Please enable JavaScript.
Coggle requires JavaScript to display documents.
The Aggregate Expenditures Model, fig9.5 - Coggle Diagram
The Aggregate Expenditures Model
Investment demand curve
The curve typically slopes downward, indicating that as interest rates decrease, the demand for investment increases, and vice versa.
Derive an economy's investment schedule
To derive an economy's investment schedule from the investment demand curve and an interest rate, you can follow these steps:
Step 1: Understand the Investment Demand Curve:
The Investment Demand Curve represents the relationship between the level of investment in an economy and the prevailing interest rates.
Typically, this curve slopes downward, indicating that as interest rates decrease, the demand for investment increases, and vice versa.
Step 2: Gather Investment Data:
Collect data on various interest rates and corresponding levels of planned investment by firms within the economy.
These interest rates can be short-term or long-term, depending on the specific analysis.
Step 3: Plot the Points:
Plot the interest rates on the horizontal axis and the corresponding levels of planned investment on the vertical axis.
Step 4: Connect the Dots:
Connect the data points with a smooth curve that represents the Investment Schedule.
This curve shows the relationship between interest rates and the level of planned investment in the economy.
Step 5: Interpret the Investment Schedule:
Examine the Investment Schedule to understand how changes in interest rates impact investment.
As interest rates decrease, the Investment Schedule shows an increase in planned investment, indicating that firms are more willing to invest in projects and expand.
Conversely, as interest rates increase, planned investment decreases, suggesting that firms are less inclined to invest due to higher borrowing costs.
By following these steps, you can derive an economy's investment schedule from the investment demand curve and interest rate data. This schedule is a valuable tool for analyzing how monetary policy, changes in interest rates, and other factors influence investment decisions and, consequently, the overall economic activity in the economy.
Aggregate Expenditures Equals Real GDP:
One way to characterize the equilibrium level of real GDP is by stating that it occurs when aggregate expenditures (total spending) in the economy are equal to the economy's real GDP.
In this context, aggregate expenditures comprise both consumption and investment spending by households and firms.
Equilibrium is reached when the total quantity of goods and services produced (real GDP) equals the total quantity of goods and services purchased (aggregate expenditures).
Mathematically, this can be expressed as: Real GDP = Consumption + Investment (GDP = C + I).
This approach focuses on the overall demand side of the economy and emphasizes the balance between spending and production.
Aggregate Supply Equals Aggregate Demand:
Equilibrium in this context indicates that the economy is producing at its potential output, and any imbalance between supply and demand would lead to adjustments in output and prices.
This concept is often represented graphically as the intersection of the aggregate supply curve (which slopes upward as production increases) and the aggregate demand curve (which slopes downward as price levels change).
In equilibrium, the quantity of goods and services supplied matches the quantity demanded, resulting in price stability and no pressure for inflation or deflation.
Another way to characterize the equilibrium level of real GDP is by stating that it occurs when the aggregate supply (the total quantity of goods and services that producers are willing and able to supply) equals the aggregate demand (the total quantity of goods and services that households, firms, and the government are willing and able to purchase).
Here's how the multiplier effect affects equilibrium real GDP:
Initial Change in Autonomous Spending:
Suppose there is an initial increase in autonomous spending, such as an increase in government infrastructure spending or business investment. This increase creates a ripple effect throughout the economy.
Increase in Aggregate Demand:
The initial increase in autonomous spending directly adds to aggregate demand. For example, increased government spending directly increases the demand for goods and services.
Increase in Production and Income:
As businesses respond to the increased demand, they produce more goods and services. To meet this increased production, firms may hire more workers, purchase more materials, and invest in capital. This, in turn, increases national income.
Rise in Consumer Spending:
The increase in income for workers and business owners leads to an increase in consumer spending. People have more income to spend on goods and services, further boosting aggregate demand.
Iterative Process:
The process described above continues in an iterative manner. The increased consumer spending leads to more production, more income, and more consumer spending again. This cycle continues until the cumulative impact on real GDP stabilizes.
Magnitude of the Multiplier:
The multiplier effect is represented as a multiplier (usually denoted as 'k'). The multiplier indicates how many times greater the final change in real GDP is compared to the initial change in spending.
The formula for the multiplier is typically: Multiplier (k) = 1 / (1 - Marginal Propensity to Consume), where the Marginal Propensity to Consume (MPC) represents the portion of additional income that people spend on consumption.
Impact on Equilibrium Real GDP:
The multiplier effect can either increase or decrease equilibrium real GDP, depending on whether the initial change in autonomous spending is an increase or a decrease.
If there is an initial increase in spending, the multiplier effect will lead to a larger increase in real GDP, pushing it further away from its initial equilibrium.
Conversely, if there is an initial decrease in spending, the multiplier effect will lead to a larger decrease in real GDP, moving it further from its initial equilibrium.
