Macroeconomics - Chapter 31: The Aggregate Expenditures Model

aggregate expenditures model

an extreme version of a sticky price model

dealing with its ability to achieve equilibrium, it’s the assumption that production decisions are made in response to unexpected changes in inventory levels

what is a key assumption of the aggregate expenditures model?

1. consumption, C

2. gross investment, Ig

Note: aggregate expenditures = C + Ig

what are the two components of aggregate expenditures in a private closed economy?

planned investment

the amount that firms plan or intend to invest

investment schedule

shows the amounts business firms collectively intend to invest each possible level of GDP

aggregate expenditures schedule

a table of numbers showing the total amount spent on final goods and services at different levels of real GDP

equilibrium output

the output whose production creates total spending just sufficient to purchase that output

equilibrium GDP

occurs where the total quantity of goods produced (GDP) equals to total quantity of goods purchase (C + Ig); this is the only level of GDP that can be sustained and need not equal full employment GDP

spending exceeds GDP; business may try to fix the issue by stepping up production, increasing employment and total income. this is where aggregate expenditures exceed total output

what happens at GDP levels that are less than equilibrium?

here businesses find that their total output fails to generate the spending needed to clear the shelves of goods, and they will cut back on the rate of production; this leads to a decrease in jobs and total income

what happens at GDP levels that are more than equilibrium?

the value of what is measured on the horizontal axis (GDP, in this case) equals the value of what’s measure on the vertical axis (aggregate expenditures, in this case)

what is happening at any point on the 45 degree line?

occurs at the intersection of the aggregate expenditures schedule and the 45 degree line

where can you see equilibrium GDP on the graph?

• saving and planned investment are equal (S=Ig)

• there are no unplanned changes in inventories

list some other characteristics of equilibrium GDP

leakage

used to describe saving as a withdrawing of spending from the economy’s circular flow of income and expenditures; causes consumption to be less than total output or GDP; others include importing and paying taxes

injection

such as investment and exports; spending into the income-expenditures stream. these can be replacements for leakages

C + Ig will be less than GDP at that level of GDP can’t be sustained, for it is an above-equilibrium GDP

what happens if a leakage at a certain level of GDP exceeds injection?

C + Ig will be greater than GDP and drive GDP upward; any GDP for which investment exceeds savings is a below-equilibrium GDP

what happens if a leakage at a certain level of GDP is less than injection?

unplanned changes in inventories

changes in inventories that firms didn’t anticipate; can occur because of unexpected increases of decreases of aggregate spending; changes in inventories are a part of investment. this term encourages firms to expand production

planned investment and saving

what are economists referring to when they say that differences between investment and saving can occur and bring about changes in equilibrium GDP?

actual investment consists of planned and unplanned investment. unplanned changes in inventories act as a balancing item that equate the actual amounts save and invested in any period

why is it when unplanned changes in inventories are taken into account that investment and saving are always equal, regardless of the level of GDP?

net exports (Xn)

exports - imports

net export schedule

lists the amount of net exports that occurs at each level of GDP; when above the horizontal axis, depicts positive net exports at all levels of GDP

postitive net exports

other things equal, this term will increase aggregate expenditures and GDP beyond what they would be in a closed economy

negative net exports

other things equal, this term will reduce aggergate expenditures and GDP below what they would in a closed economy

upward; higher

increases in public spending, like increases in private spending, shift the aggregate expenditures schedule _______ and produce a _______ equilibrium GDP

government spending (G)

subject to the multiple effect, just like private and public spending; injection into the income stream

increases in this type of spending can raise the equilibrium GDP and aggregate expenditures

what can increases in government spending do for the economy?

decreases in this type of spending will lower the aggregate expenditures schedule and result in a multiplied decline in the equilibrium GDP

what can decreases in government spending do for the economy?

lump-sum tax

a tax of a constant amount or, more precisely, a tax yielding the same amount of tax revenue at each level of GDP; decrease both the consumption and savings of households

Sa + M + T = Ig + X + G

leakages = injections

what equation shows the relationship between savings and investment, imports and exports, taxes, and government spending?

recessionary expenditure gap

the amount by which aggregate expenditures at the full employment level of GDP fall short of the amount required to achieve the full-employment level of GDP; insufficient total spending contracts or depresses the economy; the vertical distance (measured at the full-employment level GDP) by which the actual aggregate expenditures schedule lies below the hypothetical full-employment aggregate expenditures schedule

1. increase government spending

2. lower taxes

what are two different policies that a government might pursue to close a recessionary expenditure gap and achieve fully employment?

inflationary expenditure gap

the amount by which an economy’s aggregate expenditures at the full-employment level of GDP exceed those just necessary to achieve the full-employment level of GDP; the amount by which the aggregate expenditures schedule would have to shift downward to realize equilibrium at the full-employment level of GDP

• the economy ends up producing either at potential output or just above potential output due to the limited supply of labor

• the economy experiences demand-pull inflation; nominal GDP increases with higher prices but real GDP doesn’t

when an inflationary expenditure gap exists, there simply is not enough labor for the economy to produce at much more than potential output for an extended period of time. in other words, with GDP being beyond what it should be, there isn’t much firm can do to keep up. What ends up happening?