Chapter 29 - The Aggregate Expenditures Model

McConnell Brue Flynn 20e

DISCUSSION QUESTIONS
3. Why is saving called a leakage? Why is planned investment called an injection? Why must saving equal
planned investment at equilibrium GDP in the private closed economy? Are unplanned changes in
inventories rising, falling, or constant at equilibrium GDP? Explain. LO4
Answer: Saving is like a leakage from the flow of aggregate consumption expenditures because
saving represents income not spent. Planned investment is an injection because it is spending on
capital goods that businesses plan to make regardless of their current level of income. If the two
are unequal, there will be a discrepancy between spending and production that will result in
unplanned inventory changes. Firms, not wanting inventory levels to change, will change
production, implying that equilibrium can only occur when the saving leakage equals the injection
of investment spending in a private closed economy.
At equilibrium GDP there will be no changes in unplanned inventories because expenditures will
exactly equal planned output levels which include consumer goods and services and planned
investment. Thus there is no unplanned investment including no unplanned inventory changes.
4. Other things equal, what effect will each of the following changes independently have on the
equilibrium level of real GDP in the private closed economy? LO4
a. A decline in the real interest rate.
b. An overall decrease in the expected rate of return on investment.
c. A sizeable, sustained increase in stock prices.
Answer: a. This will increase interest-sensitive consumer purchases and investment, causing GDP
to increase.
b. Investment will decrease because of the lower expected rate of return, causing GDP to increase.
c. By increasing consumption (because households will feelor bemore wealthy, or because
they are hopeful about an expansion) and by increasing investment, the AE schedule will shift
upward, causing the GDP to increase.
PROBLEMS
3. By how much will GDP change if firms increase their investment by $8 billion and the MPC is .80? If
the MPC is .67? LO5
Answer: $40; $24.24
Feedback: First, we need to find the expenditure multiplier. The expenditure multiplier can be
found by dividing one by one minus the marginal propensity to consume.
Expenditure multiplier = 1/(1-MPC)
For our first value, we have an expenditure multiplier of 5 (= 1/(1-0.8)).
For our second value, we have an expenditure multiplier of 3.0303 (= 1/(1-0.67)). Some students
may round this 3.
Second, to find the change in GDP we take the expenditure multiplier and multiply this value by
the change in investment.
For our first MPC value, the change in GDP equals $40 (= 5 x $8).

For our second MPC, the change in GDP equals $24.24 (= 3.0303 x $8). Some students may
round this answer to $24 (= 3 x $8).
5. The data in columns 1 and 2 in the accompanying table are for a private closed economy: LO6

a. Use columns 1 and 2 to determine the equilibrium GDP for this hypothetical economy.
b. Now open up this economy to international trade by including the export and import figures of columns
3 and 4. Fill in columns 5 and 6 and determine the equilibrium GDP for the open economy. What is the
change in equilibrium GDP caused by the addition of net exports?
c. Given the original $20 billion level of exports, what would be net exports and the equilibrium GDP if
imports were $10 billion greater at each level of GDP?
d. What is the multiplier in this example?
Answer: a. 400
b. Column 5: -$ 10; -$ 10; -$ 10; -$ 10; -$ 10; -$ 10; -$ 10; -$ 10; Column 6: $ 230; $ 270;
$ 310; $ 350; $ 390; $ 430; $ 470; $ 510; Equilibrium GDP = 350; Change in equilibrium GDP =
-50
c. Net exports = -$ 20; -$ 20; -$ 20; -$ 20; -$ 20; -$ 20; -$ 20; -$ 20; Equilibrium GDP = $300
d. 5
Feedback: Part a:
a. Equilibrium for this economy occurs where Aggregate Expenditures for the Private Closed
Economy equals Real Gross Domestic Product. Thus, equilibrium is $400 billion.
Part b:
To find net exports we subtract imports from exports. These answers are reported in column 5
below. To find aggregate expenditures for the open economy add net exports to the aggregate
expenditures for the closed economy. These values are reported in column 6.

(1)
Real
domestic
output
(GDP=DI)
billions

(2)
Aggregate
Expenditures,
private closed
economy,
billions

$200
$250
$300
$350
$400
$450
$500
$550

$240
$280
$320
$360
$400
$440
$480
$520

(3)

(4)

(5)

(6)

Exports,
billions

Imports,
billions

Net
exports,
private
economy

Aggregate
expenditures,
open
billions

$20
$20
$20
$20
$20
$20
$20
$20

$30
$30
$30
$30
$30
$30
$30
$30

-$ 10
-$ 10
-$ 10
-$ 10
-$ 10
-$ 10
-$ 10
-$ 10

$ 230
$ 270
$ 310
$ 350
$ 390
$ 430
$ 470
$ 510

Equilibrium for this economy occurs where Aggregate Expenditures for the Private Open
Economy equals Real Gross Domestic Product. Thus, equilibrium is $350 billion. The change in
equilibrium GDP is a decrease of $50.
Part c:
If Imports were $10 billion greater at each level of GDP we would have the following table.
(1)
Real
domestic
output
(GDP=DI)
billions

(2)
Aggregate
Expenditures,
private closed
economy,
billions

$200
$250
$300
$350
$400
$450
$500
$550

$240
$280
$320
$360
$400
$440
$480
$520

(3)

(4)

(5)

(6)

Exports,
billions

Imports,
billions

Net
exports,
private
economy

Aggregate
expenditures,
open
billions

$20
$20
$20
$20
$20
$20
$20
$20

$40
$40
$40
$40
$40
$40
$40
$40

-$ 20
-$ 20
-$ 20
-$ 20
-$ 20
-$ 20
-$ 20
-$ 20

$ 220
$ 260
$ 300
$ 340
$ 380
$ 420
$ 460
$ 500

Equilibrium for this economy occurs where Aggregate Expenditures for the Private Open
Economy equals Real Gross Domestic Product. Thus, equilibrium is $300 billion.
Part d:
To find the multiplier for this example we could use the standard approach using the marginal
propensity to consume or using the change in real GDP that results from the change in net exports.
We will use the latter approach here. The change in net exports equals -$10 billion. The change in
real GDP associated with the change in net exports is -$50.
Multiplier = real GDP/ net exports = -$50 billion/-$10 billion = 5