CHAPTER 31: THE AGGREGATE EXPENDITURES MODEL
ASSUMPTIONS AND SIMPLIFICATIONS
A Stuck price model
Prices are assumed to be fixed
Unplanned inventory shortages
Demand in unexpectedly high = inventory shortages
Demand is unexpectedly low = inventory excess
Current relevance
Shows how modern economy rests to short term shock events
A Preview
Real GDP before tax = disposable income
CONSUMPTION AND INVESTMENT SCHEDULES
Private, closed economy
Components
Consumption
Gross investment
Planned investment is assumed to be independent of real disposable income
SEE IMAGE
EQUILIBRIUM GDP
C + Ig = GDP
VIEW TABLE EXAMPLE
Real GDP = potential output at various levels of employment
Firms will produce if TR > TC
Aggregate expenditure = Consumption + planned investment
GDP = Disposable income
Equilibrium I see when GDP = Consumption + planned investment/savings
DISEQUILIBRIUM GDP
C + Ig > GDP
Too much product is being bought
Shelves are empty. Encourages firms to increase production until equilibrium is reached
Promotes employment
C + Ig < GDP
Too little product is being bought
Shelves are overstocked. Firms decrease production until equilibrium is reached
Promotes unemployment
SEE GRAPH
OTHER FEATURES OF EQUILIBRIUM GDP
Savining = Planned investment
Saving = leakage/withdrawl of expenditure flowing through the economy
Causes consumption to be lower the total output/GDP
Firms sell some products to other firms as capital goods = form of investment
Prevents further spending in the economy
If leakage of saving > investment
C + Ig > GDP and won't be sustainable
If leakage of saving < investment
C + Ig < GDP and won't be sustainable
No unplanned changes in inventory
Planned investment + unplanned inventory changes = actual investment
Example
Assume (in billions): GDP = $490 and savings = $25. Consumption then is = $465. Investment sits at $20. Therefore C + Ig = $465 + $20 = $485. $490 - $485 = $5 of over supply to the economy = Unplanned excess of stock
Unplanned changes in inventories = balances actual amounts saved and invested in a period
CHANGES IN EQUILIBIRUM AND MULTIPLIER
MULTIPLIER
m = change in real GDP / initial change in spending
m = 1 / MPS
CHANGES IN EQ
Consumption and investment schedules are the main sources of EQ point change
If planned investment increased: C + Ig would shift up, causing the new EQ point to be higher on the GDP curve
If planned investment decreased: C + Ig would shift down, causing the new EQ point to be lower on the GDP curve
This shows an increase in C + Ig curve. A decrease shifts the graph lower and causes a lower GDP EQ point
Can use multiplier to determine factor to which a change in investment/savings/consumption and its effect on GDP
MPS can be worked out. For every extra x amount of DI, x * MPS of new saving occurs