Aggregate Expenditure Model Flashcards

Flashcards from Lecture Notes

Aggregate Expenditure Model (Keynesian Theory)

An alternative to the Classical theory (the Aggregate Demand – Aggregate Supply model). It explains the cause of deflation (unemployment problem) and cause of inflation (overemployment) problem.

Goal of the Aggregate Expenditure Curve

Explain how aggregate output supplied or (real GDP supplied) by firms is determined. Explain when aggregate output supplied or (real GDP supplied) by firms is either too small (recessionary), too large (inflationary), or ideal (neither recessionary nor inflationary). Explain how the Federal Government can influence aggregate output through spending and taxing (Fiscal Policy).

Aggregate Expenditures (AE)

The sum of households' planned expenditures on consumer goods (C), business firms’ planned expenditures on capital goods (I), planned government expenditures on public goods (G), and planned net expenditures by foreign buyers (Net Exports or NX, calculated as Exports minus Imports). AE = C + I + G + NX

45 Degree Line

A line where every point on the line has the same number on the vertical axis as on the horizontal axis; the slope of the curve is equal to the number 1; Every point above the 450 line Expenditures is greater the aggregate income; Every point below the 450 line, Expenditures is less than aggregate income; used to identify equilibrium aggregate income and aggregate output which is measured by real GDP

Consumption (C)

Planned household expenditures on currently produced consumer goods, assumed to be dependent on the level of aggregate income (Y). C = f(Y)

First Law of Consumption

If aggregate income (Y) increases, then Consumption (C) will increase, or if aggregate income (Y) decreases, Consumption (C) will decrease.

Second Law of Consumption

If aggregate income (Y) increases, then the increase in Consumption (C) will be less than the increase in aggregate income (Y), because households have a propensity to save part of any increase in aggregate income (Y).

Marginal Propensity to Consume (MPC)

The fraction of extra income (Y) households are expected to spend on consumer goods (C). MPC = ΔC / ΔY

Factors that Shift the Consumption Curve

Changes in taxes, interest rates, expectations of future price increases, or a decrease in the value of the dollar relative to other currencies.

Investment Spending Curve

Investment spending is assumed to be independent of aggregate income, which means the Investment curve will be drawn parallel to the horizontal axis.

Government Expenditures Curve

Government Expenditures assumed to be independent of Aggregate income, which means Government Expenditure is a fixed number and is drawn parallel to the horizontal axis

Net Exports Curve

Net Exports is assumed to be independent of aggregate income, which means Net exports curve will be drawn parallel to the horizontal axis.

Keynesian Equilibrium

Occurs when Aggregate Expenditure (AE) equals Aggregate Output (Y). In Keynesian theory, macroeconomic equilibrium occurs when planned purchases of real GDP by buyers (AE) = planned production of real GDP by firms (Y).

Keynes’ Law

Demand creates Supply

Keynesian Expenditure Multiplier

The effect of a shift in the Aggregate Expenditures curve. If the AE curve shifts by $1 trillion, the new equilibrium aggregate output (real GDP) produced increased by $3 trillion, because the increase in aggregate income induced an increase in Consumption of $2 trillion. Multiplier = (ΔYe) ÷ (Shift in AE)

Multiplier Effect

In every round the income of the previous round creates additional Consumption Spending = MPC of the income of the previous .round

Tax Multiplier Formula

Tax Multiplier = Expenditures Multiplier - 1; [ΔY/Change in Tax] = MPC ÷ (1-MPC)