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The Aggregate Expenditure Model (Closed Economy) (Notes (@ GDP Below…
The Aggregate Expenditure Model
(Closed Economy)
Graphs
Investment demand curve
Negative relationship
As interest rates decrease
borrowing becomes cheaper
and demand for investment increases
Relationship between interest
rates and investments
Investment schedule
Investment at any level in
Investment demand curve transmits
to various levels of GDP
If investment increases over time
GDP is expected to increase over time
Relationship between investment
and real GDP
Assumptions &
Simplifications
Private closed economy
Government ignored
Consumption and
Investment spending
International trade excluded
GDP = DI
Prices are fixed
Use Keynesian Aggregate
expenditure model
How modern economies respond to shock
Used today: Insight into
current economic conditions
Calculations
GDP = DI
Aggregate Expenditure = C + Ig
Notes
Investment id independent of income
and is planned or intended regardless
of the current income situation.
@ GDP Below Equilibrium GDP
Excess demand by declining inventories
Production will be expanded at any level - Less inventory than what was planned (selling more than expected)
Aggregate expenditure > GDP
@ GDP Above Equilibrium GDP
Decreased demand by excess inventories
Production will be cut back - Unplanned
inventory investment on top of what was planned
Aggregate expenditure < GDP
Equilibrium GDP
Only sustainable level of GDP
Where GDP = Aggregate Expenditure
Other features
Savings = Planned Investment
Savings is a leakage of spending
(Causes consumption < GDP)
Investment is an injection of spending
No unplanned changes
in inventories
Firms do not change production
GDP = NI = PI = DI = Household Income