Assumptions + simplifications

• Created during Great Depression

• Extreme version of sticky price model

• Even if prices are stuck, firms will still be able to receive feedback from the markets about how much they should produce

• The aggregate expenditures model can help us understand how the modern economy is likely to initially adjust to various economic shocks, including changes in things such as tax rates, government spending, consumption expenditures, and investment spending

Consumption + investment schedules

• Planned investment - An investment schedule showing the amounts business firms collectively intend to invest at each possible level of GDP

• Investment schedule - Shows the amount of investment forthcoming at each level of GDP

Equilibrium GDP

• Aggregate expenditures schedule - Shows the amount that will be spent at each possible output or income level

• Equilibrium GDP - That output whose production creates total spending just sufficient to purchase that output

• No level of GDP other than the equilibrium level of GDP can be sustained

• Total spending rises with income and output (GDP), but not as much as income rises

• The equilibrium level of GDP is determined by the intersection of the aggregate expenditures schedule and the 45° line

Other features of equilibrium GDP

• Saving = Planned investment

  • Leakage - Withdrawal of spending from the economy’s circular flow of income and expenditures

  • Saving is what causes consumption to be less than total output or GDP

  • Injection - Addition of spending into the income-expenditures stream

• No unplanned changes in inventories

  • Firms cannot earn profits by accumulating unwanted inventories

  • When unplanned changes in inventories are considered, investment and saving are always equal, regardless of the level of GDP

Changes in equilibrium GDP + multiplier

• The equilibrium GDP will change in response to changes in either the investment schedule or the consumption schedule

• If the expected rate of return on investment decreases or if the real interest rate rises, investment spending will decline

International trade

• Net exports - Exports - imports

• Exports create domestic production, income, and employment for a nation

• To avoid overstating the value of domestic production, we must subtract the amount spent on imported goods because such spending generates production and income abroad rather than at home

• A net export schedule lists the amount of net exports that will occur at each level of GDP

Net exports + equilibrium GDP

• Other things equal, positive net exports increase aggregate expenditures and GDP beyond what they would be in a closed economy

• Other things equal, negative net exports reduce aggregate expenditures and GDP below what they would be in a closed economy

International economic linkages

• A rising level of real output and income among U.S. foreign trading partners enables the United States to sell more goods abroad, thus raising U.S. net exports and increasing its real GDP

• Depreciation of the dollar relative to other currencies enables people abroad to obtain more dollars with each unit of their own currencies

Government purchases + equilibrium GDP

• The addition of government purchases to private spending yields a new, higher level of aggregate expenditures

• Increases in public spending, like increases in private spending, shift the aggregate expenditures schedule upward and produce a higher equilibrium GDP

Taxation + equilibrium GDP

• 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

• Because households use disposable income both to consume and to save, the tax lowers both consumption and saving

Equilibrium vs. full-employment GDP

• Recessionary expenditure gap - The amount by which aggregate expenditures at the full-employment GDP fall short of those required to achieve the full employment GDP

• Increase gov’t spending or lower taxes → Close recessionary expenditure gap

• Inflationary expenditure gap - The amount by which an economy’s aggregate expenditures at the full-employment GDP exceed those just necessary to achieve the full-employment level of GDP

• Decrease gov’t spending or increase taxes → Close inflationary expenditure gap