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UNIT 5
The aggregate Expenditures Model
(Closed Economy), **GDP vs C +…
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**GDP vs C + Ig
DIS-EQUILIBRIUM
Economy CANNOT sustain
GDP < equilibrium
--> unplanned decline in inventories
--> step up in production (increase output)
--> increase employment
--> increase in total income
Economy CANNOT sustain
GDP > equilibrium
--> inventories pile up
--> cut back on production (decrease output)
--> decrease in employment
--> decrease in total income
EQUILIBRIUM
Economy CAN sustain
Production output creates total spending just sufficient to purchase that output
No over-production
No excess in spending
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Real GDP vs Aggregate Expenditure
x: Real GDP
y: Aggregate Expenditures
Real GDP vs Aggregate Expenditure
x = Real GDP
y = Aggregate ExpendituresAbove equilibrium --> C + Ig is LESS than real GDP
Below Equilibrium --> C + Ig is GREATER than Real GDP
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Applicable even today as many prices are inflexible downwards in the short-run
Model enables prediction of modern economy response to economic shocks
The investment demand curve and the real interest rate together determine the amount of investment spending
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Real Domestic Output
Firms are willing to produce at any of the levels provided in the AEM as long as revenue exceeds cost