Chapter 10 Aggregate Expenditures Changes in Equilibrium GDP and the Multiplier

Chapter 10
Aggregate Expenditures
Changes in Equilibrium GDP and the Multiplier
o In the private closed economy, the equilibrium GDP will change in
response to changes in either the investment schedule or the
consumption schedule
o Changes in investment schedule are main source of instability
The Multiplier Effect
o A change in a component of aggregate expenditures leads to a larger
change in equilibrium GDP
o Determines how much larger than change will be
o Change in real GDP/ initial change in spending
o Change in GDP = Multiplier X initial change in spending
o Works in both directions
o Caused by changes in C, G, I, X
o The economy supports repetitive continuous flows of expenditures
and income through which dollars spent are received by income to be
spent and become income
Multiplier and Marginal Propensities
o The MPS determines the cumulative respending effects of any initial
change in spending and therefore determines multiplier
o MPS and multiplier are inversely related
o The smaller the fraction of any change in income saved, the greater
the respending at each round, therefore the greater the multiplier
o M = 1/MPS
o M = 1/ 1-MPC
Significance of the Multiplier
o That a small change in the investment plans of businesses or in the
consumption and saving plans of households can trigger a larger
change in the equilibrium GDP
International Trade and Equilibrium Output
o Exports create domestic production, income and employment for a
o Added as a component of each nation’s aggregate expenditures
o Imports reduces domestic production
o C + I + (X-M)
o Net export > 0 increase aggregate expenditures and GDP beyond what
they would be in a closed economy
o Net export < 0 reduce aggregate expenditures and GDP below what
they would be in a closed economy
Public Sector
o Adding government spending and taxes to the model
o Assumptions
o Levels of investment and net exports are independent of the
level of GDP
o Government purchases neither depress nor stimulate private
o Government net tax revenues derived entirely from personal
o A fixed amount of taxes is collected
o Price level is constant
o Government purchases
o Increases in public spending, like increase in private spending
shift the aggregate expenditures schedule upward and result in a
higher equilibrium GDP
o Government Taxation
o Lump sum tax
 Which is a tax of a constant amount or more precisely a
tax yielding the same amount of tax revenue at each level
of GDP
 Taxes cause disposable income to fall short of GDP by
the amount of the taxes.
 This decline of DI reduces both consumption and
saving at each level of GDP
 The MPC and the MPS determine the declines in C
and S
 Increases in taxes lower the aggregate expenditures
schedule and reduce the equilibrium GDP
Balanced Budget Multiplier
o Equal increases in government spending and in taxation increase the
equilibrium GEP
o If G and T are each increased by a particular amount, the equilibrium
level of real output will rise by the same amount
o Government spending has a direct and unadulterated impact on
aggregate expenditures
o Change in taxes affects aggregate expenditures indirectly by
changing disposable income and thereby changing consumption
o Equal increases in G and T expand GDP by an amount equal to
those increases
Equilibrium VS Full-Employment GDP
o Recessionary GAP
o Is the amount by which aggregate expenditure at the full
employment GDP fall short of those required to achieve the full
employment GDP
o Inflationary GAP
o Is the amount by which an economy’s aggregate expenditures at
the full employment GDP exceed those just necessary to
achieve the full employment GDP