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UNIT 5: THE AGGREGATE EXPENDITURES MODEL - CLOSED ECONOMY (Chapter 31) -…
UNIT 5: THE AGGREGATE EXPENDITURES MODEL - CLOSED ECONOMY (Chapter 31)
ASSUMPTIONS & SIMPLIFICATIONS
Planned investment, investment schedule showing the amounts business firms collectively intend to invest at each possible level of GDP
Assume that planned investment is independent of the level of current disposable income or real output.
Consumption schedule, the consumption plans of households
2 components of aggregate expenditure in a closed economy
Consumption (C)
Gross investment (Ig)
GDP = DI (disposable income)
GDP = NI (national income)
GDP = PI (personal income)
in a closed economy
Prices are fixed, the price level cannot be changed at all
Private closed economy
Consists of households and businesses
Ignore government and international trade
All savings are personal savings
Private open economy
Includes exports and imports
Mixed economy
Includes government sector ( influenced by gov expenditures and taxes)
Aggregate expenditure model (aka Keynesian cross model), the the amount of goods & services produced and the level of employment depend directly on the level of aggregate expenditures (total spending). businesses will produce only a level of output that they think they can profitably sell.
Provide insight into current economic conditions
INVESTMENT DEMAND & INVESTMENT SCHEDULE
Consumption & Investment
Investment demand curve
Investment schedule
INVESTMENT DEMAND CURVE
x axis - investment
y axis - real interest rates
negative relationship
as interest rates decrease, borrowing becomes cheaper and the demand for investment increases
shows the level of investment spending
INVESTMENT SCHEDULE
x axis - real domestic product (GDP)
y axis - investment
the amount of investment forthcoming at each level pf GDP (the interest rate and investment demand curve together determine this amount)
if investment over time increases we expect GDP to increase over time as well
EQUILIBRIUM GDP
Total output level that the economy is capable of sustaining
the output whose production creates total spending just sufficient to purchase that output
therefore where the total quantity of goods produced (GDP) = the quantity of goods purchased ( C + Ig)
GDP = C + Ig (equilibrium GDP level)
Consumption level is directly related to level of income and income = level of output
Investment is independent of income and is planned/ intended regardless of the current income situation
equilibrium GDP is the level of output whose production will create total spending just sufficient enough to purchase at a specific level of output
Graphically - the point where aggregate expenditure schedule intersects the 45' line.
C + Ig has a constant slope and = MPC
C and C + Ig are parallel to each other because investment is assumed to be the same at each level of GDP
NO UNPLANNED CHANGES IN INVENTORY
firms do not change production
as part of their investment plans, firms may decide to increase/ decrease their inventories - but at equilibrium there are no unplanned changes in inventories
S = Ig
Savings = planned investment
Savings is a leakage/ withdrawal of spending from the economy's flow of income and expenditures (causes C to be less than GDP)
Investments is an injection of spending (purchases of capital goods)
GDP = C + Ig
Actual investment = planned investment (Ig) + unplanned increase/ decrease in inventories
Actual investment = savings (S)
Unplanned increase/ decrease in inventories acts as a balancing item
AGGREGATE EXPENDITURE
In a closed economy aggregate expenditure = consumption (C) + investment (Ig)
Makes up the aggregate expenditures schedule for a private closed economy
Shows the amount (C + Ig) that will be spent at each possible output or income level.
Ig - planned investment - the amount that firms plan/ intend to invest, not the amounts they actually will invest if there are unplanned changes in inventories.
REAL DOMESTIC OUTPUT (&INCOME) (GDP=DI)
Levels of total output (of real GDP) in a private sector
Firms will produce at any level of output as long as revenue is = or > than the cost of production (costs include payments to obtain land, labour, capital & entrepreneurship)
Eg. firms willing to produce $370b of output if costs of production (wages, rent, interest & normal profits) do not exceed $370b in revenue they will get from selling the output
