28 The Aggregate Expenditures Model Mc Graw-Hill Irwin Copyright

28 The Aggregate Expenditures Model Mc. Graw-Hill/Irwin Copyright © 2012 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Assumptions and Simplifications • Use the Keynesian aggregate • • • LO 1 expenditures model Prices are fixed GDP = DI Begin with private, closed economy • Consumption spending • Investment spending 28 -2

Equilibrium GDP (C + Ig = GDP) Equilibrium point Aggregate expenditures C + Ig C Ig = $20 billion C = $450 billion LO 1 28 -3

Other Features of Equilibrium GDP • Saving equals planned investment • Saving is a leakage of spending • Investment is an injection of • LO 2 spending No unplanned changes in inventories • Firms do not change production 28 -4

Changes in Equilibrium GDP (C + Ig)1 (C + Ig)0 (C + Ig)2 Increase in investment Decrease in investment LO 3 28 -5

Adding International Trade • Include net exports spending in • • • LO 4 aggregate expenditures • Private, open economy Exports create production, employment, and income Subtract spending on imports Xn can be positive or negative 28 -6

Net Exports and Equilibrium GDP C + Ig+Xn 1 C + Ig+Xn 2 Aggregate expenditures with positive net exports Aggregate expenditures with negative net exports Positive net exports 450 470 Negative net exports LO 4 Xn 1 490 Xn 2 28 -7

International Economic Linkages • Prosperity abroad • Can increase U. S. exports • Exchange rates • Depreciate the dollar to increase • LO 4 exports A caution on tariffs and devaluations • Other countries may retaliate • Lower GDP for all 28 -8

Adding the Public Sector • Government purchases and • LO 4 equilibrium GDP • Government spending is subject to the multiplier Taxation and equilibrium GDP • Lump sum tax • Taxes are subject to the multiplier • DI = GDP 28 -9

Government Purchases and Eq. GDP C + Ig + Xn + G C + Ig + Xn C Government spending of $20 billion LO 4 28 -10

Aggregate expenditures (billions of dollars) Taxation and Equilibrium GDP C + Ig + Xn + G Ca + I g + X n + G $15 billion decrease in consumption from a $20 billion increase in taxes 45° 490 550 Real domestic product, GDP (billions of dollars) LO 4 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 T LO 5 28 -12

Aggregate expenditures (billions of dollars) Equilibrium versus Full-Employment AE 0 AE 1 530 Recessionary expenditure gap = $5 billion 510 490 Full employment 45° 490 510 530 Real GDP (a) Recessionary expenditure gap LO 5 28 -13

Equilibrium versus Full-Employment AE 2 Inflationary expenditure gap = $5 billion AE 0 Full employment LO 5 28 -14