S
pending
NX
Open Economy with Government
S+T = I + G + X-MS+T+M = I + G + X
Savings must finance Investment, the government’s deficit and the
trade deficit.
C+I+G+NX
45
S+T+M
I+G+X
Y Equilibrium
Y Equilibrium
AE
I+G+X=S+T+M
Leakages =
Injections
Y above equilibrium
Inventories increase
Inventories fall
Y below equilibrium
Leakages <
Injections
Y < AE
Leakages >
Injections
Y > AE
What is the equilibrium GDP?
For what value of GDP is:Y = AE?
For what value of GDP is:S = I +(G-T) +(X-M)?
At Y = 5,000 are inventories rising? Falling? Unchanged?For what value of GDP is:Y = AE?
At Y = 3,000 are inventories rising? Falling? Unchanged?
I + (G-T) + (X-M)
Aggregate Expenditures
Match Expenditures (C+I+G+NX) with the corresponding value of output/income.
Real Income = Real GDP = YReal Income = Real GDP = Y
Ag
gre
gate
Exp
en
dit
ure
s =
AE
Ag
gre
gate
Exp
en
dit
ure
s =
AE
Building Aggregate Demand
Matches each price level with the corresponding equilibrium value of output
Aggregate DemandPrice Level
Equilibrium Output
AD
P0
Y0
Real GDP Demanded
When prices increase from P0 to P1,
The AE line shifts down
the value of wealth
decreases and consumption
decreases from C0 to C1.
and the equilibrium value of output decreases from Y0 to Y1.
Aggregate DemandPrice Level
Equilibrium Output
AD
P0
Y0
When prices increase from P0 to P1, the equilibrium value of output decreases from Y0 to Y1.
P1
Y1 Real GDP Demanded
A movement ALONG the AD line NOT a SHIFT!
When prices decrease from P0 to P2,
The value of wealth increases and consumption increases from C0 to C2.
The AE line shifts up
and the equilibrium value of output increases from Y0 to Y2.
Aggregate DemandPrice Level
Equilibrium Output
AD
P0
Y0
P2
Y2
When prices decrease from P0 to P2, the equilibrium value of output increases from Y0 to Y2.
Real GDP Demanded
A movement ALONG the AD line NOT a SHIFT!
When prices increase from P0 to P1,
Output Y1 corresponds to P1
Output Y2 corresponds to P2the value of wealth
decreases and consumption decreases from C0 to C1.The AE line shifts downand the equilibrium value of output decreases from Y0 to Y1.
When prices decrease from P0 to P2, the value of wealth increases and consumption increases from C0 to C2.The AE line shifts upand the equilibrium value of output increases from Y0 to Y2.
Building the Aggregate Demand CurveBuilding the Aggregate Demand Curve
AE 0=
C+I+G+NXAE 0=
C+I+G+NX
45
AE1=
C+I+G+NXAE1
=
C+I+G+NX
If G,I,C, NX increaseIf G,I,C, NX increase
AE line Shifts up Equilibrium Income increase
Y0 Y1
AD0
AD1
Pri
ce level
Real GDP
P0
Y0Y1
Real GDP
Aggre
gate
Expendit
ure
s
Real GDP Demanded
A shift of the AD line NOT a movement
ALONG !
A shift of the AD line NOT a movement
ALONG !
The size of the change in equilibrium Y is the size of the shift in AD
Shifts in the Aggregate Demand Line
Price Level
AD0
P0
Y0Y1
AD1
When C, I, G or NX increase the AE shifts up and the equilibrium
value of output increases: AD line
shifts right (outward).
When C, I, G or NX increase the AE shifts up and the equilibrium
value of output increases: AD line
shifts right (outward).
Real GDP Demanded
When Prices Drop…Price Level
Equilibrium Output
AD
P0
Y0
P2
Y2
When prices decrease from P0 to P2, the equilibrium value of output increases from Y0 to Y2.
Real GDP Demanded
A movement ALONG the AD line NOT a SHIFT!
AE 0= C+I+G+NX
AE 1=
C+I+G+NX
If G,I,C, NX decreaseAE line Shifts down
Equilibrium Income decrease
Y0Y1
AD0
AD1
Pri
ce level
P0
Y0Y1
Real GDP
Aggre
gate
Expendit
ure
s
Real GDP Demanded
A shift of the AD line NOT a movement
ALONG !
The size of the change in equilibrium Y is the size of the shift in AD
Shifts in the Aggregate Demand Line
Price Level
AD0
P0
Y0Y1
AD1
When C, I, G or NX decrease AE shifts down, equilibrium
output decreases, AD line shifts left (inward).
When C, I, G or NX decrease AE shifts down, equilibrium
output decreases, AD line shifts left (inward).
Real GDP Demanded
When Prices Increase…Price Level
Equilibrium Output
AD
P0
Y0
When prices increase from P0 to P1, the equilibrium value of output decreases from Y0 to Y1.
P1
Y1 Real GDP Demanded
A movement ALONG the AD line NOT a SHIFT!
Factors that shift the consumption function
1. Changes in wealth shift the consumption function. Example: value of stocks, bonds,
consumer durables.2. Changes in consumer expectations
Shift the consumption function. Example: Pessimistic expectations
decrease autonomous consumption.3. Taxes and Transfers
Tax increase or decrease in transfers: decrease disposable income and shift the consumption function down.
4. Prices Affect the purchasing power of
assets.
Shift up in AE lineShift right in AD line
OrShift down in AE lineShift left in AD line
Shift up in AE lineShift right in AD line
OrShift down in AE lineShift left in AD line
Shift AE line
Movement Along AD
line
Shift AE line
Movement Along AD
line
Determinants of Investment
Interest Rates Tax Incentives Technical Change Expectations about
the strength of demand
Political Stability and the rule of law
Shift AE line
Shift AD line
Shift AE line
Shift AD line
Government expenditures are determined by the budget process: The president, Congress and the Senate.
Shift AE line
Shift AD line
Shift AE line
Shift AD line
National Incomes GDP of other
countries Relative Prices Exchange Rates
Shift AE line
Shift AD line
Shift AE line
Shift AD line
= 7,000-6,000 =1,000
A recessionary gap occurs when actual GDP falls SHORT of
full employment GDP
A recessionary gap occurs when actual GDP falls SHORT of
full employment GDP
To increase AE, we
need an increase in C, I, G
or NX
To increase AE, we
need an increase in C, I, G
or NX
To eliminate a recessionary gap, AE
must rise.
To eliminate a recessionary gap, AE
must rise.
To Eliminate a Recessionary/Deflationary Gap
Increase Consumption by a sufficiently large price drop, a decrease in taxes or an increase in transfers.
Increase Investment tax incentives. lower interest rates
Increase Government Spending Increase Exports and reduce Imports:
make dollar weaker (increasing supply of dollars)
= 7,000-8,000 =-1,000= 7,000-8,000 =-1,000
An inflationary gap occurs
when equilibrium GDP is higher than
full employment GDP
An inflationary gap occurs
when equilibrium GDP is higher than
full employment GDP
To decrease AE, we need a
decrease in C, I, G
or NX
To decrease AE, we need a
decrease in C, I, G
or NX
To eliminate
an inflationary gap, AE must fall.
To eliminate
an inflationary gap, AE must fall.
To Eliminate an Inflationary Gap Decrease Consumption by a
sufficiently large price increase, an increase in taxes or a decrease in transfers.
Decrease Government Spending Increase interest rates to decrease
spending Decrease exports and increase
imports: stronger dollar.
1. Determine the effect on AE, AD, Equilibrium output
a)Prices Increase (decrease): in red because changes in prices do not shift the AD line!
b)NX Increase (decrease)c) Exports Increase (decrease)d)Imports Increase (decrease)e)Wealth Increase (decrease)f) Interest rates Increase (decrease)g)Technological Improvementh)Government spending Increase (decrease)i) Taxes Increase (decrease)j) Transfers Increase (decrease)
Questions to prepare for test
AE component
affected
Shift? Movement
Along?
AE Shift
sEquilibrium
Y AD
Prices Increase
C drops due to wealth effect
C shifts down
down decreases
Movement down along
Prices Decrease
C increases due to wealth effect C shifts up up increases
Movement up along
NX Increase NX increase NX shifts up up increases shifts right
NX Decrease NX decreaseNX shifts down
down decreases shifts left
Exports Increase NX increase NX shifts up up increases
shifts right
Exports Decrease NX decrease
NX shifts down
down decreases shifts left
Imports increase NX decrease
NX shifts down
down decreases shifts left
Imports Decrease NX increase NX shifts up up increases
shifts right
Wealth Increase
C increases due to wealth effect C shifts up up increases
shifts right
Wealth Decrease
C drops due to wealth effect
C shifts down
down decreases shifts left
AE component
affected
Shift? Movement
Along?
AE Shift
sEquilibriu
m Y AD
Interest rates increase Investment drops I shifts down
down decrease
shifts left
Interest rates Decrease
Investment Increases I shifts up up increase
shifts right
Technological Improvement
Investment increases I shifts up up increase
shifts right
Government Spending Increase G increases G shifts up up increase
shifts right
Government Spending Decrease G drops
G shifts down
down decrease
shifts left
Taxes Increase C drops
C shifts down
down decrease
shifts left
Taxes Decrease C increases C shifts up up increase
shifts right
Transfers Increase C increases C shifts up up increase
shifts right
Transfers Decrease C drops
C shifts down
down decrease
shifts left
3. If the economy is at equilibrium, is total spending greater, less than or equal to Output? Do Inventories fall, rise or remain unchanged? Does the economy experience a recessionary gap or an inflationary gap? If an inflationary (recessionary) gap exists, how can the gap be closed?
4. If the economy is at equilibrium, is total spending greater, less than or equal to Output? Do Inventories fall, rise or remain unchanged? Does the economy experience a recessionary gap or an inflationary gap? If an inflationary (recessionary) gap exists, how can the gap be closed?
Which AE line will cause a recessionary
gap?Which AE line will cause an Inflationary
gap?
Questions to prepare continuedLabel the two lines in the next slide.Use the information in the graph to find the following:A. Find the slope of the AE line. Recall the slope of the AE
line is the MPC.B. Find the intercept of the AE line.C. Write down the equation of the AE line.D. Find the value of AE when income is 40,000E. What is the equilibrium value of income/output in this
case?F. Find the value of AE when income is 50,000 and when
income is 25,000.G. Fill in the values for each box in the graph.Repeat the exercise with the graph in the next slide.
40,000 50,00025,000
49,000
26,500
40,000 50,00025,000
49,000
26,500
SlopeAE /Y = 22,500/25,000=0.9SlopeAE /Y = 22,500/25,000=0.9
40,000 50,00025,000
49,000
26,500
4,000
SlopeAE /Y = 22,500/25,000=0.9SlopeAE /Y = 22,500/25,000=0.9
0.9AE /Y0.9AE /Y
AE =Y*0.9AE =Y*0.9
AE =*0.9 =22,500AE =*0.9 =22,500
Y=-25,000Y=-
25,000
0
AE=26,500-22,500 =4,000AE=26,500-22,500 =4,000
AE =4,000+0.9YAE =4,000+0.9Y
40,000 50,00025,000
49,000
26,500
45 degree line
4,000
25,000
AE
40,000
50,000
Output/Income (Y)
AE
A. Find the slope of the AE line. Recall the slope of the AE line is the MPC = 0.9
B. Find the intercept of the AE line = 4,000C. Write down the equation of the AE line=
4,000+0.9YD. Find the value of AE when income is 40,000:
AE = 4,000 + 0.9*40,000 = 40,000E. What is the equilibrium value of
income/output in this case? Y = 40,000F. Find the value of AE when income is 50,000:
AE = 4,000 + 0.9*50,000 = 49,000 G. and when income is 25,000: AE = 4,000 +
0.9*25,000 = 26,500
40,000 50,00020,000
48,500
21,500
35,000 50,00020,000
48,500
21,500
45 degree line
3,500
20,000
AE
35,000
50,000
Output/Income (Y)
AE
AE1
450
AE2
Y0Y1
83
Y C I G NX 1000 1400 500 700 1001500 1850 500 700 1002000 2300 500 700 1002500 2750 500 700 1003000 3200 500 700 1003500 3650 500 700 1004000 4100 500 700 1005700 5630 500 700 100
84
Y C =800+0.9Y I G NX AE S= -800+0.1*Y1000 1700 500 700 100 3000 -7001500 2150 500 700 100 3450 -6502000 2600 500 700 100 3900 -6002500 3050 500 700 100 4350 -5503000 3500 500 700 100 4800 -5003500 3950 500 700 100 5250 -4504000 4400 500 700 100 5700 -4005700 5930 500 700 100 7230 -230
Output Consumption Investment Net Exports
1000 800 500 100
1500 1200 500 100
2000 1600 500 100
2500 2000 500 100
3000 2400 500 100
3500 2800 500 100
4000 3200 500 100
Write the AE equation: Write the AE equation: 600 + 0.8 Y
2. Use the table in the next slide to answer the following:
a)Calculate the MPC and the intercept.b)Write the consumption function: C = intercept (a)
+ slope (MPC)* Y c) Calculate Aggregate Expenditures (add a Col. to
the table for AE).d)Find the equilibrium value of output. e) If output is 4000 calculate the change in
inventories. Given your answer for the change in inventories, how would firms react to this change in inventories?
f) If investment increase from 500 to 800 (a 300 increase in investment). Recalculate the entire table and find the new equilibrium value of output.
g)If autonomous consumption (the intercept) increases by 300 what is the new equilibrium value of output?
Output Consumption
Investment Net Exports
1000 800 500 100
1500 1200 500 100
2000 1600 500 100
2500 2000 500 100
3000 2400 500 100
3500 2800 500 100
4000 3200 500 100
88
Output
C = 0.8YInvestme
nt Net
Exports AE
Change in
Inventories
Firms will S=
0.2*Y
1000 800 500 100140
0-400
Increase Y
200
1500 1200 500 100180
0-300
Increase Y
300
2000 1600 500 100220
0-200
Increase Y
400
2500 2000 500 100260
0-100
Increase Y
500
3000 2400 500 100300
00
No change
600
3500 2800 500 100340
0100
Decrease Y
700
4000 3200 500 100380
0200
Decrease Y
800
Equilibrium
89
Output C = 300+0.8Y Investment Net
Exports AE
Change in Inventories
Firms will
1000 1100 500 100 1700 -700 Increase Y
1500 1500 500 100 2100 -600 Increase Y
2000 1900 500 100 2500 -500 Increase Y
2500 2300 500 100 2900 -400 Increase Y
3000 2700 500 100 3300 -300 Increase Y
3500 3100 500 100 3700 -200 Increase Y
4000 3500 500 100 4100 -100 Increase Y
4500 3900 500 100 4500 0 No change
5000 4300 500 100 4900 100 Decrease Y
5500 4700 500 100 5300 200 Decrease Y
New equilibrium
Output C = 0.8YInvestmen
t Net
Exports AE
Change in
Inventories
Firms will
1000 800 800 100 1700 -700Increase
Y
1500 1200 800 100 2100 -600Increase
Y
2000 1600 800 100 2500 -500Increase
Y
2500 2000 800 100 2900 -400Increase
Y
3000 2400 800 100 3300 -300Increase
Y
3500 2800 800 100 3700 -200Increase
Y
4000 3200 800 100 4100 -100Increase
Y
4500 3600 800 100 4500 0No
change
5000 4000 800 100 4900 100Decrease
Y
5500 4400 800 100 5300 200Decrease
Y
New equilibrium
Aggregate Expenditures
Actual Sales100
PlannedInventories
20
Total Productio
n
Net Exports
Consumption
GovernmentSpending
Planned
Investment
Inventories do not change…
Production100
PlannedInventories
20
ActualInventories
20 Total Production = 100
Firms do not change productionTHE ECONOMY IS IN EQUILIBRIUM
=
Firms end only with WANTED inventories: their actual Investment and their planned Investment are the same.
Firms will not change their production levels.
Inventories are “too high”
Production100
PlannedInventories
20
PlannedInventories
20
UnplannedInventories 40
Total Production = 100
Firms react by reducing production
Actual Inventories
=60
If firms’ inventories pile up unsold, their actual investment is greater than their planned Investment.
Firms will decrease production to adjust their inventories to the desired level.
Inventories are “too low”
Production100
WantedInventories
20
Total Production = 100
Firms react by increasing production
Firms sell part of their inventories, their actual investment is lower than their planned Investment.
Firms will increase their production levels to adjust their inventories to the desired level.