Unit 5: The Aggregate Expenditures Model
The British economist, John Maynard Keynes created this model in the 1936 writings. He created it during the Great Depression. The basic premise for this model was that "the amount of goods and services produced and the level of employment depend directly on the level of aggregate expenditures(total spending)." and that a business will manipulate the workers and machinery to make sure it reaches the level of output that they think they can profitably sell.
Assumptions were made:
Prices are fixed; The "Stuck-Price" Model(prices cannot change), because prices didn't decline sufficiently during the Great Depression to boost spending and maintain output & employment at the pre-Depression levels
Economy sank far below its potential output.
US real GDP declined by 27% from 1929 - 1933
Unemployment rate + to 25%
Insufficient demand of output - factories produced nothing.
Firms reacted in a predictable way to the unplanned increases in inventory levels -> caused massive unemployment of labor and capital. Inventory = produced goods but not sold.
Reduced spending of households & businesses -> inventories of unsold goods surged unexpectedly. Inventories piled up because firms were unwilling or unable to lower their prices. Having them to reduce production rates even closing factories.
Achieving equilibrium, production decisions are made in response to unexpected changes in inventory levels.
Unexpected rise in inventories -> cut back on production
Unexpected fall in inventories -> increase production
Preview: different stages
Equilibrium GDP for a private closed economy: C + Ig = GDP
Private open economy(includes international trade with exports/imports
"Mixed" economy(includes government)
Private closed economy(without international trade and government)
Gross Domestic Product(GDP) = Disposable Income(DI)
2 components: Consumption(C) & Gross Investment(Ig)
Investment schedule(Ig) -> Shows amount of investment forthcoming at each level of GDP. Constructed by business investment decisions with the amount firms intend to invest(planned investment) & consumption plans of households
Investment demand curve(ID) -> shows how much investment firms plan to make at each interest rate. ID and the interest rate determine investment schedule(-)
Firms will produce at the level of output where the revenue equals or exceeds the costs, so where the total quantity of goods produced(GDP) = the total quantity of goods purchased(C + Ig). GDP = C + Ig
No level of GDP other than the equilibrium GDP can be sustained. If GDP = less than equilibrium the spending exceeds so they will have to boost production. If the GDP = greater than equilibrium they will have to slow down on production, inventories will pile up.