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Chapter 9 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-1 9 The Aggregate Expenditures Model Copyright 2008 The McGraw-Hill Companies Chapter 9 Chapter Objectives Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-2 • Understand How Economists Combine Consumption and Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy. • Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy. • How Changes in Equilibrium Real GDP Occur and Relate to Multiplier. • Integrate Government and Foreign Sectors into AE. • Recessionary and Expansionary Expenditure Gaps. Copyright 2008 The McGraw-Hill Companies • Simplifications – Private Closed Economy – Planned Investment – Investment Schedule Investment Demand Curve Investment Demand Curve 8 20 ID Investment Schedule Investment (billions of dollars) Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word r and i (percent) Chapter 9 Consumption and Investment Investment Schedule 20 Ig 20 Investment (billions of dollars) 9-3 Real GDP (billions of dollars) Copyright 2008 The McGraw-Hill Companies 1 Chapter 9 Consumption and Investment Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-4 • Equilibrium GDP: C + Ig = GDP • Real Domestic Output. • Aggregate Expenditures. – Aggregate Expenditures Schedule. • Equilibrium GDP. • Disequilibrium. Copyright 2008 The McGraw-Hill Companies Chapter 9 Consumption and Investment Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word (2) Real Domestic (3) (7) (8) Output Con(5) (6) Unplanned Tendency of (1) (and sump(4) Investment Aggregate Changes in Employment Employ- Income) tion Saving (S) (Ig) Expenditures Inventories Output and ment (GDP=DI) (C) (1-2) (C+Ig) (+ or -) Income …in Billions of Dollars (1) 40 $370 $375 $-5 20 $395 $-25 Increase (2) 45 390 390 0 20 410 -20 Increase (3) 50 410 405 5 20 425 -15 Increase (4) 55 430 420 10 20 440 -10 Increase (5) 60 450 435 15 20 455 -5 Increase (6) 65 470 450 20 20 470 0 Equilibrium (7) 70 490 465 25 20 485 +5 Decrease (8) 75 510 480 30 20 500 +10 Decrease (9) 80 530 495 35 20 515 +15 Decrease (10) 85 550 510 40 20 530 +20 Decrease Graphically… 9-5 Copyright 2008 The McGraw-Hill Companies Chapter 9 Consumption and Investment Equilibrium GDP 530 (C + Ig = GDP) 510 Consumption (billions of dollars) Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Equilibrium Point 490 470 C + Ig C Aggregate Expenditures 450 Ig = $20 Billion 430 410 390 C = $450 Billion 370 45° 370 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) 9-6 Copyright 2008 The McGraw-Hill Companies 2 Chapter 9 Equilibrium GDP Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-7 • Other Features… – Saving Equals Planned Investment. • Leakage. • Injection. – No Unplanned Changes in Inventories. Copyright 2008 The McGraw-Hill Companies Chapter 9 Changes in Equilibrium GDP Aggregate Expenditures (billions of dollars) …and the Multiplier Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word (C + Ig)1 (C + Ig)0 (C + Ig)2 510 490 Increase in Investment Decrease in Investment 470 450 430 45° 430 450 470 490 510 Real GDP (billions of dollars) 9-8 Copyright 2008 The McGraw-Hill Companies Chapter 9 International Trade Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-9 • Net Exports and Aggregate Expenditures. • Net Exports Schedule. • Net Exports and Equilibrium GDP. – Positive Net Exports. – Negative Net Exports. • International Economic Linkages. – Prosperity Abroad. – Tariffs. – Exchange Rates. Copyright 2008 The McGraw-Hill Companies 3 Chapter 9 International Trade Net Exports and Equilibrium GDP Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Aggregate Expenditures (billions of dollars) Aggregate Expenditures 490 with Positive Net Exports Aggregate Expenditures with Negative Net Exports 470 450 430 45° 430 Net Exports Xn (billions of Dollars) 9-10 C + Ig+Xn1 C + Ig C + Ig+Xn2 510 450 470 490 510 Real GDP (billions of dollars) +5 0 -5 Positive Net Exports 450 470 Xn1 490 Real Xn2 GDP Negative Net Exports Copyright 2008 The McGraw-Hill Companies Chapter 9 International Trade Global Perspective Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Net Exports of Goods - Select Nations, 2004 Negative Net Exports Positive Net Exports +37 Canada -17 France Germany +195 Italy -2 Japan +111 -117 United Kingdom United States -707 -700 200 150 100 50 0 50 100 150 200 250 Source: World Trade Organization 9-11 Copyright 2008 The McGraw-Hill Companies Chapter 9 Adding the Public Sector Government Purchases and GDP Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-12 (1) (5) Level of (7) Net Exports Output (2) (Xn) Aggregate and Consump(4) (6) Income tion (3) Investment Exports Imports Government Expenditures (C+Ig+Xn+G) (GDP=DI) (C) Saving (S) (Ig) (X) (M) (G) (2)+(4)+(5)+(6) …in Billions of Dollars (1) $370 $375 $-5 $20 10 10 20 $415 (2) 390 390 0 20 10 10 20 430 (3) 410 405 5 20 10 10 20 445 (4) 430 420 10 20 10 10 20 460 (5) 450 435 15 20 10 10 20 475 (6) 470 450 20 20 10 10 20 490 (7) 490 465 25 20 10 10 20 505 (8) 510 480 30 20 10 10 20 520 (9) 530 495 35 20 10 10 20 535 (10) 550 510 40 20 10 10 20 550 Copyright 2008 The McGraw-Hill Companies 4 Chapter 9 Adding the Public Sector Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Aggregate Expenditures (billions of dollars) Government Spending and GDP C + Ig + Xn + G C + Ig + Xn C Government Spending of $20 Billion $20 Billion Increase in Government Spending Yields an $80 Billion Increase In GDP 45° 470 550 Real GDP (billions of dollars) 9-13 Copyright 2008 The McGraw-Hill Companies Chapter 9 Adding the Public Sector Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Aggregate Expenditures (billions of dollars) Lump-Sum Tax Increase and GDP C + Ig + Xn + G Cd + Ig + Xn + G $15 Billion Decrease In Consumption From a $20 Billion (MPC=.75) Increase in Taxes $20 Billion Increase in Taxes Yields a $60 Billion Decrease In GDP 45° 490 550 Real GDP (billions of dollars) 9-14 Copyright 2008 The McGraw-Hill Companies Chapter 9 Adding the Public Sector Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-15 Cd + Ig + Xn + G = GDP • Leakages • Injections • No Planned Inventory Changes Sd + M + T = Ig + X + G Copyright 2008 The McGraw-Hill Companies 5 Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Recessionary Expenditure Gap 550 Aggregate Expenditures (billions of dollars) Chapter 9 Equilibrium Versus Full-Employment GDP 530 510 AE0 AE1 $5 Billion Gap Yields $20 Billion GDP Change Recessionary Expenditure Gap = $5 Billion 490 Full Employment 470 45° 490 510 530 Real GDP (billions of dollars) 9-16 Copyright 2008 The McGraw-Hill Companies Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Inflationary Expenditure Gap AE2 550 Aggregate Expenditures (billions of dollars) Chapter 9 Equilibrium Versus Full-Employment GDP 530 AE0 Inflationary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change 510 490 Full Employment 470 45° 490 510 530 Real GDP (billions of dollars) 9-17 Copyright 2008 The McGraw-Hill Companies Chapter 9 Equilibrium Versus Full-Employment GDP Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-18 • Application: – U.S. Recession of 2001. • Inflationary Expenditure Gap. – U.S. Inflation in the Late 1980s. – Full-Employment Output with Large Negative Net Exports. • Negative Net Exports. Copyright 2008 The McGraw-Hill Companies 6 Chapter 9 Equilibrium Versus Full-Employment GDP Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-19 • Limitations of the Model – Does Not Show Price Level Changes. – Ignores Premature Demand-Pull Inflation. – Limits Real GDP to the FullEmployment Level of Output. – Does Not Deal with Cost-Push Inflation. – Does Not Allow for “Self-Correction”. Copyright 2008 The McGraw-Hill Companies Chapter 9 Say’s Law - The Great Depression and Keynes t Las d r o Consumption W and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-20 • Classical School – Automatic Self-Adjustment to Full Employment – Mill, Ricardo. • Views Based Upon “Say’s Law” - J.B. Say (1767-1832) – Supply Creates its Own Demand. • Great Depression Caused Questions. • Keynes Answered in his General Theory of Employment, Interest, and Money. • Income and Saving Discrepancies. • Volatility in Investment Spending. • Cyclical Unemployment Can Occur. • Government Should Be Active in the Recovery Process. Copyright 2008 The McGraw-Hill Companies Chapter 9 Key Terms Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-21 • • • • • • • • • • • Planned investment Investment schedule Aggregate expenditures schedule Equilibrium GDP Leakage Injection Unplanned changes in inventories Net exports Lump-sum tax Recessionary-expenditure gap Inflationary-expenditure gap Copyright 2008 The McGraw-Hill Companies 7 Chapter 9 Next Chapter Preview… Consumption and Investment Equilibrium GDP Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 9-22 Aggregate Demand and Aggregate Supply Chapter 10 Copyright 2008 The McGraw-Hill Companies 8
