11 The Aggregate Expenditures Model McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Assumptions and Simplifications • Not at full-employment • Prices are fixed • GDP = DI • Begin with private, closed economy • No government • No trade LO1 Investment Schedule (Ig) • Shows the amount that businesses • LO1 plan to invest at different levels of GDP Assume investment (Ig) is independent of GDP => investment is constant at all GDP levels Leakages/Injections • Leakages – Income not used to buy • • LO1 domestically produced goods and services Injections – Spending in addition to consumption expenditures on domestically produced goods and services GDP, output, income are the same Aggregate Expenditures • Aggregate expenditures = total • • LO1 spending Economic speak The amount of goods and services produced and therefore the level of employment depend directly on the level of aggregate expenditures Equilibrium GDP TABLE 28.2 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 (4) Saving (S), Billions (5) Investment (Ig), Billions (6) Aggregate Expenditure (C+Ig), Billions (7) Unplanned Changes in Inventories, (+ or -) (1) 40 $370 $375 $-5 $20 $395 $-25 Increase (2) 45 390 390 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 Equilibrium (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 * 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 Planned vs Actual Investment • Actual investment includes planned • LO4 investment (Ig) and unplanned changes in inventories As a result, actual investment equals savings at all GDP levels Multiplier Effect • A change in spending changes real GDP more than the initial change in spending Multiplier = change in real GDP initial change in spending Change in GDP = multiplier x initial change in spending LO4 Multiplier & Marginal Propensities • Multiplier and MPC directly related • Multiplier and MPS inversely related Multiplier = LO4 1- MPC Multiplier = MPS Adding International Trade • Include net exports spending in aggregate expenditures • Private, open economy Xn can be positive or negative • • Net exports are independent of GDP => net exports are constant at all GDP levels LO4 Adding the Public Sector • Government purchases not impact • • LO4 private spending Taxes are personal Lump sum tax Government Purchases and Eq GDP TABLE 28.4 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 (3) Saving (S), Billions (4) Investment (Ig), Billions Exports (X) $375 $-5 $20 (2) 390 390 (3) 410 405 (4) 430 (2) Consumption (C), Billions (1) $370 LO4 Taxation and Equilibrium GDP TABLE 28.5 Determination of the Equilibrium Levels of Employment, Output, and Income: Private and Public Sectors (1) Real Domestic Output and Income (GDP), Billions (7) Net Exports (Xn), Billions (9) Aggregate Expenditures (Ca +Ig+Xn +G), Billions (4)+(6)+(7) +(8) (2) Taxes (T), Billions (3) Disposable Income (DI), Billions, (1)-(2) (4) Consumption (Ca), Billions (5) Saving (Sa), 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