CHAPTER 10: THE AGGREGATE Expenditures MODEL

2 components of expenditures:

·         Consumption

·         Gross investment

Planned investment – such a schedule represents the investment plans of businesses.

Investment schedule – shows the amount of investment forthcoming at each level of GDP.

• Tabular Analysis

·         Real Domestic Output

·         Aggregate expenditures

Aggregate expenditures schedule – shows the amount (C + I_g) that will be spent at each possible output or income level.

·         Equilibrium GDP – the level at which the total quantity of goods produced (GDP) equals the total quantity of goods produced (C + I_g).

·         Disequilibrium – no level of GDP other than the equilibrium level of GDP can be sustained.

• OTHER FEATURES OF EQUILIBRIUM GDP

• Saving Equals Planned Investment

Saving is a leakage of withdrawal from spending of the income expenditures stream.

• No Unplanned Changes in Inventories

Actual Investment – consists of planned investment plus unplanned changes in inventories (+ or -) and is always equal to saving in a private closed economy.

But when unplanned changes in inventories are considered, investment and saving are always equal, regardless of the level of GDP.

CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER

Through the multiplier effect, an initial change in investment spending can cause a magnified change in domestic output and income.

ADDING INTERNATIONAL TRADE

• Net Exports and Aggregate Expenditures

For a private closed economy, aggregate expenditures are C + I_g. But for an open economy, aggregate expenditures are C + I_g + x_n.

•  The Net Export Schedule – lists the amount of net exports that will occur at each level of GDP.

• Net Exports and Equilibrium GDP

·         Positive net exports – increase aggregate expenditures relative to the closed economy and, other things equal, increase equilibrium GDP.

·         Negative net exports – decrease aggregate expenditures relative to the closed economy, and, other things equal, reduce equilibrium GDP.

•  International Economic Linkages

·         Prosperity Abroad – A rising level of real output and income among U.S. foreign trading partners enables the U.S. to sell more goods abroad, thus raising U.S.

·         Tariffs – Suppose foreign trading partners impose high tariffs on U.S. goods to reduce their imports from the U.S. and thus increase production in their economies.

·         Exchange rates – depreciation of the dollar relative to other currencies enables people abroad to obtain more dollars with each unit of their own currencies.

ADDING THE PUBLIC SECTOR

• Government Purchases and Equilibrium GDP

Government purchases do not cause any upward or downward shifts in the consumption and investment schedules.

•  Taxation and Equilibrium GDP

Lump-sum tax – is a tax of a constant amount or, more precisely, a tax yielding the same amount of tax revenue at each level of GDP.

• Differential Impacts

When total spending equals total production, the economy’s output is in equilibrium. In the open mixed economy, equilibrium GDP occurs where:

C + I_g +x_n +G = GDP

• Injections, Leakages and Unplanned Changes in Inventories

At the equilibrium GDP, the sum of leakages equals the sum of injections. In symbols:

S_a + M + T = I_g + x + G

EQUILIBRIUM VERSUS FULL-EMPLOYMENT GDP

• Recessionary Gap – is the amount by which aggregate expenditures at the full employment GDP fall short of those produces a negative GDP gap.

• Inflationary Gap – is the amount by which aggregate expenditures at the full employment GDP exceed those just sufficient to achieve the full-employment GDP. This gap causes demand-pull inflation.

LIMITATIONS OF THE MODEL

• It does not show price-level changes.

• It ignores premature demand-pull inflation.

•  It limits real GDP to the full-employment level of output.

• It does not deal with cost-push inflation.

•  It does not allow for “self-correction”.