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Unit 5: The aggregate Expenditures Model - Coggle Diagram
Unit 5: The aggregate Expenditures Model
The aggregate expenditures model is an extreme version of a sticky price model. It is in fact a stuck-price model because the price level cannot change at all
The most important assumption is that prices are fixed.
Keynes created the aggregate expenditures model in the middle of the Great Depression. Hoping to explain both why the Great Depression had happened and how it might be ended.
To Keynes the Great Depression's massive unemployment of labor and capital was caused by firms reacting in a predictable way to unplanned increases in inventory levels.
Stages of the aggregate expenditures model:
Examine aggregate expenditures and equilibrium GDP in a private closed economy that lacks international trade and government.
Open the closed economy to exports and imports.
Convert the private economy that has only private actors (Households and Businesses) into a more realistic "mixed" economy that includes the government sector.
GDP = DI (Disposable Income)
In the private closed economy, the 2 components of aggregate expenditure are consumption C and and gross investment I.
planned investment
The amount that firms plan or intend to invest.
investment schedule
A curve or schedule that shows the amounts that firms plan to invest at various possible values of real gross domestic product (real GDP).
The investment schedule shows the amount of investment forthcoming at each level of GDP: Ig is different from the investment demand curve ID, which shows how much investment firms plan to make at each interest rate.
aggregate expenditures schedule
A table of numbers showing the total amount spent on final goods and final services at different levels of real gross domestic product (real GDP). The schedule shows the amount (C + Ig)
The equilibrium output is the output whose production creates total spending just sufficient to purchase that output.
equilibrium GDP
The gross domestic product at which the total quantity of final goods and final services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve. Also known asequilibrium real output.
No level of GDP other than the equilibrium level of GDP can be sustained.
At levels of GDP less than equilibrium, spending always exceeds.
At levels of GDP greater than equilibrium, spending becomes less.
Where GDP is above equilibrium level C + Ig falls short of GDP. The aggregate expenditures schedule lies below the 45 degree line.
Where the GDP is below the equilibrium level C + Ig exceeds total output. The aggregate expenditures schedue lies above the 45 degrees line.
Characteristics of equilibrium GDP
Saving and planned investment are equal ( S = Ig)
= Saving is a leakage of spending and investment is an injection of spending
There are no unplanned changes in inventories =
If the leakage of saving exceeds the injection of investment then C + Ig will be less that GDP and at that level GDP cannot be sustained. (above equilibrium GDP)
If injection of investment exceeds the leakage of saving then C + Ig will be greater than GDP and drive GDP upwards. (below equilibrium GDP)
At S = Ig the leakage of saving is exactly offset by the injection of planned investment. (C + Ig) = GDP equality defines the equilibrium GDP
unplanned changes in inventories
Changes in inventories that firms did not anticipate; changes in inventories that occur because of unexpected increases or decreases of aggregate spending (or of aggregate expenditures).
The initial change in spending can cause a greater change in real output through the Multiplier effect.
Multiplier = change in real GDP divide by initial change in spending
The size of the multiplier depends on the size of the MPS in the economy.
Multiplier = 1 divide by MPS