Chapter 29: The Aggregate Expenditures Model

Prosperity Abroad

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

Lump-Sum Tax

A tax yielding the same amount of tax revenue at each level of GDP.

Saving and Planned Investment

At equilibrium GDP, saving equals planned investment. This is because saving is a leakage or withdrawal of spending from the economy's circular flow, while investment is an injection of spending into the circular flow. These must cancel out for aggregate expenditures to equal real GDP.

Caution on Tariffs and Devaluations

Because higher net exports increase real GDP, countries often look for ways to reduce imports and increase exports during recessions, such as putting tariffs on imports or devaluing the dollar. However, when we place tariffs on other countries' goods or devalue our currency, other countries often retaliate in the same way. As a result, it is possible that tariffs and devaluation of the dollar may decrease our net exports.

Slope of Aggregate Expenditures Schedule

Equals the economy's MPC.

Government Purchases and Equilibrium GDP

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

Keynes's Solution to a Recessionary Expenditure Gap

Increasing government spending and lowering taxes increases aggregate expenditures to the point where equilibrium GDP equals full-employment GDP.

Leakages and Injections

Leakages = Injections Sa + M + T = Ig + X + G After-Tax Saving (Sa) + Imports (M) + Taxes (T) = Investment (Ig) + Exports (N) + Government Spending (G)

GDP Greater than Equilibrium

Occurs when GDP exceeds spending. Inventories will increase, prompting decreased production of businesses to the point where output (GDP) equals spending.

GDP Less than Equilibrium

Occurs when spending exceeds GDP. Inventories will decrease, prompting increased production of businesses to the point where output (GDP) equals spending.

Graphically Determining Equilibrium GDP

Occurs where the aggregate expenditures schedule intersects the 45° line (so that aggregate expenditures equals GDP).

Features of Equilibrium GDP

Saving and planned investment are equal. There are no unplanned changes in inventories.

Aggregate Expenditures Model

Shows the amount that will be spent at each possible output level (GDP) of an economy.

Investment Schedule

Shows the amounts business firms collectively intend to invest at each possible level of GDP. Assuming planned investment is independent of the level of current disposable income or real output, and that the real interest rate remains constant, this schedule will be a horizontal line (constant investment for each possible level of GDP).

Taxation and Equilibrium GDP

Taxes reduce disposable income relative to GDP by the amount of the taxes, reducing both consumption and saving at each level of GDP. The extent of the C and S reductions depend on the MPC and the MPS. Therefore, since the aggregate expenditures schedule only relies on consumption spending, taxation of some amount decreases the aggregate expenditures schedule by that amount times the MPC.

Inflationary Expenditure Gap

The (vertical) amount by which aggregate expenditures at the full-employment GDP exceeds those required to achieve the full-employment GDP.

Recessionary Expenditure Gap

The (vertical) amount by which aggregate expenditures at the full-employment GDP falls short of those required to achieve the full-employment GDP.

Net Exports and Equilibrium GDP

The addition of net exports to the aggregate expenditures schedule can shift the curve either up or down.

Planned Investment

The amounts business firms collectively intend to invest.

Exchange Rates

The depreciation of the dollar relative to other currencies enables people abroad to obtain more dollars with each unit of their own currencies. The price of US Goods in terms of those currencies will fall, stimulating purchases of US exports. Also, US customers will find they need more dollars to buy foreign goods and, consequently, will reduce their spending on imports. This increases net exports and therefore expands the US real GDP.

Equilibrium GDP

The level at which the total quantity of goods produced (GDP) equals the total quantity of goods purchased (aggregate expenditures). This is the only level of GDP the economy is capable of sustaining.

Equilibrium GDP and the Multiplier Effect

When the aggregate expenditures schedule shifts, equilibrium GDP shifts that much times the multiplier.

Unplanned Changes in Inventories

When there are unplanned decreases in inventories, aggregate expenditures exceed real GDP, prompting an increase in planned investment. When they're unplanned increases in inventories, aggregate expenditures exceed real GDP, prompting a decrease in planned investment.