The Aggregate Expenditures Model (PRIVATE CLOSED ECONOMY) and OPEN ECONOMY…
The Aggregate Expenditures Model
(PRIVATE CLOSED ECONOMY) and OPEN ECONOMY
Prices in the economy are fixed
Real GDP equals disposable income (DI)
Presence of excess production capacity and unemployed labor implies that an increase in aggregate expenditures will increase real output and employment without raising the price level.
Consumption & Investment Schedules
In the private closed economy, the two components of aggregate expenditures are
consumption, C, and gross investment, Ig
investment demand curve
together determine the level of investment spending
shows the amount of investment forthcoming at each level of GDP.
The amount that firms plan or intend to invest.
The equilibrium output is that output whose production creates total spending just sufficient to purchase that output
equilibrium GDP :
Consumption + Investment = GDP
There is no
which would result in stack up of unsold goods and reduction in the production rate.
There is no an
surplus of total spending
, which would reduce inventories of goods and cause increases in the rate of production.
No level of GDP other than the equilibrium level of GDP can be sustained
Real Domestic Output
is measure of the value of economic output adjusted for price changes.
Spending always exceeds GDP at levels where GDP is less than equilibrium,
C + Ig exceeds total output
Buyers would be taking goods off the shelves faster than firms could produce them
An unplanned decline in business inventories
Need to increase production into order to reach equilibrium GDP
GDP always exceeds spending at levels where GDP is above equilibrium,
C + Ig falls short of GDP
The total outputs fail to generate the spending needed to clear the shelves of goods
Need for cutting back the production rate inorder to go back at equilibrium
- consist of Consumption, C + Investment, lg
Other Features of Equilibrium GDP
Saving Equals Planned Investment
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.
—the purchases of capital goods—is an
of spending into the income-expenditures stream
It is an addition to consumption
is the withdrawal of potential spending from the income-expenditure stream via savings, tax, payment or import.
is an addition of spending into the income-expenditure stream.
Any GDP for which saving exceeds investment is an above-equilibrium GDP.
Any GDP for which investment exceeds saving is a below-equilibrium GDP.
No Unplanned Changes in Inventories
There are no unplanned changes in inventories at equilibrium GDP.
it is equal to zero
Changes in Equilibrium GDP and the Multiplier
In a private closed economy, the equilibrium GDP will change in response to changes in either the investment schedule or the consumption schedule
If the expected rate of return on investment rises or that the real interest rate falls the investment spending increases
Multiplier = change in real GDP÷ initial change spending
the size of the multiplier depends on the size of the MPS in the economy:
multiplier =1/ Marginal Propensity to Save
The extent of the changes in equilibrium GDP will depend on the size of the multiplier
Investment spending will decline if the expected rate of return on investment decreases or if the real interest rate rises.
Adding the Public Sector
Government Purchases and Equilibrium GDP
The aggregate expenditures schedule shift upwards and produce a higher equilibrium GDP when there is an increases in public spending
When we add government purchases to private spending a new higher level of aggregate expenditures is produced
When government purchases decline,it will lower the aggregate expenditures schedule and this result in a multiplied decline in the equilibrium GDP
The final step in constructing the full aggregate expenditures model is to move the analysis from a private (no-government) open economy to an economy with a public sector
Taxation and Equilibrium GDP
The government not only spends but also collects taxes
The tax lowers both consumption and saving because households use disposable income both to consume and to save,
The MPC and MPS tell us how much consumption and saving will decline as a result of the taxes
We calculate aggregate expenditures again inorder to find the effect of taxes on equilibrium GDP,
Economy’s output is in equilibrium when total spending equals total production
In the open mixed economy, equilibrium GDP occurs where
Ca + Ig + Xn + G = GDP
Equilibrium versus Full-Employment GDP
A key point about the equilibrium GDP of the aggregate expenditures model is that it need not equal the economy’s full-employment GDP
Recessionary Expenditure Gap
Is the amount by which aggregate expenditures at the full-employment GDP fall short of those required to achieve the full-employment GDP.
Insufficient total spending contracts or depresses the economy
Inflationary Expenditure Gap
Is the amount by which an economy’s aggregate expenditures at the full-employment GDP exceed those just necessary to achieve the full-employment level of GDP
The inflationary expenditure gap is the amount by which the aggregate expenditures schedule would have to shift downward to realize equilibrium at the full-employment GDP.
It is shown by the vertical distance between the
actual aggregate expenditures
schedule and the
that would be just sufficient to achieve the full-employment GDP
Adding International Trade
Net Exports and Aggregate Expenditures
Conversely, when an economy is open to international trade, it will spend part of its income on imports—goods and services produced abroad
For an open economy, aggregate expenditures are
C + Ig + (X − M)
The Net Export Schedule
A net export schedule lists the amount of net exports that will occur at each level of GDP.
.i.e. netexport = Exports (X)-Imports(M)
Net Exports and Equilibrium GDP
positive net exports
In general, other things equal, positive net exports increase aggregate expenditures and GDP beyond what they would be in a closed economy.
Negative Net Exports
In general other things equal, negative net exports reduce aggregate expenditures and GDP below what they would be in a closed economy.