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Aggregate Expenditure Model - Coggle Diagram
Aggregate Expenditure Model
Assumption & Simplifications
Economy consist of: households & businesses, government is ignored
Stuck-price model: prices are fixed; output amount depends directly on total spending amount
Explains how modern economies adjust to economic shocks
Production decisions made in response to unplanned inventory adjustments: (1) if inventories unexpectedly rise, firms decrease production (2) if inventories unexpectedly fall, firms increase production
Economic conditions during Great Depression
Consumption & Investment
Investment demand curve (ID): (1) how much investment firms plan to make at each interest rate (2) relationship between interest rate and investment (3) negative relationship, as interest rate decreases, borrowing becomes cheaper and demand for investment increases; vice versa
Investment schedule (Ig): (1) amount of investment forthcoming at each level of GDP (2) relationship between investment and real GDP
Private closed economy components: (1) consumption, C (2) gross investment, Ig
Equilibrium GDP
Investment is independent of income and is planned regardless of income
Levels of GDP below equilibrium GDP: (1) excess demand = declining inventory (2) increase production
Consumption level is directly related to level of income, here income is equal to output
Levels of GDP above equilibrium GDP: (1) excess supply = unsold, unplanned inventory (2) decrease production (3) jobs & total income decline
Level of output where production equals total spending sufficient to purchase output.
No level of GDP other than equilibrium level GDP can be sustained
Occurs where aggregate expenditures (C+I) = real domestic output (GDP)
Other Features of Equilibrium GDP
Aggregate expenditure < equilibrium GDP = unplanned investment + planned investment
Aggregate expenditure > equilibrium GDP = negative amount of unplanned investment
No unplanned changes in inventories
Savings & planned investments are equal (S=Ig): (1) savings is a leakage of spending, and causes C < GDP (2) investment is an injection of spending, planned output for business investment
Changes in Equilibrium GDP & the Multiplier
Through the multiplier effect, an initial change in investment spending can cause a magnified change in domestic output and income
(1) an upward shift of the aggregate expenditure will increase equilibrium GD; vice versa (2) extent of the changes in equilibrium GDP depend on the size of the multiplier
(1) multiplier = change in real GDP/initial change in spending (2) size of the multiplier depends on the size of the MPS in the economy: multiplier = 1/MPS
Equilibrium GDP: Graphically
Vertical distance between C+Ig & C do not change, since investment is assumed to be constant at each level of GDP
Equilibrium GDP = aggregate expenditures schedule intersects 45 degree line
Aggregate expenditures schedule (C+I): investment schedule, Ig, + upsloping consumption schedule, C
