The Aggregate Expenditures Model

Assumptions and Simplifications
Use the Keynesian aggregate expenditures model
Prices are fixed
GDP = DI
Begin with private, closed economy
Consumption spending
Investment spending
LO1
28-

Equilibrium GDP
C
Ig = $20 billion
Aggregate
expenditures
C = $450 billion
C + Ig
(C + Ig = GDP)
Equilibrium
point
LO1
28-

Other Features of Equilibrium GDP
Saving equals planned investment
Saving is a leakage of spending
Investment is an injection of spending
No unplanned changes in inventories
Firms do not change production
LO2
28-

Changes in Equilibrium GDP
Increase in
investment
(C + Ig)0
Decrease in
investment
(C + Ig)2
(C + Ig)1
LO3
28-

Adding International Trade
Include net exports spending in aggregate expenditures
Private, open economy
Exports create production, employment, and income
Subtract spending on imports
Xn can be positive or negative
LO4
28-

Net Exports and Equilibrium GDP
Aggregate expenditures
with positive
net exports
C + Ig
Aggregate expenditures
with negative net
exports
C + Ig+Xn2
C + Ig+Xn1
Xn1
Xn2
Positive net exports
Negative net exports
450
470
490
LO4
28-

International Economic Linkages
Prosperity abroad
Can increase U.S. exports
Exchange rates
Depreciate the dollar to increase exports
A caution on tariffs and devaluations
Other countries may retaliate
Lower GDP for all
LO4
28-

Adding the Public Sector
Government purchases and equilibrium GDP
Government spending is subject to the multiplier
Taxation and equilibrium GDP
Lump sum tax
Taxes are subject to the multiplier
DI = GDP
LO4
28-

Government Purchases and Eq. GDP
C
Government spending
of $20 billion
C + Ig + Xn
C + Ig + Xn + G
LO4
28-

Taxation and Equilibrium GDP
$15 billion
decrease in
consumption
from a
$20 billion
increase
in taxes
Ca + Ig + Xn + G
C + Ig + Xn + G
LO4
28-

Equilibrium versus Full-Employment
Recessionary expenditure gap
Insufficient aggregate spending
Spending below full-employment GDP
Increase G and/or decrease T
Inflationary expenditure gap
Too much aggregate spending
Spending exceeds full-employment GDP
Decrease G and/or increase T
LO5
28-

Equilibrium versus Full-Employment
AE0
AE1
Full
employment
Recessionary
expenditure
gap = $5 billion
LO5
28-