The most important assumption is that prices are fixed. The aggregate expenditures model is an extreme version of a sticky price model

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.

The model's other key assumption-the one that allows it to achieve equilibrium-is that production decisions are made in response to unexpected changes in inventory levels.

The Keynesian aggregate expenditures model remains relevant today because many prices in the modern economy are inflexible downward over relatively short periods of time,

As a first step, we examine aggregate expenditures and equilibrium GDP in a private closed economy that lacks both international trade and government. Then we will open the closed economy to exports and imports.

investment schedule showing the amounts business firms collectively intend to invest-their planned investment-at each possible level of GDP. Such a schedule represents the investment plans of businesses in the same way the consumption schedule represents the consumption plans of households. In developing the investment schedule, we will assume that planned investment is independent of the level of current disposable income or real output.

• The investment schedule shows the amount of investment forthcoming at each level of GDP is different from the investment demand curve, which shows how much investment firms plan to make at each interest rate.

. Firms are willing to produce any one of these 10 levels of output just as long as the revenue that they receive from selling any particular amount of output equals or exceeds the costs of producing it. Those costs are the factor payments needed to obtain the required amounts of land, labor, capital, and entrepreneurship.

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).

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.

A withdrawal of potential spending from the income expenditures stream via savings,tax payments or imports or a withdrawal that reduces the lending potential of the banking system

an addition of spending into the income expenditure system : any increment to consumption,investment,government purchases or net exports

changes in inventories that firms did not anticipate ; changes in inventories that occured because of unexpected increases or decreass in aggregate spending

Like consumption and investment, exports create domestic production, income, and employment for a nation. Although U.S. goods and services produced for export are sent abroad, foreign spending on those goods and services increases production and creates jobs and incomes in the United States. We must therefore include exports as a component of U.S. aggregate expenditures.

positive net exports increase aggregate expenditures and GDP beyond what they would be in a closed economy

negative net exports reduce aggregate expenditures and GDP below what they would be in a closed economy

Depreciation (a decrease in the value) of the dollar relative to other currencies enables people abroad to obtain more dollars with each unit of their own currencies. The price of U.S. goods in terms of those currencies will fall, stimulating purchases of U.S. exports. Also, U.S. customers will find they need more dollars to buy foreign goods and, consequently, will reduce their spending on imports. If the economy has available capacity, the increased exports and decreased imports will increase U.S. net exports and expand the nation's GDP.

In the full model, it is still the case that injections into the income expenditures stream equal leakages from the income stream.For theprivate closed economy, $ = Ig. For the expanded economy, imports and taxes are added leakages. Saving, importing, and paying taxesare all uses of income that subtract from potential consumption. Consumption will now be less than GDP-creating a potential spending Bap-in the amount of aftertax saving (Sa), imports (M), and taxes (T). But exports (X), government purchases (G), and investment (Ig), are injections into the income expenditures stream. At the equilibrium GDP, the sum of the leakages equals the sum of injections, In symbols

A recessionary expenditure gap is the amount by which an economy's aggregate expenditures schedule must shift upward to achieve the full-employment GDP; an inflationary expenditure gap is the amount by which the economy's aggregate expenditures schedule must shift downward to achieve full-employment GDP and eliminate demand-pull inflation.

When the price of an individual product falls, the consumer's (constant) nominal income allows a larger purchase of the product; that's the income effect.
At the same time, the consumer will want to buy more of the individual product because it becomes less expensive relative to other goods, whose prices have not changed; that's the substitution effect.

real-balances effect
The tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.

Interest-rate effect
The tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases)

forelgn purchases effect
The inverse relationship between the net exports of an economy and its price level relative to foreign price levels.

Consumer Wealth
Consumer wealth is the total dollar value of all assets owned by consumers less the dollar value of their liabilities (debts). Assets include stocks, bonds, and real estate. Liabilities include mortgages, student loans, and credit card balances.

Household Borrowing
Consumers can increase their consumption spending by borrowing. Doing so shifts the aggregate demand curve to the right.

Personal Taxes
A reduction in personal income tax rates raises take-home income and increases consumer purchases at each possible price level. Tax cuts shift the aggregate demand curve to the right. Tax increases reduce consumption spending and shift the aggregate demand curve to the left.

Real Interest Rates
Other things equal, an increase in real interest rates will raise borrowing costs, lower investment spending, and reduce aggregate demand.

Expectations about future business conditions:If firms are optimistic about future business conditions, they are more likely to forecast high rates of return on current investment and therefore may invest more today.

Technology :New and improved technologies enhance expected returns on investment and thus increase aggregate demand.

Degree of excess capacity: A rise in excess capacity-unused capital-reduces the expected return on new investment and hence decreases aggregate demand.

Business taxes: An increase in business taxes will reduce after-tax profits from capital investment and lower expected returns.

Government Spending
Government purchases are the third determinant of aggregate demand. An increase in government purchases (for example, more transportation projects) shifts the aggregate demand curve to the right,

National Income Abroad
Rising national income abroad encourages people living abroad to buy more products, some of which are made in the United States. U.S. net exports thus rise, and the U.S. aggregate demand curve shifts to the right. Declines in national income abroad do the opposite: They reduce U.S. net exports and shift the U.S. aggregate demand curve to the

Exchange Rates
Changes in the dollar's exchange rate-the price of foreign currencies in terms of the U.S. dollar-may affect U.S. exports and therefore aggregate demand.

The immediate-short-run aggregate supply curve is horizontal: given fixed input and output prices, producers will supply whatever quantity of real output is demanded at the current price level.

The short-run aggregate supply curve slopes upward: given fixed resource prices, higher output prices raise profits and encourage firms to increase their output levels

The long-run aggregate supply curve is vertical: given sufficient time, wages and other input prices rise or fall to match any change in the price level.

domestic resource prices :Other things equal, decreases in wages increase profits by reducing per-unit production costs. So when wages fall, the aggregate supply curve shifts to the right. By contrast, increases in wages reduce profits by raising per-unit production costs. So when wages rise, the aggregate supply curve shifts to the left. Examples:

Prices of Imported Resources
Resources imported from abroad (such as oil, tin, and copper) affect U.S. aggregate supply because added supplies of resources-whether domestic or imported-typically reduce resource prices and, consequently, per-unit production costs.

Higher productivity implies greater efficiency. An increase in productivity enables the economy to obtain more output from its limited resources.

Business Taxes and Subsidies
Higher business taxes, such as sales, excise, and payroll taxes, increase per-unit costs and reduce short-run aggregate supply. Higher business taxes shift aggregate supply to the left.

Government Regulation
It is usually costly for businesses to comply with government regulations. More regulation therefore tends to increase per-unit production costs and shift the aggregate supply curve to the left.

equillbrium price level
In the aggregate demand-aggregate supply (AD-AS) model, the price level at which aggregate demand equals aggregate supply; the price level at which the aggregate demand curve intersects the aggregate supply curve.

equilibrium real output
(see equilibrium real domestic output) 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.

The equilibrium price level and amount of real output are determined at the intersection of the aggregate demand curve and the aggregate supply curve.

Increases in aggregate demand beyond the full-employment level of real GDP cause demand-pull inflation.

Decreases in aggregate demand cause recessions and cyclical unemployment, partly because the price level and wages tend to be inflexible in a downward direction.

Full employment, high economic growth, and price stability are compatible with one another if productivity-driven increases in aggregate supply are sufficient to balance growing aggregate demand.