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The Aggregate Expenditures Model - Coggle Diagram
The Aggregate Expenditures Model
Keynesian aggregate expenditure model
Stuck Price Model: Prices in the economy are fixed
The amount of real output depends directly on the amount of total spending in the economy
Great depression observation
Prices did not decline enough to boost spending and maintain output
Unplanned inventory adjustments
Firms acted predictably to unexpected inventory levels
Unplanned inventory increases was responsible for the large amounts of idle labor and capital during the Great Depression
Current relevance: Helps us understand how modern economy adjust to shocks over shorter periods of time.
Private closed economy
(2 components of aggregate expenditure)
Consumption "
C
"
Gross Investment "
Ig
"
The investment schedule shows the amount of investment at each level of GDP.
Derived from the:
Interest rate
Investment demand curve, ID, shows how much investment firms plan to make at each interest rate
Based upon and determined by the real rate of interest
Planned investment: The amounts that firms
collectively
plan or intend to invest
at each level of GDP
Equilibrium GDP: C+Ig =GDP
total quantity of goods produced = total quantity of goods purchased
No overproduction or excess spending.
Thus no reason to alter this rate
C+Ig: Aggregate expenditure
The amount that will be spent at each level of output
Aggregate expenditure schedule reflects the total amount that will be spent at each possible output or income level.
Output "
GDP
"
Firms will produce any level of output as long as revenue> costs of production
Other features of Equilibrium GDP
Savings and
planned
investments are equal (S=Ig)
Savings- a leakage or withdrawal of spending from the economy's circular flow of income and expenditure
Investment- an injection of spending into the income-expenditure stream
Any GDP where savings> investments is an above level GDP, therefore GDP must decline
There are no
unplanned
changes in inventories
Firms may decide to increase or decrease inventory
When sales fall short of planned production output, the unsold output is known as "unplanned changes in inventory" and is included in actual output
It is undesirable for GDP to be greater than the equilibrium level because it will lead to a decline in output, jobs and total income.
It is undesirable for GDP to be less than the equilibrium level because there will be an unplanned decline in business inventories.
Disequilibrium:
Output levels below equilibrium GDP results in a reduction of goods in inventory and too low a production rate
When GDP is above equilibrium, firms will decrease the rate of production.
Graphical Analysis
Equilibrium GDP is found at the intersection of the aggregate expenditures schedule and the 45 degree line. Levels above or below this are unsustainable.
Suppose the real interest rate increases, causing businesses to decrease investment spending. Using the the graph on the right. The aggregate expenditure curve will shift downward.
Changes in Equilibrium GDP and the multiplier
Multiplier effect
Multiplier= Change in real GDP ÷ initial change in spending
Multiplier= 1 ÷ MPS
Multiplier effect means that there is a bigger change in equilibrium GDP than the change in aggregate expenditures
If the rate of return on a firm's potential project or the real interest rate increases or decreases, the size of the effect they will have on the equilibrium GDP is based on the "multiplier effect"
Private open economy
Focuses on "Net Exports" (exports minus imports)
Aggregate expenditure for an open economy: C+Ig + (X-M) OR net exports (Xn) = (X-M)
Net Exports Schedule: lists the amount of net exports that occurs at each level of GDP
Economy is open to "
International trade
". To ovoid overstating the value of domestic production we need to subtract amount spent on imported goods, because such goods generate income abroad.
