Lecture Economics (18th edition): Chapter 28 - McConnell, Brue, Flynn''s

Chapter 28 - The aggregate expenditures model. In this chapter, you will learn to: Aggregate expenditures for a private closed economy, characteristics of equilibrium real GDP in a private closed economy, changes in equilibrium real GDP and the multiplier, adding the government and international sectors, recessionary and inflationary expenditure gaps.

The Aggregate Expenditures

Model

Chapter 28

Chapter Objectives

• Aggregate expenditures for a private closed economy

• Characteristics of equilibrium real

GDP in a private closed economy

• Changes in equilibrium real GDP

and the multiplier

• Adding the government and

international sectors

• Recessionary and inflationary

expenditure gaps

Model Simplifications

• Private closed economy

• Consumption and investment

only

• Prices are fixed

• Excess capacity exists

• Unemployed labor exists

• Disposable income = real GDP

–No taxes

Investment Schedule

Equilibrium GDP

• Aggregate expenditures

–Equal to C + I g

–Aggregate expenditures schedule

• Quantity goods produced =

quantity goods purchased

• Disequilibrium

–Only 1 equilibrium level of GDP

465 480 495 510

$-5 0 5 10 15

20

25 30 35 40

20 20 20 20 20

20

20 20 20 20

$395 410 425 440 455

470

485 500 515 530

$-25 -20 -15 -10 -5

0

+5 +10 +15 +20

Increase Increase Increase Increase Increase

Equilibrium

Decrease Decrease Decrease Decrease

Output (and Income)

(GDP=DI)

(3) Con- sump- tion (C)

(4) Saving (S) (1) – (2)

(5) Investment (I g )

(6) Aggregate Expenditures (C+I g )

(7) Unplanned Changes in Inventories (+ or -)

(8) Tendency of Employment, Output, and Income

C = $450 Billion

C + Ig

Equilibrium Point

Equilibrium GDP

(C + Ig)0

Decrease in Investment by 5

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

The Multiplier Effect

International Trade

• 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

Real GDP

C + Ig

Aggregate Expenditures with Negative Net Exports

C + Ig+Xn2

C + Ig+Xn1

Xn1

Xn2

Positive Net Exports

Negative Net Exports

Net Exports of Goods

Italy Germany

United Kingdom United States

Adding the Public Sector

• Lump sum taxes

–Taxes affect disposable income

–Consumption and the MPC

Adding the Public Sector

$-5 0 5 10 15 20 25 30 35

$20 20 20 20 20 20 20 20 20

10 10 10 10 10 10 10 10 10

20 20 20 20 20 20 20 20 20

$415 430 445 460 475 490 505 520 535

10 10 10 10 10 10 10 10 10

(4) Investment (I g )

(5) Net Exports (X n )

(6) Government (G)

(7) Aggregate Expenditures

(C+I g +X n +G)

(2)+(4)+(5)+(6)

Exports (X)

Imports (M)

…in Billions of Dollars

$80 Billion Increase

In GDP

Recessionary Expenditure Gap

GDP is below full employment

Recessionary Expenditure Gap = $5 Billion

$5 Billion Gap Yields

$20 Billion GDP Change

Inflationary Expenditure Gap

GDP is above full employment

AE0

AE2

Full Employment

Inflationary Expenditure

Gap Yields

$20 Billion GDP Change

The Complete Model

• GDP and full employment

• U.S economy late 1990’s

–Too much investment

–Stock market bubble

–Consumer debt

–Fraudulent business practice

• Aggregate expenditure falls

• U.S recession of 2001

• Terror attacks prolonged

The Great Depression

• Classical economics

– Mills and Ricardo

– Prices adjust to maintain full

employment

• Say’s Law

– Supply creates its own demand

• Depression challenged the theory

• New theory developed

– Keynes

– Aggregate expenditure model

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Aggregate Demand

and Aggregate Supply