PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
The Aggregate
Expenditures Model
11
LEARNING OBJECTIVES
LO11.1
LO11.2
LO11.3
LO11.4
LO11.5
LO11.6
LO11.7
LO11.8
Explain how sticky prices relate to the aggregate expenditures model.
Explain how an economy’s investment schedule is derived from the investment demand curve
and an interest rate.
Illustrate how economists combine consumption and investment to depict an aggregate
expenditures schedule and equilibrium output for a private closed economy.
Discuss the two other ways to characterize the equilibrium level of real GDP in a private closed
economy: (1) saving = investment and (2) unplanned changes in inventories.
Analyze how changes in equilibrium GDP can occur in the aggregate expenditures model and
how those changes relate to the multiplier.
Explain how economists integrate the international sector (exports and imports) into the
aggregate expenditures model.
Explain how economists integrate the public sector (government expenditures and taxes) into
the aggregate expenditures model.
Differentiate between equilibrium GDP and full-employment GDP, and identify and describe the
nature and causes of recessionary expenditure gaps and inflationary expenditure gaps.
© 2016 McGraw‐Hill Education Limited
11-2
11.1
The Aggregate Expenditures
Model: Consumption and Saving
Assumptions and Simplifications
• Use the Keynesian aggregate expenditures model
• Prices are fixed
• GDP = DI
• Begin with private, closed economy
• Consumption spending
• Investment spending
LO1
© 2016 McGraw‐Hill Education Limited
11-3
The Investment Demand Curve and the Investment
Schedule
FIGURE 11-1
Investment
demand
curve
8
20
ID
Investment Schedule
Investment (billions of dollars)
r and i (percent)
Investment Demand Curve
Investment
schedule
Ig
20
20
20
Investment
(billions of dollars)
(a)
Investment demand curve
LO2
© 2016 McGraw‐Hill Education Limited
Real domestic product, GDP
(billions of dollars)
(b)
Investment schedule
11-4
TABLE 11-1
LO2
The Investment Schedule (in billions)
(1) Level of real output and income
(2) Investment (Ig)
$370
$20
390
20
410
20
430
20
450
20
470
20
490
20
510
20
530
20
550
20
© 2016 McGraw‐Hill Education Limited
11-5
TABLE 11-2
Determination of the Equilibrium Levels of Employment,
Output, and Income: A Private Closed Economy
(2)
Real
Domestic
Output (and
Income)
(GDP =DI)
(billions)
(3)
Consumption
(C) (billions)
(4)
Saving (S)
(billions)
(1) 2.5
$370
$375
(2) 5.0
390
(3) 7.5
(1)
Possible
Levels of
Employment
(millions)
(5)
Investment
(Ig)
(billions)
(6)
Aggregate
Expenditure
(C + Ig)
(billions)
(7)
Unplanned
Changes in
Inventories
(+) or (-)
(8)
Tendency of
Employment,
Output, and
Income
$-5
$20
$395
$-25
Increase
390
0
20
410
-20
Increase
410
405
5
20
425
-15
Increase
(4) 10.0
430
420
10
20
440
-10
Increase
(5) 12.5
450
435
15
20
455
-5
Increase
(6) 15.0
470
450
20
20
470
0
Equilibrium
(7) 17.5
490
465
25
20
485
+5
Decrease
(8) 20.0
510
480
30
20
500
+10
Decrease
(9) 22.5
530
495
35
20
515
+15
Decrease
(10) 25.0
550
510
40
20
530
+20
Decrease
* If depreciation
and net
foreign
that all9.1
saving occurs in the household sector of the
©2013 McGraw-Hill
Ryerson
Ltd. factor income are zero, government is ignored and it is assumed Chapter
economy, then GDP as a measure of domestic output is equal to NI,PI, and DI. Household income = GDP
LO3
© 2016 McGraw‐Hill Education Limited
6
11-6
KEY GRAPH - Equilibrium GDP in a Private Closed
Economy
FIGURE 11-2
530
C + Ig
Aggregate expenditures, C + Ig (billions of dollars)
510
(C + Ig = GDP)
490
470
450
C
Equilibrium
point
Aggregate
expenditures
Ig = $20 billion
430
410
390
C = $450 billion
370
45°
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
LO3
© 2016 McGraw‐Hill Education Limited
11-7
11.4
Other Features of Equilibrium
GDP
SAVING EQUALS PLANNED INVESTMENT
• saving represents a leakage of spending
• investment can be thought of as an injection of spending
NO UNPLANNED CHANGES IN INVENTORIES
• unplanned increases in inventories result when firms produce
above-equilibrium GDP output level
• unplanned decreases in inventories result when firms produce
below-equilibrium GDP output level
LO4
© 2016 McGraw‐Hill Education Limited
11-8
11.5
Changes in Equilibrium GDP
and the Multiplier
• In the private closed economy, the equilibrium GDP will
change in response to changes in either the investment
schedule or the consumption schedule
• Because changes in the investment schedule usually are the
main source of fluctuations, we direct our attention to
them…
LO5
© 2016 McGraw‐Hill Education Limited
11-9
Aggregate expenditures (billions of dollars)
FIGURE 11-3
Changes in the Aggregate Expenditure Schedule
and the Multiplier Effect
(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 domestic product, GDP (billions of dollars)
LO5
© 2016 McGraw‐Hill Education Limited
11-10
Adding International
11.6 Trade
Net Exports and Aggregate Expenditures
• Exports (X) create domestic production, income and
employment
• Imports (M) represent goods and services produced abroad
• In an open economy, aggregate spending is C+ Ig + Xn, where
Xn = (X - M)
• Xn can be either positive or negative
LO6
© 2016 McGraw‐Hill Education Limited
11-11
Adding International
11.6 Trade
Determinants of Net Export
• If GDP in other countries is growing, demand for our exports
will increase
• Our imports are dependent on our own GDP
• Both imports and exports are affected by the exchange rate
• depreciation
• appreciation
LO6
© 2016 McGraw‐Hill Education Limited
11-12
TABLE 11-3
LO6
Net Export Schedule
(1)
Domestic
output
(GDP = DI)
(billions)
(2)
Exports
(X)
(billions)
(3)
Imports
(M)
(billions)
(4)
Net Exports
(Xn )
(2)- (3)
(billions)
$370
$40
$15
$+25
390
40
20
+20
(20-15)/(390-370) = 0.25
410
40
25
+15
0.25
430
40
30
+10
0.25
450
40
35
+5
0.25
470
40
40
0
0.25
490
40
45
-5
0.25
510
40
50
-10
0.25
530
40
55
-15
0.25
550
40
60
-20
0.25
© 2016 McGraw‐Hill Education Limited
(5)
Marginal
propensity to import
(MPM)
Δ(3)/Δ(1)
11-13
Adding International
11.6 Trade
Imports and the Multiplier
• Marginal Propensity to Import (MPM)
• MPM = ΔM (import) / ΔGDP
• MPM is the slope of net export schedule
• Open Economy Multiplier
•
•
•
•
The closed economy the multiplier is 1/MPS
Expenditure on imports is a leakage
Open economy multiplier = 1/ (MPS + MPM)
From the data of Table 11-3:
• Multiplier = 1/(0.25+0.25) = 2
LO6
© 2016 McGraw‐Hill Education Limited
11-14
TABLE 11-4
LO6
Determinants of the Equilibrium Levels of Output and
Income in an Open Economy (Without Government)
(1)
Domestic Output
(and Income)
(GDP = DI),
(billions)
(2)
Aggregate
Expenditures for
private economy
(no G)
(C+Ig),
(billions)
(4)
Imports
(M)
(billions)
(5)
Net Exports,
Xn
(3)- (4)
(billions)
(6)
Aggregate
Expenditures for
open economy
(no G)
(C+Ig+Xn),
(billions)
(3)
Exports
(X)
(billions)
$370
$395
$40
$15
$+25
$420
390
410
40
20
+20
430
410
425
40
25
+15
440
430
440
40
30
+10
450
450
455
40
35
+5
460
470
470
40
40
0
470
490
485
40
45
-5
480
510
500
40
50
-10
490
530
515
40
55
-15
500
550
530
40
60
-20
510
© 2016 McGraw‐Hill Education Limited
11-15
FIGURE 11-4
Net Exports and the Equilibrium GDP
(C + Ig+Xn)1
(C + Ig+Xn)0
(C + Ig+Xn)2
Aggregate expenditures
(billions of dollars)
510
Aggregate expenditures
490 with positive
net exports
Aggregate expenditures
with negative net
exports
470
450
430
45°
430
450
470
490
510
Real domestic product GDP (billions of dollars)
LO6
© 2016 McGraw‐Hill Education Limited
11-16
Adding International
11.6 Trade
Net Exports and Equilibrium GDP
• A decline in net exports decreases aggregate expenditures and
reduces GDP
• A rise in net exports increases aggregate expenditures and increases
GDP
LO6
© 2016 McGraw‐Hill Education Limited
11-17
Adding International
11.6 Trade
International Economic Linkages
• Prosperity Abroad
• Exchange Rates
• Tariffs and Devaluations
LO6
© 2016 McGraw‐Hill Education Limited
11-18
11.1 GLOBAL PERSPECTIVE
Net Exports of Goods, Selected Nations, 2014
Source: CIA World Factbook, www.cia.gov
LO6
© 2016 McGraw‐Hill Education Limited
11-19
11.7 Adding the Public Sector
Simplifying Assumptions
• government purchases do not cause any shift in
consumption or investment schedules
• net tax revenues are derived totally from personal taxes
• taxes do not vary with GDP
LO7
© 2016 McGraw‐Hill Education Limited
11-20
11.7 Adding the Public Sector
Government Purchases and Equilibrium GDP
• Increases in public spending shift the AE schedule
upward and result in higher equilibrium GDP
• Examples
• suppose government add $40 billion of purchases
• suppose government also imposes $40 billion of lump-
sum tax
LO7
© 2016 McGraw‐Hill Education Limited
11-21
TABLE 11-5
(1)
Real Domestic
Output and
Income
(GDP=DI)
(billions
The Impact of Government Purchases on Equilibrium
GDP
(5)
Net Exports
(Xn) (billions)
Imports
(M)
(6)
Government
Purchases
(G) (billions)
(7)
Aggregate
Expenditures
(C+Ig+Xn+G)
(billions)
(2)+(4)+(5)+(6)
(2)
Consumption (C)
(billions)
(3)
Saving (S)
(billions)
(4)
Investment
(Ig)
(billions)
(1) $370
$375
$-5
$20
$40
$15
$40
$460
(2) 390
390
0
20
40
20
40
470
(3) 410
405
5
20
40
25
40
480
(4) 430
420
10
20
40
30
40
490
(5) 450
435
15
20
40
35
40
500
(6) 470
450
20
20
40
40
40
510
(7) 490
465
25
20
40
45
40
520
(8) 510
480
30
20
40
50
40
530
(9) 530
495
35
20
40
55
40
540
(10) 550
510
40
20
40
60
40
550
LO7
Exports
(X)
© 2016 McGraw‐Hill Education Limited
11-22
Aggregate expenditures (billions of dollars)
FIGURE 11-5
Government Spending and the Equilibrium GDP
C + Ig + Xn + G
C + Ig + X n
C
Government spending
of $40 billion
45°
470
550
Real domestic product, GDP (billions of dollars)
LO7
© 2016 McGraw‐Hill Education Limited
11-23
TABLE 11-6 Determination of the Equilibrium Levels of Employment,
Output, and Income (in billions): Private and Public Sectors
(7)
Net Exports
(Xn)
Imports
(M)
(8)
Government Purchases
(G)
(9)
Aggregate
Expenditures
(C+Ig+Xn
+G)
(4)+(6)+(7)+(
8)
$40
$15
$40
$440
20
40
20
40
450
-5
20
40
25
40
460
390
0
20
40
30
40
470
410
405
5
20
40
35
40
480
40
430
420
10
20
40
40
40
490
(7) 490
40
450
435
15
20
40
45
40
500
(8) 510
40
470
450
20
20
40
50
40
510
(9) 530
40
490
465
25
20
40
55
40
520
(10) 550
40
510
480
30
20
40
60
40
530
(1)
Real
Domestic
Output and
Income
(GDP=DI)
(2)
Taxes
(T)
(3)
Disposable
Income (DI)
(1) - (2)
(4)
Consumption (C)
(5)
Saving (S)
(3) - (4)
(6)
Investment (Ig)
Exports
(X)
(1) $370
$40
$330
$345
$-15
$20
(2) 390
40
350
360
-10
(3) 410
40
370
375
(4) 430
40
390
(5) 450
40
(6) 470
LO7
© 2016 McGraw‐Hill Education Limited
11-24
FIGURE 11-6
Taxes and the Equilibrium GDP
C + Ig + Xn + G
Aggregate expenditures (billions of dollars)
Ca + Ig + Xn + G
$20 billion
decrease on
aggregate
expenditure.
45°
510
550
Real domestic product, GDP (billions of dollars)
LO7
© 2016 McGraw‐Hill Education Limited
11-25
11.7 Adding the Public Sector
Taxes and Equilibrium GDP
• Differential Impacts
• Equal changes in G and T do not have equivalent impacts on GDP
• Injections, Leakages, and Unplanned Changes in Inventories
Sa+ M + T = Ig + X +G
LO7
© 2016 McGraw‐Hill Education Limited
11-26
11.8
Equilibrium versus FullEmployment GDP
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
LO8
© 2016 McGraw‐Hill Education Limited
11-27
FIGURE 11-7
Recessionary and Inflationary Expenditure Gaps
Aggregate expenditures
(billions of dollars)
AE0
AE1
530
510
Recessionary
expenditure
gap = $10 billion
490
Full
employment
45°
490
510
530
Real GDP
(a)
Recessionary expenditure gap
LO8
© 2016 McGraw‐Hill Education Limited
11-28
Aggregate expenditures
(billions of dollars)
FIGURE 11-7
Recessionary and Inflationary Expenditure Gaps
AE2
530
Inflationary
expenditure
gap = $10 billion
AE0
510
Full
employment
490
45°
490
510
530
Real GDP
(b)
Inflationary expenditure gap
LO8
© 2016 McGraw‐Hill Education Limited
11-29
11.8
Equilibrium versus FullEmployment GDP
Application: The Recession of 2008-2009
• Late 2008 recession began
• Aggregate expenditures declined
• Consumption spending declined
• Investment spending declined
• Recessionary expenditure gap
• The federal government undertook various Keynesian policies in
2008 and 2009 to try to eliminate the recessionary expenditure gap.
LO8
© 2016 McGraw‐Hill Education Limited
11-30
The LAST
WORD
Say’s Law, the Great
Depression, and Keynes
• Classical economics
• Say’s Law
• Economy will automatically adjust
• Laissez-faire
• Keynesian economics
• Cyclical unemployment can occur
• Economy will not correct itself
• Government should actively manage macroeconomic instability
© 2016 McGraw‐Hill Education Limited
11-31
Chapter Summary
LO11.1 Explain how sticky prices relate to the aggregate expenditures model.
LO11.2 Explain how an economy’s investment schedule is derived from the
investment demand curve and an interest rate.
LO11.3 Illustrate how economists combine consumption and investment to depict
an aggregate expenditures schedule and equilibrium output for a private closed
economy.
LO11.4 Discuss the two other ways to characterize the equilibrium level of real GDP in a
private closed economy: (1) saving = investment and (2) unplanned changes in
inventories.
LO11.5 Analyze how changes in equilibrium GDP can occur in the aggregate
expenditures model and how those changes relate to the multiplier.
LO11.6 Explain how economists integrate the international sector (exports and imports)
into the aggregate expenditures model.
LO11.7 Explain how economists integrate the public sector (government expenditures and
taxes) into the aggregate expenditures model.
LO11.8 Differentiate between equilibrium GDP and full-employment GDP, and identify and
describe the nature and causes of recessionary expenditure gaps and inflationary
expenditure gaps.
© 2016 McGraw‐Hill Education Limited
11-31