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THE AGGREGATE EXPENDITURES MODEL, CHAPTER 31, UNIT 5 (clockwise format), .…

- - - - https://www.minneapolisfed.org/article/2016/are-prices-sticky-and-does-it-matter
      - The Aggregate Expenditures Model is more of a stuck-price model because the price level is fixed.
        
        Popular macroeconomic theories at the time had predicted that prices would fall to the point where quantity supplied = quantity demanded.
        
        Instead, prices did not decrease enough during the Great Depression to boost spending and maintain output and employment at their pre-Depression levels.
        
        Because prices did not reduce sufficiently enough, thousands of factories in the U.S. were idle, due to a lack of demand.
      - The Aggregate Expenditures Model is an extreme version of a sticky price model, which occurs where "some sellers set prices in nominal terms that do not adjust quickly in response to changes in the aggregate price level or to changes in economic conditions more generally".
  - - - Households and businesses unexpectedly reduced their spending, which caused a huge increase in inventory of unsold goods.
      - Firms could not sell output fast enough because firms were either unable or unwilling to drop prices. Thus, inventories continued to pile up.
      - Because inventory levels were extremely high, firms significantly reduced production, some firms even having to shut-down production until inventory levels dropped.
      - Due to this reduced production, there were many idle factories/shut-down factories.
      - The conditions above meant that the market needed to once again reach its equilibrium level, which brought about ANOTHER KEY ASSUMPTION (which allows the market to reach equilibrium), namely, that PRODUCTION DECISIONS ARE MADE IN RESPONSE TO UNEXPECTED CHANGES IN INVENTORY LEVELS.
        
        If inventories are unexpectedly high (because sales decrease), firms will reduce production to balance production with sales and prevent inventory levels from exceeding storage capacity.
        
        If inventories are unexpectedly low (because sales exceed production), then firms will increase production in order to take advantage of the surprisingly good selling environment.
- - - - Please refer to VISUAL 1 to the left for graphical representation (click on the link once, then a second time, without editing).
        
        https://live.staticflickr.com/65535/52373624341_57b53b9c68_z.jpg
        
        In Graph (b), the investment schedule (I(g)) shows the amount of investment as determined in Graph (a), at various levels of GDP. The amount of investment of $20 billion is the same at all levels of GDP.
        
        In Graph (a), The level of investment spending of $20 billion is determined by the real interest rate of 8% together with the investment demand curve (ID). Firms will spend $20 billion on investment goods at both low and high levels of GDP - this is shown in the investment schedule, Graph (b).
- - - - Please refer to the graph in Visual 3
        
        At any point on the 45 degree line (Visual 3 graph), the value of what is measured on the horizontal access (GDP) equals the value of what is measured on the vertical axis (aggregate expenditures).
        
        The equilibrium level of domestic output occurs where C + I(g) = GDP, thus, the 45 degree line is a graphical representation of that equilibrium.
        
        The aggregate expenditures schedule, C + I(g), is determined by adding the investment schedule, I(g) (constant $20 billion)
        ,vertically to the upsloping consumption schedule, C.
        It is assumed that investment is the same at each level of GDP. Thus, the vertical distance between C and C + I(g) does not change.
        Equilibrium GDP is determined where the aggregate expenditures schedule intersects the 45 degree line, at $470 billion dollars.
        
        The aggregate expenditures line shows that total spending rises with income and output (GDP), but not a much as income rises. Why?
        Because the the marginal propensity to consume (MPC) (slope of line C) is less than 1. A part of any increase in income will be saved rather than spent. And because the aggregate expenditures line is parallel to the consumption line, the slop of the aggregate expenditures line is also equal to the MPC for the economy and is less that 1.
        Aggregate expenditures rise by $15 billion for every $20 billion increase in real output and income, because $5 billion of each $20 billion increment is saved. Thus, the slop of the aggregate expenditures line is $15/$20 =0.75 < 1
        
        No levels of GDP above equilibrium are sustainable because at those levels, aggregate spending does not cover GDP. Here, the aggregate expenditures schedule lies below the 45 degree line. The underspending causes inventories to rise. Firms will need to adjust downward, toward the equilibrium output level of $470 billion.
        
        At levels of GDP below equilibrium, the economy spends in excess of what is being produced by firms. Here, aggregate consumption exceeds total output. The aggregate expenditures schedule lies above the 45 degree line. This overspending causes inventories to fall below their planned level. Firms will adjust production upward, toward the $470 billion output.
        
        Once the equilibrium level has been achieved, it will be sustained there indefinitely unless there is some change in the location of the aggregate expenditure lines.
  - - - Spending always exceeds GDP.
      - Example: In the table (Visual 2) - Firms produce $410 billion GDP (row 3), which yields $405 billion in consumer spending (C), and $20 billion planned investment spending (I(g)). Aggregate spending (C + I(g)) = $425 billion. Thus, C + I(g) > GDP
        
        Refer to the table in Visual 2, click on the link to the left once, then a second time (without editing)
        
        https://live.staticflickr.com/65535/52375890758_24660e284b_z.jpg
      - If the situation continues: Purchases occur faster in relation to production, causing unplanned decline in inventories of (GDP - aggregate spending = $15 billion)
      - But firms can adjust to this disequilibrium, by increasing production. Greater output will increase employment and total income. This process will continue until GDP reaches its equilibrium level ($470 billion)
    - - Refer to the table in Visual 2 (to the left and upward), click on the link once, then a second time (without editing)
      - GDP > $470 billion equilibrium: Production levels exceed aggregate spending, keeping more inventory on site.
      - As the firm is now unable to recover their costs, it must reduce production levels.
      - For example: At $510 billion output, consumption spending is $480 billion, and planned investment spending is $20 billion. Thus, aggregate spending is (480 + 20 = $500 billion), which is still less than the $510 billion GDP.
      - If this disequilibrium continues, $10 billion (510 - 500) worth of unplanned inventory would pile up. The firm can adjust to this by reducing production levels. The decline in output will cause fewer jobs and decreased total income.
- - - - In the table in Visual 2, saving and planned investment are both $20 billion at the equilibrium level.
      - Saving is a leakage (or withdrawal) of spending money from the economy's circular flow of income and expenditures.
      - Saving causes consumption to be less than total output. Because of saving, consumption by itself is not sufficient to cover production costs. Thus, there will be a decline in total output.
      - Firms will not sell all their output to consumers. A portion of that output will be capital goods sold to other businesses.
        Investment - purchases of capital goods - is therefore an injection of spending into the income-expenditures stream.
        Investment is a potential replacement for the leaking savings (consumption).
        
        If the leakage of saving > injection of investment, then C + I(g) < GDP and that level of GDP cannot be sustained. Any GDP for which saving > investment - is an above-equilibrium GDP.
        
        In row 8 (Visual 2) there is GDP of $510 billion. Households save &30 billion and firms only plan to invest $20 billion. This $10 billion excess of saving over planned investment reduces total spending to $10 billion below the value of total output. Aggregate expenditures will be $500 billion, but GDP is $510 million. This spending deficiency reduces real GDP.
        
        The reverse is true if the injection exceeds the leakage. Then C + I(g) > GDP and drives GDP upward. Any GDP where investments exceeds saving is a below-equilibrium GDP.
        
        The large injection of investment spending more than compensates for the small leakage of savings at this relatively low GDP level.
        Only where saving (S) = I(g) - where the leakage of saving of $20 billion is exactly offset by the planned investment of $20 billion - will aggregate expenditures be equal to real output. C + I(g) =GDP defines the equilibrium GDP.
    - - Firms may decide to alter inventory levels as part of their investment plans, but there are no unplanned changes in inventories at equilibrium GDP. This is a trait of GDP equilibrium.
      - The following are the characteristics of GDP equilibrium: C + I(g) = GDP; S = I(g); and there are no unplanned changes in inventories at equilibrium.
      - But unplanned inventory changes do play a major role in achieving equilibrium GDP, as shown previously. Inventory changes are a part of investment, so we must be aware of the difference between planned investment and actual investment. Actual investment = planned investment + increase/decrease in inventories. The increase/decrease in inventories is caused by consumers saving instead of purchasing. Actual investment = the saving.