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THE AGGREGATE EXPENDITURES MODEL - Coggle Diagram
THE AGGREGATE EXPENDITURES MODEL
Origin
Created by Keynes in the middle of the Great Depression to explain why it had happened and how it might be ended.
Originated in the 1936 writings of the British Economist John Maynard Keynes.
The amount of goods & services produced and the level of employment depend directly on the level of aggregate expenditures.
"Stuck Price Model"
the most important assumption is that prices are fixed. Keynes observed prices did not decline enough during the GD to boost spending and maintain output & employment at their pre-Depression levels.
Unplanned Inventory Adjustments
Massive unemployment of labor & capital was caused by firms reacting in a predictable way to unplanned increases in inventory levels.
Great Depression Impact
Inventories continued piling up as firms would not sell output fast enough. Households & businesses reduced their spending. Reduced production caused discharged workers, idle factory lines and an overall stand still.
Another key assumption: production decisions are made in response to unexpected changes in inventory levels, which allows for equilibrium.
If total spending is unexpectedly low in the economy, inventories will unexpectedly rise, causing firms to cut back on production. If total spending is high, inventories will unexpectedly fall, causing firms to increase production.
A few basic concepts
GDP= Disposable Income
Private closed economy- lacks both international trade and government
The presence of excess production capacity and unemployed labor implies that an increase in aggregate expenditures increase output & employment without raising prices.
Consumption schedule= consumption plans of households VS Investment schedule= investment plans of businesses.
Because aggregate expenditures line C + Ig is parallel to consumption line C, the slope of the aggregate expenditures line also equals the MPC for the economy and is less than 1.
In the private closed economy aggregate expenditures= consumption + investment.
Current Relevance
helps us understand how present economy would adjust to various economic shocks in the short-run.
Consumption and Investment Schedule
in a private closed economy two components of aggregate expenditures are consumption C and gross investment Ig.
investment schedule= amounts business firms collectively intend to invest at each possible level of GDP
Investment Schedule(Ig) VS Investment Demand Curve (ID)
Ig shows the amount of investment forthcoming at each level of GDP. ID shows how much investment firms plan to make at each interest rate.
Equilibrium GDP
The equilibrium output is the output whose production creates total spending just sufficient to purchase that output. When GDP= C + Ig
Disequilibrium
No level of GDP other than the equilibrium level of GDP can be sustained. At levels of GDP less than equilibrium, spending always exceeds GDP. Greater output will increase employment and total income. The reverse is true at all levels of GDP greater than equilibrium. Businesses will find that total output fail to generate the spending needed to clear the shelves. The resulting decline in output means fewer jobs and less total income.
Graphical Analysis
In tabular analysis equilibrium occurs when C + Ig= GDP. In graphical analysis the 45º line represent equilibrium.
The equilibrium level of GDP occurs at the intersection of the aggregate expenditures schedule and the 45º line.
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Below the 45º line, C + Ig falls short of GDP. The underspending causes inventories to rise, firms adjust production downwards.
Above the 45º line, C + Ig exceeds total output. The excess spending causes inventories to fall below their planned level, firms need to adjust production upward.