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aggregate expenditures model for closed economy (excludes international…

- - - - Prices are fixed: main assumptions of the aggregate expenditure model is that prices in the economy are fixed
        
        Current relevance: Model remains relevant because many prices in modern economy are inflexible downwards over relatively short periods of time
        
        the presence of excess production capacity and unemployed labor implies that an increase in aggregate expenditure will increase real output and employment without raising price level
      - GDP=DI (Disposable income, National income, Personal income are all the same )
        
        Why?
        This is before taxes
        For every $1 output produced, households receive $1
      - Unplanned inventory adjustments: Other key assumption is that production decisions are made in response to unexpected changes in inventory levels to achieve equilibrium
    - - Keynes created the aggregate expenditure model in the middle of the Great Depression hoping to explain why the Great Depression had happened and how it might be ended
      - "Stuck Price" model. Aggregate expenditures model is an extreme version of a sticky price model because the price level cannot change at all
        
        Reason is prices has not declined sufficiently during the Great Depression to boost spending and main output and employment at per-Depression levels. Macroeconomics theories popular before the Great Depression has predicted prices would fall to equate quantity supplied and quantity demanded.
        
        Keynes describe the relationship between labor, capital, and inventory during the Great Depression: Firms acted predictably to unexpected inventory levels.
- - - - Tabular analysis
        (Row#) (Column 1) Possible levels of employments Milllions (Column 2) Real Domestic Output (and income) GDP=DI $ Billions (Column 3) Consumption C
        (Column 4) Savings S $Billions (Column 5) Investment Ig $Billions (Column 6) Aggregate expenditure C+Ig $Billions
        (Column 7) Unplanned changes in Inventories $Billions (Column 8) Tendencies of Employment Output and Income
        (1) 40 | 370 | 375 | -5 | 20 | 395 | -25 | Increase
        (2) 45 | 390 | 390 | 0 | 20 | 410 | -20 | Increase
        (3) 50 | 410 | 405 | 5 | 20 | 425 | -15 | Increase
        (4) 55 | 530 | 420 | 10 | 20 | 440 | -10 | Increase
        (5) 60 | 450 | 435 | 15 | 20 | 455 | -5 | Increase
        (6) 65 | 470 | 450 | 20 | 20 | 470 | 0 | Equilibrium
        (7) 70 | 490 | 465 | 25 | 20 | 485 | +5 | Decrease
        (8) 75 | 510 | 480 | 30 | 20 | 500 | +10 | Decrease
        (9) 80 | 530 | 495 | 35 | 20 | 515 | +15 | Decrease
        (10) 85 | 550 | 510 | 40 | 20 | 530 | +20 | Decrease
        
        Real Domestic Output
        Column 2 list the various possible levels of total output of real GDP that private sector might produce as long as revenue >= costs of producing it
        
        These Costs are the factor payments needed to obtain the required amount of land, labour, capital and entrepreneurship
        
        Aggregate Expenditures
        In private closed econmoy aggregate expenditures consists of consumption (col 3) plus investments (col 5) with the sum in (col 6)
        
        Planned investment (column 5) - amount that firms PLAN or INTEND to invest, not amounts they actually will invest if there are unplanned changes in inventories
        
        Equilibrium GDP
        The equilibrium is the output whose production creates total spending just sufficient to purchase that output.
        Equilibrium GDP is where GDP = C + Ig
        
        At levels of GDP < equilibrium : spending exceeds GDP
        At levels > equilibrium : total output fail to generate the spending needed to clear shelves of goods
        
        At equilibrium:
        GDP = C+ Ig
        Planned Investments (Ig) = Savings (S)
        Unplanned inventories = 0
        
        Savings is a LEAKAGE or WITHDRAWAL of spending from the economy's circular flow of income and expenditure
        
        Investment (purchase of capital goods) is an INJECTION of spending into the income-expenditure stream.
        
        total qty of goods products = total qty of goods purchased
        
        no unplanned inventories and no unplanned investment.
        
        Multiplier: An initial change ion spending causes a bigger change in real output through the multiplier effect
        
        Multiplier = Change in real GDP / initial Change in spending
        
        there is a bigger change in equilibrium GDP than the change in aggregate expenditures
        
        Multiplier = 1 / MPS
        (1 / Marginal prosperity to spend)
        
        If real rate of return on investment decreases, or if real interest rates rises, investment spending will decline
      - Graphically, a 45 degree line is where Aggregate expenditure (C + Ig) = GDP, this a graphical representation of the equilibrium condition
        
        If aggregate expenditure schedule line is above the 45degree line:
        Then GDP is below equilibrium
        
        If aggregate expenditure schedule line is below the 45degree line:
        Then GDP is above equilibrium
        
        equilibrium GDP:
        Savings and planned investment are equal.
        There are no unplanned changes in inventories.
        
        NB: Actual investment equals savings at all GDP levels: Actual investment includes unplanned changes in inventories causing savings and actual investment to be equal.
- - - - real GDP increases