11

The Aggregate
Expenditures Model

McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Assumptions and Simplifications

Use the Keynesian aggregate

LO1

expenditures model
Prices are fixed
GDP = DI
Begin with private, closed economy
Consumption spending
Investment spending
11-2

Consumption and Investment

Investment
demand
curve
8

20

ID
20

Investment
(billions of dollars)
(a)
Investment demand curve

LO1

Investment Schedule
Investment (billions of dollars)

r and i (percent)

Investment Demand Curve

Investment
schedule

Ig

20

20

Real domestic product, GDP

(billions of dollars)
(b)
Investment schedule

11-3

Equilibrium GDP
Determination of the Equilibrium Levels of Employment, Output, and Income: A Private Closed Economy
(2)
Real
Domestic
Output
(and
Income)
(GDP =
DI),*Billio
ns

(3)
Consumption
(C),
Billions

(1) 40

$370

(2) 45

(4)
Saving
(S),
Billions

(5)
Investment
(Ig),
Billions

(6)
Aggregate
Expenditure
(C+Ig),
Billions

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

$375

$-5

$20

$395

$-25

Increase

390

390

20

410

-20

Increase

(3) 50

410

405

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

(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

(1)
Possible
Levels of
Employment,
Millions

(8)
Tendency of
Employment,
Output, and
Income

Equilibrium

* If depreciation and net foreign factor income are zero, government is ignored and it is assumed that all saving occurs in the household sector of the
economy, then GDP as a measure of domestic output is equal to NI,PI, and DI. Household income = GDP

LO1

11-4

Aggregate expenditures, C + Ig (billions of dollars)

Equilibrium GDP
530
510
490
470
450

(C + Ig = GDP)
Equilibrium
point
Aggregate
expenditures

430

C + Ig
C

Ig = $20 billion

410
390
370

C = $450 billion

45
370 390 410 430 450 470 490 510 530 550

Real domestic product, GDP (billions of dollars)

LO1

11-5

Planned and Unplanned

Expenditures
Aggregate expenditure equals
aggregate income and real GDP.
But aggregate planned
expenditure might not equal real
GDP because firms can end up
with larger or smaller inventories
than they had intended.

 Production takes time

Production for contract and
production for market.

Production

Inventories

Sales

Aesops Bottles B.C. 400

Investment Plans
Planned spending on buildings, equipment,
and tools

20,000 drachmas

Planned inventory investment

0 drachmas

Value of inventories on Dec. 31, 401 B. C.

11,000 drachmas

Value of inventories on Dec. 31, 400 B.C.

13,500 drachmas

Unplanned inventory investment in 400 B.C.

2,500 drachmas

Actual investment in 400 B.C.

22,500 drachmas

Other Features of Equilibrium GDP

Saving equals planned investment

Saving is a leakage of spending
Investment is an injection of

LO2

spending
No unplanned changes in inventories
Firms do not change production

11-9

Changes in Equilibrium GDP

Aggregate expenditures (billions of dollars)

510

(C + Ig)1
(C + Ig)0
(C + Ig)2

490

Increase in
investment

470

Decrease in
investment

450

430

45
430

450

470

490

510

Real domestic product, GDP (billions of dollars)

LO3

11-10

Adding International Trade

Include net exports spending in

LO4

aggregate expenditures
Private, open economy
Exports create production,
employment, and income
Subtract spending on imports
Xn can be positive or negative

11-11

The Net Export Schedule

Two Net Export Schedules (in Billions)

LO4

(1)
Level of GDP

(2)
Net Exports,
Xn1 (X > M)

(3)
Net Exports,
Xn2 (X < M)

$370

$+5

$-5

390

+5

-5

410

+5

-5

430

+5

-5

450

+5

-5

470

+5

-5

490

+5

-5

510

+5

-5

530

+5

-5

550

+5

-5
11-12

Net Exports and Equilibrium GDP

Aggregate expenditures
(billions of dollars)

510

490

C + Ig+Xn1
C + Ig
C + Ig+Xn2

Aggregate expenditures
with positive
net exports

470

Aggregate expenditures
with negative net
exports

450

430

45

Net exports, Xn
(billions of
dollars)

430

LO4

450

470

490

510

Real domestic product GDP (billions of dollars)

+5
0
-5

Positive net exports

450
470
Negative net exports

Xn1
490

Real

Xn2 GDP
11-13

International Economic Linkages

Prosperity abroad
Can increase U.S. exports
Exchange rates
Depreciate the dollar to increase

LO4

exports
A caution on tariffs and devaluations
Other countries may retaliate
Lower GDP for all
11-14

Global Perspective

Source: World Trade Organization, http://www.wto.org.

LO4

11-15

Adding the Public Sector

Government purchases and

LO4

equilibrium GDP
Government spending is subject to
the multiplier
Taxation and equilibrium GDP
Lump sum tax
Taxes are subject to the multiplier
DI = GDP
11-16

Government Purchases and Eq.

GDP
The Impact of Government Purchases on Equilibrium GDP
(1)
Real
Domestic
Output and
Income
(GDP=DI),
Billions

(5)
Net Exports
(Xn), Billions
Imports
(M)

(6)
Government
Purchases
(G), Billions

(7)
Aggregate
Expenditures
(C+Ig+Xn+G),
Billions
(2)+(4)+(5)+(6)

$10

$10

$20

$415

20

10

10

20

430

20

10

10

20

445

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

(2)
Consumption
(C),
Billions

(3)
Saving (S),
Billions

(4)
Investment
(Ig),
Billions

Exports
(X)

(1) $370

$375

$-5

$20

(2) 390

390

(3) 410

405

(4) 430

LO4

11-17

Aggregate expenditures (billions of dollars)

Government Purchases and Eq.

GDP
C + Ig + X n + G
C + Ig + Xn
C

Government spending
of $20 billion

45
470

550

Real domestic product, GDP (billions of dollars)

LO4

11-18

Taxation and Equilibrium GDP

Determination of the Equilibrium Levels of Employment, Output, and Income: Private and Public Sectors
(1)
Real
Domestic
Output
and
Income
(GDP=DI),
Billions

(7)
Net Exports
(Xn), Billions

(9)
Aggregate
Expenditures
(C+Ig+Xn
+G),
Billions
(4)+(6)+(7)
+(8)

(2)
Taxes
(T),
Billions

(3)
Disposable
Income
(DI),
Billions,
(1)-(2)

(4)
Consumption (C),
Billions

(5)
Saving
(S),
Billions

(6)
Investment (Ig),
Billions

Export
s
(X)

Import
s
(M)

(8)
Government
Purchases
(G),
Billions

(1) $370

$20

$350

$360

$-10

$20

$10

$10

$20

$400

(2) 390

20

370

375

-5

20

10

10

20

415

(3) 410

20

390

390

20

10

10

20

430

(4) 430

20

410

405

20

10

10

20

445

(5) 450

20

430

420

10

20

10

10

20

460

(6) 470

20

450

435

15

20

10

10

20

475

(7) 490

20

470

450

20

20

10

10

20

490

(8) 510

20

490

465

25

20

10

10

20

505

(9) 530

20

510

480

30

20

10

10

20

520

(10) 550

20

530

495

35

20

10

10

20

535

LO4

11-19

Aggregate expenditures (billions of dollars)

Taxation and Equilibrium GDP

C + Ig + X n + G
Ca + Ig + Xn + G

$15 billion
decrease in
consumption
from a
$20 billion
increase
in taxes

45
490

550

Real domestic product, GDP (billions of dollars)

LO4

11-20

Equilibrium versus FullEmployment

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
LO5

11-21

Aggregate expenditures
(billions of dollars)

Equilibrium versus FullEmployment

AE0
AE1

530

510

Recessionary
expenditure
gap = $5 billion

490

Full
employment
45
490

510

530

Real GDP
(a)
Recessionary expenditure gap
LO5

11-22

Aggregate expenditures
(billions of dollars)

Equilibrium versus FullEmployment

AE2
530

Inflationary
expenditure
gap = $5 billion

AE0

510

490

Full
employment
45
490

510

530

Real GDP
(b)
(billions of dollars)
LO5

11-23

Application: The Recession of

2007-09

December 2007 recession began

Aggregate expenditures declined
Consumption spending declined
Investment spending declined
Recessionary expenditure gap

LO5

11-24

Application: The Recession of

2007-09
Federal government undertook
Keynesian policies
Tax rebate checks
$787 billion stimulus package

LO5

11-25

Says Law, Great Depression,

Keynes
Classical economics
Says Law
Economy will automatically adjust
Laissez-faire
Keynesian economics
Cyclical unemployment can occur
Economy will not correct itself
Government should actively manage
macroeconomic instability
11-26

Says Law1
Supply creates its own demand.
By producing goods and services,
firms create a total demand for
goods and services equal to what
they have produced.
Says law apparently
rules out the
possibility of a
widespread glut of
goods.

J.B. Say. Treatise on Political Economy, 1803.

Simplified Circular Flow

Keynes: No
guarantee
that S will
be offset by
Planned I

In
co
m

Households

Resource
Markets

Product
Markets

cto
Fa
nts
me
ay
rP

Firms

The Classical view

Market industrialized economies are

inherently stable and tend automatically to
full employment.
Government policies that aim to improve the
performance of the economy do more harm
than good.
Laissez-faire.

The Keynesian View

Market, industrialized economies are inherently
unstable and do not automatically tend to full
employment.
Private spending (and most importantly,
investment spending) is volatilecausing
business cycle fluctuations.
The economy needs to be stabilized, the
economy can be stabilized, the economy should
be stabilized (Franco Modigliani).
Keynesian economics is an attack on the Classical
theory.
John Maynard Keynes (1936). The General Theory of
Employment, Interest, and Money

J.M. Keynes