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The Aggregate Expenditure Model - Coggle Diagram
The Aggregate Expenditure Model
:silhouette: John M. Keynes
British Economist
(1936 writings based on The Great Depression)
Production decisions are made in response to unexpected responses to inventory
If inventories rise, firms cut back on production to balance with sales
If inventories fall, firms increase production to maximize sales
The amount of goods and services produced and the level of employment depend directly on the level of aggregate expenditure.
Private closed economy – lacks government and international trade.
Sticky price model - prices are fixed
Equilibrium GDP
Equilibrium GDP
GDP at which the total quantity of final goods and final services purchased (aggregate expenditures) is equal to the total quantity of final goods and final services produced (real domestic output)
the real domestic output at which the aggregate demand curve intersects the aggregate supply curve.
(C + Ig) = GDP
Total quantity of goods produced equas total quantity of goods purchased
GDP + DI
only level of GDP equilibrim level can be sustained
Annual production and spending balance no need to adjust unplanned inventories (increase nor decrease)
Aggregate expenditure schedule
Consumption + Gross Investment (planned)
(C + Ig)
Firms are willing to produce as along as revenue received is equal to or exceed the cost of production.
Disequilibrium
Below equilibrium
At levels of GDP less than equilibrium, spending exceeds GDP
Spending is more than production resulting in a decrease in inventories.
Firms adjust production to meet increased demand by increasing production
Greater output increases employment and total income till equilibrium is reached
Above equilibrium
At levels of GDP greater than equilibrium, spending is below GDP
Spending is less than production resulting in an increase in inventories.
Firms adjust production to meet decreased demand by decreasing production
lesser output, decreases employment and total income till equilibrium is reached
Equilibrium graph (private closed economy)
(C + Ig) shows total spending rises with income and output
Equilibrium level of GDP occurs at the aggregate expenditures schedule and 45˚ line.
At above equilibrium GDP occurs below the aggregate schedule below 45˚- (C + Ig) < total output
At below equilibrium GDP occurs above the aggregate schedule above 45˚- (C + Ig) > total output
At all points at the 45˚ angle, equilibrium GDP is possible
Consumption and Investment spending Schedule
The Investment schedule
The Investment schedule shows the amount of investment at each level of GDP as related to the investment demand curve
Investment demand curve (ID) & Investment schedule
Investment demand curve (ID)
Investment demand curve shows how much investment firms plan to make at each real interest rate
Components of aggregate expenditure
Gross Investment, Ig
Consumption, C
Planned investment - the amount that firms plan or intend to invest at possible levels of GDP
The level of investment spending is determined by the investment rate.
Other Features of Equilibrium GDP
Savings = Planned Investment
(S = Ig)
Investment is an injection
Investment is an injection of spending to an economy’s flow of income and expenditure
Saving is a leakage
Saving is a leakage or withdrawal of spending from an economy’s flow of income and expenditure.
causes consumption to be less than GDP
Unplanned changes in Inventory
No unplanned changes of inventories at equilibrium
GDP(C + Ig) = GDP, (S = Ig) means there is equilibrium in a private closed economy
at equilibrium savings equal planned investments (S = Ig) while unplanned changes in inventories equal zero.
Multiplier Effect
Multiplier Effect = Change in GDP / initial change in spending
