Unit 5: The Aggregate Expenditures Model - Coggle Diagram
Unit 5: The Aggregate Expenditures
Formulated by John Maynard Keynes during The Great Depression.
Like a "stuck price" model
The most important assumption is that Prices are fixed.
The real output depends directly on the amount of total spending in the economy
The unplanned Inventory Adjustments
To Keynes the Great Depression's massive unemployment of labor and capital was caused by firms reacting in a predictable way to unplanned increases in Inventory levels.
If total spending is unexpectedly low in the economy, inventories will unexpectedly rise which causes firms to cut back on the production. If the total spending is unexpectedly high, the inventories will unexpectedly fall causing firms to increase production.
Relevant to modern economy, because many prices are inflexible downward over relatively short periods of time.That is why this model helps us to understand how the modern economy is likely to adjust to economics shocks over shorter periods of time.
Private Closed Economy
The two components are Consumption, C, and gross investment, Ig.
Investment Schedule: The investment decisions of businesses to the consumption plans of households must be added and we need to construct an investment schedule showing the amounts businesses collectively intend to invest, which is called Planned investment, at each possible level of GDP.
Equilibrium GDP: C + I g = GDP
Saving equals planned investment and is a leakage of spending because it is a removal from the flow of aggregate consumption.
Planned Investment is called an injection, because it is an addition to the flow of aggregate spending.
No unplanned changes in inventories
Firms do not change production
Disequilibrium: No level of GDP other than the equilibrium level of GDP can be sustained. GDP levels LESS than equilibrium the spending always exceeds GDP. If GDP is greater than equilibrium businesses will find that these total outputs fail to generate the spending to to clear the shelves of goods and being unable to recover their costs, businesses will cut back on production.
Investment Demand curve: The level of investment spending is determined by the real interest rate. The curve, in other words, will represent how much firms plan to make at each interest rate.
Households and businesses only, not international trade and government.
(GDP = DI)