The Aggregate

Expenditures Model

McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Assumptions and Simplifications

Use the Keynesian aggregate

LO1

expenditures model
Prices are fixed
GDP = DI
Begin with private, closed economy
Consumption spending
Investment spending
28-2

Consumption function
Consumption a function of income
MPC
Consumption schedule drawn to MPC =1
and < 1

Consumption and Investment

Investment
demand
curve
8

20

ID
20

Investment
(billions of dollars)
(a)
Investment demand curve

LO1

Investment Schedule
Investment (billions of dollars)

r and i (percent)

Investment Demand Curve

Investment
schedule

Ig

20

20

Real domestic product, GDP

(billions of dollars)
(b)
Investment schedule

28-4

Equilibrium GDP
(C + Ig = GDP)
Equilibrium
point
Aggregate
expenditures

C + Ig
C

Ig = $20 billion

C = $450 billion

LO1

28-5

Other Features of Equilibrium GDP

Saving equals planned investment

Saving is a leakage of spending
Investment is an injection of

LO2

spending
No unplanned changes in inventories
Firms do not change production

28-6

Changes in Equilibrium GDP

(C + Ig)1
(C + Ig)0
(C + Ig)2

Increase in
investment
Decrease in
investment

LO3

28-7

Equilibrium GDP
How is equilibrium GDP reached?
Through the process of unplanned
inventories
In equilibrium, full employment reached

Adding International Trade

Include net exports spending in

LO4

aggregate expenditures
Private, open economy
Exports create production,
employment, and income
Subtract spending on imports
Xn can be positive or negative

28-9

Net Exports and Equilibrium GDP

C + Ig+Xn1
C + Ig
C + Ig+Xn2

Aggregate expenditures
with positive
net exports

Aggregate expenditures
with negative net
exports

Positive net exports

450
470
Negative net exports

LO4

Xn1
490

Xn2
28-10

International Economic Linkages

Prosperity abroad
Can increase U.S. exports
Exchange rates
Depreciate the dollar to increase exports
A caution on tariffs and devaluations
Other countries may retaliate
Lower GDP for all

LO4

28-11

Adding the Public Sector

Government purchases and

LO4

equilibrium GDP
Government spending is subject to
the multiplier
Taxation and equilibrium GDP
Lump sum tax
Taxes are subject to the multiplier
DI = GDP
28-12

Government Purchases and Eq.

GDP
C + Ig + X n + G
C + Ig + X n
C

Government spending
of $20 billion

LO4

28-13

LO5

Equilibrium versus FullEmployment

Recessionary expenditure gap
Insufficient aggregate spending
Spending below full-employment GDP
Increase G and/or decrease T
Inflationary expenditure gap
Too much aggregate spending
Spending exceeds full-employment
GDP
Decrease G and/or increase T
28-14

Aggregate expenditures
(billions of dollars)

Equilibrium versus FullEmployment

AE0
AE1
530

510

Recessionary
expenditure
gap = $5 billion

490

Full
employment
45
490

510

530

Real GDP
(a)
Recessionary expenditure gap
LO5

28-15

Equilibrium versus FullEmployment

AE2
Inflationary
expenditure
gap = $5 billion

AE0

Full
employment

LO5

28-16

Policy implications
In times of recession, a small increase in
G will increase GDP by the multiplier
Multiplier formula
Q: Use the AE model to show how the
government can provide a fiscal stimulus
to the economy?

Says Law, Great Depression,

Keynes

Classical economics
Says Law
Economy will automatically adjust
Laissez-faire
Keynesian economics
Cyclical unemployment can occur
Economy will not correct itself
Government should actively manage
macroeconomic instability

28-18