Aggregate expenditure and Aggregate demand
•
•
•
•
•
•
Aggregate expenditure line
Real GDP demanded
Changes in aggregate expenditure
Simple spending multiplier
Changes in the price level
Aggregate demand curve
AE = C + I + G + (X – M)
Aggregate expenditure line: A
relationship tracing, for a given
price level, planned spending at
each level of income or real GDP
Aggregate expenditure
(trillions of dollars)
Incomeexpenditure line
450
0
At every point on this line, planned spending is
equal to real GDP—so unplanned investment is
zero
Real GDP
(trillions of dollars)
Haley’s Hammers 2007 Investment
Plans
Planned spending for new plant
and equipment . . . . . . . . . . . . . . . . . . . . . .$95,000
Planned inventory investment . . . . . . . . . . . . . . . . .0
Actual inventory investment . . . . . . . . . . . . . .3,500
Actual investment . . . . . . . . . . . .. . . . . . . . $98,500
Remember, that:
Actual I = Planned I + Unplanned I
We normally cut back on
production when
we see our inventories piling
up.
Aggregate expenditure (trillions of dollars)
Deriving the real GDP demanded for a given price level
d
15.0
C+I+G+(X-M)
14.8
c
e
14.0
13.2
b
13.0
a
Real GDP demanded for a given
price level is found where
aggregate expenditure equals
aggregate output – that is, where
spending equals the amount
produced, or real GDP.
This occurs at point e, where the
aggregate expenditure line
intersects the 45-degree line.
45°
0
13.0
14.0
15.0
Real GDP
(trillions of dollars)
6
When Real GDP = $14 trillion
• Planned spending of households, firms,
government units, and foreigners is equal to
real output; thus the plans of producing and
spending units “match up.”
• Firms on average experience zero unplanned
investment.
• Firms on average have nor reason to ‘scale up’
or ‘scale down’ production.
Effect of an increase in investment on real
GDP demanded
Aggregate expenditure (trillions of dollars)
C+I’+G+(X-M)
e’
14.5
j
i
f
14.1
A $0.1 trillion increase in
investment shifts the AE line up
vertically by $0.1 trillion.
Real GDP increases until it equals
spending at point e’.
As a result of the $0.1 trillion
increase in investment, real GDP
demanded increases by $0.5
trillion, to $14.5 trillion.
k
h
g
14.0
C+I+G+(X-M)
e
0.1
45°
Real GDP
(trillions of dollars)
The economy is initially at point e, where spending=real GDP demanded = $14.0 trillion.
0
14.0 14.1
14.5
8
Tracking the rounds of spending following a $100
billion increase in investment (billions of dollars)
Assume that MPC = 0.8 and MPS = 0.6
Round
1
2
3
.
.
.
10
.
.
.
∞
New spending
this round
100
80
64
.
.
.
13.4
.
.
.
0
Cumulative
new spending
100
180
244
.
.
.
446.3
.
.
.
500
New saving
this round
20
16
.
.
.
3.35
.
.
.
0
Cumulative
new saving
20
36
.
.
.
86.6
.
.
.
100
9
1
1
k

1  MPC MPS
Note that:
1
1
GDP  I 
 $0.1trillion 
 $0.5trillion
1  MPC
1  0.8
The income-expenditure approach and the AD
curve
AE” (P=120)
Aggregate expenditure
(trillions of dollars)
(a)
e’’
AE (P=130)
AE’ (P=140)
e
At the higher price level of 140, the
AE line shifts down to AE’, and real
GDP demanded falls to $13.5 trillion:
point e’ on panel (b).
e’
45°
0
13.5
14.0
Real GDP At the lower price level of 120, the AE
(trillions of dollars) line shifts up to AE’’, and real GDP
14.5
demanded increases to $14.5 trillion:
point e” on panel (b).
e’
Price level
140
(b)
130
e
120
e’’
AD
0
At the initial price level =130, the AE
line identifies real GDP demanded
of $14.0 trillion: point e on panel
(b).
13.5
14.0
14.5
Connecting e, e’, and e’’ yields the
downward-sloping AD curve.
Real GDP (trillions of dollars)
11
A shift of AE line that shifts the AD curve
C+I’+G+(X-M)
Aggregate expenditure
(trillions of dollars)
(a)
e’
C+I+G+(X-M)
0.1
e
45°
Price level
0
130
(b)
14.0
e
14.5
Real GDP
(trillions of dollars)
e’
AD
0
14.0
14.5
A shift of the AE line at a given price
level shifts the AD curve.
In (a), an increase in investment of
$0.1 trillion, with the price level
constant at 130, causes the
aggregate expenditure line to
increase from C+I+G+(X-M) to
C+I’+G+(X-M). As a result, real DGP
demanded increases from $14.0
trillion to $14.5 trillion. In (b), the
aggregate demand curve has shifted
from AD to AD’. At the prevailing
price level of 130, real GDP
demanded has increased by $0.5
trilion.
AD’
Real GDP (trillions of dollars)
Effect of a shift of autonomous spending on
real GDP demanded
Aggregate expenditure
(trillions of dollars)
C+I’+G+(X-M)
0
e’
C+I+G+(X-M)
e
$0.1
An increase in investment,
other things constant, shifts
the spending line up from
C+I+G+(X-M) to C+I’+G+(XM), increasing the quantity of
real GDP demanded.
45°
Real GDP
14.0 14.333
(trillions of dollars)
13