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Unit 5 The Aggregate Expenditures Model - Coggle Diagram
Unit 5
The Aggregate Expenditures Model
Formulated by John Keynes, during the Great Depression
The model states that the
amount of goods and services produced
in an economy and
level of employment
depends directly
on
total spending
.
Businesses ONLY produce a level of output that they are certain will be able to sell for a profit.
Explains how modern economies adjust to economic shock.
Is used to provide insights into current economic conditions.
Government is ignored = closed economy
The most important assumption underpinning this model is that
prices are fixed
. The price level cannot change at all.
This assumption was made, because Keynes noticed that
prices did not decline fast enough
, during the Great Depression, to boost
spending
and maintain
output and employment.
Prices did not fall, and so employment rate was sky-high and factories could not produce, because there was an
insufficient demand
for their output.
The massive unemployment rate and loss of capital was due to producers reacting in a
predictable
way to unplanned increases in production levels.
Key assumption of the Model
: Production decisions are made in response to unexpected changes in inventory levels.
If inventories rise = firms will cut back on production. If inventories are falling = firms increase production.
Two components of the Aggregate Expenditures Module
Consumption
Investment
Investment demand Schedule
: Shows the amount businesses intend to invest at each level of GDP.
Shows the relationship between Investments and the real GDP.
If Investments
increase
, we expect GDP to
increase
too.
Investment Demand Curve
shows the relationship between the interest rate and investment.
It is a
negative relationship
(downward sloping)
As the interest rate
decreases
,
borrowing becomes cheaper
and
demand for interest increases
.
Equilibrium GDP
: C + Ig = GDP
In the
private closed economy
of aggregate expenditures consist of
consumption + investment
Expenditures schedule
shows the amount (C + Ig) that will be spent at each possible level of output/ income.
The Aggregates Expenditure Schedule is determined by
adding the investment schedule
to the
upsloping consumption schedule
.
Investment is assumed to be the same at each level of GDP, so the vertical distances between consumption and and C + Ig
do not change.
Equilibrium Output
= output whose production creates total spending just sufficient enough to purchase that output. (Where
total quantity of goods produced
EQUALS the total
quantity of goods purchased
.
C + Ig = GDP
If levels of GDP are
below equilibrium
, production of goods will expand/ increase.
If levels of GDP are
above equilibrium
, production will be cut back/ slowed down.
No other level except for
level of equilibrium
can be sustained by a firm.
Other features of Equilibrium GDP
Saving equals
planned investment
Saving is a leakage of spending
Investment is an injection of spending.
No
unplanned
changes in
inventory
Firms DO NOT change production.