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Aggregate expenditure model - Coggle Diagram
Aggregate expenditure model
Assumptions and Simplifications
Stuck price model
Most important assumption = prices are fixed
Aggregate expenditure model is a stuck-price model in which the amount of real output depends directly on the amount of total spending in the economy
Simplifying assumption
observed prices had not declined sufficiently during the Great Depression to boost spending and maintain output and employment at pre-Depression levels
Unplanned inventory adjustments
Great depressions unemployment of labor and capital caused firms reacting in predictable way to unplanned increase in inventory levels
production decisions are made in response to unexpected change in inventory levels
Inventories unexpectedly rising firms will cut back on production to balance production with sales and prevent inventory levels from exceeding warehouse levels
Inventories unexpectedly falling firms will increase production take advantage of unexpectedly good selling environment
Firms decide how much real output to produce in response to unexpected changes in inventory levels
Consumption and Investment
Investment schedule
Ig
Shows the amount of investment forthcoming at each level of GDP
Investment demand curve
ID
shows how much investment firms plan to make at each interest rate
Planned investment - amount that firms plan or intend to invest
Equilibrium GDP
C +Ig = GDP
Private closed economy, equilibrium GDP occurs where aggregate expenditures equal real domestic outcome
The equilibrium occurs where aggregate expenditure is equal to national income
this occurs where the aggregate expenditure schedule crosses the 45-degree line
The equilibrium in the diagram occurs where the aggregate expenditure line crosses the 45-degree line, which represents the set of points where aggregate expenditure in the economy is equal to output, or national income
Equilibrium in a Keynesian cross diagram can happen at potential GDP—or below or above that level.
S = Ig
At equilibrium GDP savings equals planned investment and unplanned changes in inventories are zero
Other features of equilibrium
Saving = planned investment
Actual investment consists of planned investment plus unplanned changes in inventories (+ or -) and is always equal to saving in a private closed economy
Through multiplier effect, an initial change in investment spending can cause a magnified change in domestic output and income
No unplanned changes in inventories
