The Aggregate Expenditures Model (Assumptions and Simplifications of The…
The Aggregate Expenditures Model
Assumptions and Simplifications of The Aggregate Expenditures Model
Most fundamental: prices in the economy are fixed
This is as a result of the Great Depression
The aggregate expenditures model therefore can help us understand how the modern economy is likely to initially adjust to various economic shocks over shorter periods of time.
It also illuminates the thinking underlying the stimulus programs (tax cuts, government spending increases) enacted by the government during the recession.
Aggregate Expenditures, Equilibrium GDP in a Private and Closed economy
One without international trade or government
Consumption and Investment Schedules
Consumption = C
Investment = Ig
To add the investment decisions of businesses to the consumption plans of households, we need to construct an investment schedule showing the amounts business firms collectively intend to invest—their planned investment—at each possible level of GDP
Investment demand curve - interest rate
Investment schedule - shows the amount of investment forthcoming at each level of GDP
C + Ig = GDP
We look at it in tabular form and there are different aspects to it
Real domestic output
We can also look at it in graphical form
This shows us that no levels of GDP above the equilibrium level are sustainable because at those levels C + Ig falls short of GDP
Other features of Equilibrium GDP
Saving and planned investment are equal (S = Ig).
There are no unplanned changes in inventories.
Savings Equals Planned Investment
Saving is a leakage or withdrawal of spending from the economy’s circular flow of income and expenditures. Saving is what causes consumption to be less than total output or GDP.
Investment—the purchases of capital goods—is therefore an injection of spending into the income-expenditures stream. As an adjunct to consumption, investment is thus a potential replacement for the leakage of saving.
No Unplanned Changes in Inventory