Aggregate Expenditures Model

Aggregate expenditures comprise:

consumption investment government spending and net exports.

The consumption schedule is the aggregate expenditures schedule when:

consumption is the only source of expenditures.

Assuming the inflation rate is zero, a firm will buy capital if and only if the _____ rate of return on _____ is greater than or equal to the prevailing _____ rate

expected, capital, interest

If output is higher than the full-employment level then:

expenditures are too high.

The difference between expenditures at the full-employment level of output and expenditures when output is _____ than the full-employment level is called a recessionary gap.

less

When disposable income is greater than consumption, people _____ the difference

save

Assuming that the inflation rate equals zero, a firm will buy capital if and only if:

the expected rate of return on capital is greater than or equal to the prevailing interest rate.

Real Gross Domestic Product (Real GDP, Y)

A measure of the constant dollar value of all final goods and services produced in a country during a fixed period of time; sometimes called inflation-adjusted GDP. When an economy is in equilibrium, real GDP equals income, Y.

The _____ line represents the combinations of consumption and disposable income that equal one another.

equilibrium

Interest rate changes:

play little if any role in government purchases.

If the purpose of a tax cut is to increase consumption spending, we often see tax cuts for the _____ in times of economic hardship.

poor

If the multiplier equals 4, an increase in investment spending of $10 billion will result in an overall increase in real GDP of $_____ billion

4

With an MPC of 0.75, the expenditures multiplier will equal _____

4

You are an economist in the country of Econlandia trying to estimate the equilibrium level of output. You have the following information: C = A + 0.4(Y−T)A = $75I = $200G = $150NX = −-$75T = $200 The equilibrium level of output in Econlandia is _____

450

With an MPC of 0.8, the expenditures multiplier will equal _____

5

Savings

= Disposable Income - Consumption

When taxes increase:

disposable income decreases. consumer expenditures fall.

The larger the expenditures multiplier, the _____ the swings in output will tend to be.

larger

The multiplier effect causes the:

larger change in real GDP resulting from an increase in expenditures.

In the absence of taxes, the slope of the savings schedule is equal to:

the marginal propensity to save.

When using the aggregate expenditures model, if expenditures change:

the model will move to a new equilibrium.

The activity of investment can take a variety of forms, including:

the purchase of a new machine by a paper company. the construction of a ski lift. the purchase of a new home. the construction of a hot spring sauna.

Savings Schedule

A graph showing the relationship between income and savings.

The formula for consumption is:

A + MPC x (Y - T).

Negative Shock to Aggregate Supply

A change to one of the determinants of aggregate supply that causes a decrease in the aggregate quantity of real GDP supplied at every price level. Graphically, a negative shock is represented by a leftward shift of the aggregate supply curve.

Starting in equilibrium with real GDP equal to $1000 billion gross investment equal to $50 billion a marginal propensity to consume of 0.75 and an expenditures multiplier of 4. If gross investment decreases by $25 billion the aggregate expenditures schedule shifts vertically by $_____ billion. The new equilibrium GDP will be $_____ billion

-25, 900

With an MPC of 0.8, the tax multiplier will equal _____

-4

Mathematically, the tax multiplier equals:

-MPC/(1 - MPC).

If the MPC equals 0.8, an increase in taxes of $5 billion will result in an overall decrease in real GDP of $_____ billion.

2

In the business cycle, the high points are known as _____ and the low points are known as _____

peaks, troughs

The expected rate of return is the:

additional profit the firm expects to earn for each dollar of physical capital purchased expressed as a percentage.

The aggregate expenditures model states that, in equilibrium, output or real GDP (Y) will be equal to:

C plus I plus G plus NX.

Output Gap

The difference, or gap, between current real GDP and full-employment real GDP.

The multiplier effect on real GDP from a change in expenditures and its size is determined by the _____ multiplier

expenditures

A change in interest rates matters most to ________ when making economic decisions.

firms

When disposable income is _____ than consumption, savings is positive and people save the difference.

greater

When aggregate expenditures increase, the change in equilibrium real GDP is:

greater than the change in aggregate expenditures.

Assuming that net exports are independent of real GDP, the net exports schedule is:

horizontal

In the aggregate expenditures model, the relationship between government purchases and real GDP is a _____ line

horizontal

In the aggregate expenditures model, the relationship between gross investment is a _____ line.

horizontal

A fully employed economy is one that is operating at what economists call the:

natural rate of unemployment.

In the aggregate expenditures model, expenditure drives:

output

If the slope of the line is _____ , there is a positive relationship between the two variables.

positive

Use the graph above to answer the following question. The full-employment output level in Guilder is $10,000. Suppose now that Guilder's current real GDP is $8,000. This situation represents a(n) _____ gap

recessionary

When households take some of their income and hold it expecting to spend it in the future, it is called _____

saving

In an economy where all spending is done by households and individuals in equilibrium,:

savings equals zero. consumption equals disposable income.

A horizontal line showing the relationship between net exports and real GDP is called the net exports _____

schedule

Additional profit the firm expects to earn for each dollar of physical capital purchased expressed as a percentage is called:

the expected rate of return.

Because the only category of spending that depends on income is consumption,:

the slope of the aggregate expenditures line is the marginal propensity to consume.

If the MPC equals 0.75, an increase in taxes of $5 billion will result in an overall _____ in real GDP of $_____ billion

15

If taxes increase by $10 billion and real GDP decreases by $30 billion, the tax multiplier is _____

-3

With an MPC of 0.75, the tax multiplier will equal _____

-3

If the MPC equals 0.8, a decrease in taxes of $4 billion will result in an overall increase in real GDP of $_____ billion

16

Starting in equilibrium with real GDP equal to $600 billion gross investment equal to $12 billion a marginal propensity to consume of 0.8 and an expenditures multiplier of 5. If gross investment decreases by $5 billion the aggregate expenditures schedule shifts down by $_____ billion. The new equilibrium GDP will be $_____ billion

5, 575

_____ expenditures equals autonomous expenditure plus the marginal propensity to consume times income minus taxes plus gross investment plus government purchases plus net exports.

Aggregate

The aggregate expenditures model states that in equilibrium output or real GDP (Y) will be equal to:

C plus I plus G plus NX.

Optimization Rule for Investment

If Expected Rate of Return > Cost of Investment, invest

The investment schedule is:

horizontal

The opportunity cost of the investment is the _____ interest rate adjusted for _____

nominal, inflation

The _____ cost of the investment equals the cost that the firm pays if it borrows money to make the purchase.

opportunity

Assuming there are no _____, income equals disposable income.

taxes

Adding a given level of government purchases to gross investment and consumption shifts the aggregate expenditures schedule:

vertically by an amount equal to government purchases.

If gross investment increases, it will shift the aggregate expenditures schedule:

vertically by an amount equal to gross investment.

If investment spending increases by $15 billion and real GDP increases by $75 billion, the expenditures multiplier is

5

If the MPC equals 0.8, a decrease in taxes of $2 billion will result in an overall _____ in real GDP of $_____ billion

increase, 8

Suppose there is a decrease in taxes of $15. If the MPC equals 0.8 consumption will _____ by $_____.

increase; 12

Intervening in the economy to help it recover does have a downside: When the government spends more or takes in less tax revenue, the deficit and debt _____

increases

Given the equilibrium equation: 'Y_e=(1/(1-MPC))(A+I+G+NX)+((-MPC)/(1-MPC))T' which term represents the GDP or expenditures multiplier?

'1/(1-MPC)'

Which of the following variables influence investment decisions? (Choose all that apply.)

Interest rate Expected rate of return

The equilibrium condition of the aggregate expenditures model is:

Y = C + I + G + NX AE = Y

The expenditures multiplier is used to calculate:

a change in real GDP whenever expenditures such as consumption gross investment government purchases or net exports change.

Adding the given level of government purchases to consumption and gross investment increases _____ expenditures by the level of government purchases.

aggregate

Adding the given level of net exports to government purchases, consumption, and gross investment increases _____ expenditures by the level of net exports.

aggregate

Consumption equals:

autonomous expenditure plus the marginal propensity to consume times income minus taxes.

When firms consider investment, they compare the marginal _____ of the investment to the marginal _____

benefit, cost

The peaks and troughs that we observe in the business cycle are the result of:

changes in consumption gross investment government purchases or net exports.

Assuming taxes are zero, changing disposable income in the aggregate expenditure model:

changes the intercept of the consumption schedule. does not change the shape of the consumption schedule.

The sum of the marginal propensities to consume and save equals 1 because a fraction of each additional dollar is _____ and the remaining fraction is _____

consumed, saved

Assuming taxes are zero, the equilibrium consumption and disposable income occur where the _____ schedule crosses the equilibrium line.

consumption

Suppose there is an increase in taxes of $5. If the MPC equals 0.8 consumption will _____ by $_____

decrease, 4

Suppose there is an increase in taxes of $20. If the MPC equals 0.8 consumption will _____ by $_____.

decrease; 16

In the aggregate expenditures model, output or real GDP is driven by _____

expenditure

A change in real GDP equals the _____ multiplier times the initial change in expenditures.

expenditures

The equilibrium condition of the aggregate expenditures model is _____

income

_____ interest rates make purchasing new capital less expensive, potentially increasing _____ spending and productivity over time.

low, investment

During the Great Depression, Keynes argued that if expenditures rose factories would produce _____ output

more

The difference between expenditures at the full-employment level of output and expenditures when output is _____ than the full-employment level is called an inflationary gap.

more

Economic expansions are beneficial since:

more people will be working and saving money that can lead to more investment down the road.

The size of the _____ effect caused by a change in taxes is determined by the tax multiplier.

multiplier

A fully employed economy is one that is operating at what economists call the _____ rate of unemployment.

natural

Investment demand slopes downward because the:

quantity of investment demanded increases as interest rates fall.

A small change in interest rates could have an enormous impact on employment, output, and future economic growth. (True or False)

true

Even when there is no income, there is consumption. (True or False)

true

AEM

AE = C + I + G + NX C + A +[MPC x (Y - T)] AE = A + [MPC x (Y - T)] + I + G + NX

The aggregate expenditures model states that in equilibrium output, or real GDP, Y, will be equal to:

C plus I plus G plus NX.

When there are taxes, the initial change in consumption will equal the:

MPC times the change in disposable income due to taxes.

Disposable income refers to:

after-tax income.

The _____ expenditures model states that in equilibrium output, or real GDP, Y, will be equal to expenditures, C plus I plus G plus NX.

aggregate

The equilibrium line or 45-degree line represents the combinations where aggregate expenditures and real GDP:

are equal.

Aggregate expenditures equals:

autonomous expenditure plus the marginal propensity to consume times income minus taxes plus gross investment plus government purchases plus net exports

When a firm purchases capital goods to replace work-out equipment or to expand production, it is called:

economic investment.

The investment _____ shows the level of investment for each level of real interest rates whereas the investment _____ shows the level of investment for each level of real GDP.

demand, schedule

The Congressional Budget Office:

determines the likely impacts of much legislation.

If the multiplier equals 5, an increase in investment spending of $5 billion will result in an overall increase in real GDP of $_____ billion

25

In the early 1930s, the economic engine of the United States sputtered to a halt and unemployment rates reached a high of _____ percent in 1933.

25

Intervening in the economy to help it recover does have a downside: When the government spends more or takes in less tax revenue,:

the deficit and debt increase.

In the absence of taxes, the slope of the consumption schedule is equal to:

the marginal propensity to consume.

Suppose you get $100 for your birthday and you spend $75 on a new smartphone and save the remaining $25. The marginal propensity to consume or MPC is equal to _____

0

Negative Shock to Aggregate Demand

A change to one of the determinants of aggregate demand that causes a decrease in the aggregate quantity of real GDP demanded at every price level. Graphically, a negative shock is represented by a leftward shift of the aggregate demand curve.

Aggregate Expenditures Model

A model, developed by John Maynard Keynes, that relates income and expenditure in an economy such that, in equilibrium, total expenditures in the economy will be equal to total output.

Capital Goods

Durable (long-lasting) goods that are used to produce other goods and services. Sometimes referred to simply as capital.

Optimization

The idea that people make choices in order to maximize the overall benefit, or utility, of an action subject to its cost. People will engage in an activity as long as the marginal benefit of an activity is greater than or equal to its marginal cost.

Real Interest Rate

The interest rate paid to lenders and savers when the expected rate of inflation equals zero; the inflation-adjusted return, equal to the nominal interest rate minus the inflation rate.

When an individual purchases a new home, it is considered _____

investment

As disposable income rises so does consumption, but not by the full amount because the marginal propensity to consume is:

less than 1.

There is a(n) _____ relationship between disposable income and consumption.

positive

Investment Demand

The negative relationship between the quantity of new physical capital demanded by firms and the prevailing interest rate.

_____ in economics refers only to purchases of new physical capital by firms and households.

investment

Consumption Schedule

A graph showing the relationship between income and consumption.

Aggregate Expenditures Equilibrium Identity (Equilibrium Line)

AE = Y

Consumption (C)

All expenditures made by households on goods and services, like clothing, food, electronics, and recreation, during a given time period.

Government Purchases (G)

All final goods purchased by federal, state, and local governments—such as tanks, police cars, fire engines, and office supplies—during a given time period, as well as all final services purchased from labor resources—such as airport security personnel, police officers, and teachers.

Expected Rate of Return

An anticipated increase in profit resulting from additional investment; expressed as a percentage of the monetary cost of the additional investment.

The aggregate expenditures model states that in equilibrium, output or real GDP (Y), will be equal to:

C plus I plus G plus NX.

Assuming there are no taxes, income equals _____ income

disposable

If investment spending increases by $4 billion and real GDP increases by $16 billion, the expenditures multiplier is _____

4

Calculate Ye for Country A using the following information: A= $100, G = $80, I = $150, NX = −$50, T = $125, and MPC = 0.75.

$745

Given the equilibrium equation: 'Y_e=(1/(1-MPC))(A+I+G+NX)+((-MPC)/(1-MPC))T' which term represents the tax multiplier?

'(-MPC)/(1-MPC)'

If taxes decrease by $15 billion and real GDP increases by $75 billion, the tax multiplier is _____

-5

Starting in equilibrium with real GDP equal to $200 billion, gross investment equal to $20 billion, a MPC equal to 0.6, and an expenditures multiple of 2.5. Suppose gross investment decreases by $10 billion. Arrange the outcomes below in order than they occur according to the aggregate expenditures model.

1. The decrease in expenditures 2. Decreased output 3. There is a further decrease 4. Expenditures and output both decrease 5. The economy arrives at its new equilibrium

Mathematically, the expenditures multiplier equals:

1/(1 - MPC).

Starting in equilibrium with real GDP equal to $800 billion gross investment equal to $20 billion a marginal propensity to consume of 0.75 and an expenditures multiplier of 4. If gross investment increases by $10 billion the aggregate expenditures schedule shifts vertically by $_____ billion. The new equilibrium GDP will be $_____ billion

10. 840

If the multiplier equals 4, an increase in investment spending of $5 billion will result in an overall increase in real GDP of $_____ billion

2

The marginal propensities to consume and save are surprisingly constant across countries. (True or False)

False

Optimization Rule for Activity

If MB > MC, do it. If MB < MC, don't do it.

The Consumption/Saving Identity

Marginal Propensity to Consume + Marginal Propensity to Save = 1 MPC + 1 MPS = 1

Which of the following best illustrates the difference between savings and investment?

Savings refers to putting money in a savings account, the stock market, or some other assets, while investment references to purchasing new capital, machinery, or a new home

Decreasing Marginal Benefit

The negative relationship between the marginal benefit associated with the use of a good or service and the quantity consumed. The more of a good or service that is consumed, in a given period of time, the lower the marginal benefit associated with each additional unit

The expenditures multiplier times the initial change in expenditures equals:

a change in real GDP.

The tax multiplier times the initial change in taxes equals:

a change in real GDP.

Adding the given level of gross investment to consumption increases _____ expenditures by the level of gross investment.

aggregate

The equilibrium level of real GDP is found at the intersection of the:

aggregate expenditures schedule and the equilibrium line.

Adding the given level of gross investment to consumption increases ________ by the level of ________.

aggregate expenditures; gross investment

If the MPC equals 0.75, an increase in taxes of $5 billion will result in an overall _____ in real GDP of $_____

decrease, 15

In an economy where all spending is done by households and individuals, in equilibrium _____ equals disposable income and savings equals zero.

consumption

The _____ schedule is the first basic piece in the aggregate expenditures model.

consumption

Investment demand is:

downsloping

The equilibrium line represents the combinations where consumption and disposable income are _____consumption

equal

A change in disposable income matters most to __ when making economic decisions.

households

A(n) _____ in taxes will reduce real GDP.

increase

The difference between expenditures at the full-employment level of output and expenditures when output is more than the full-employment level is called a(n) _____ gap

inflationary

The graph best represents a(n):

inflationary gap

Expected rate of return and interest rate are two factors that:

influence the investment decisions of firms.

Ordinarily, the Congressional Budget Office (CBO) does not know exactly what the correct multiplier for each type of spending. Therefore:

it uses a high estimate and a low estimate.

During the Great Depression, Keynes argued that if expenditures fell, factories would produce _____ output

less

The net exports schedule shows the:

level of net exports at each level of real GDP.

If output is lower than the full-employment level, expenditures are too:

low

_____ is always equal to _____ , so we use the same abbreviation for both (Y).

output, income

The fraction of each additional dollar of income saved is called the marginal _____ to save

propensity

The opportunity cost of the investment is the _____ interest rate.

real

The difference between expenditures at the full-employment level of output and expenditures when output is less than the full-employment level is called a(n) _____ gap

recessionary

Greater capital formation and increased productivity in the future is made possible when there is:

saving

With a small expenditures multiplier, the swings in output will tend to be:

smaller

A change in real GDP equals the _____ multiplier times the initial change in taxes.

tax

Adding a given level of net exports to government purchases, gross investment, and consumption shifts the aggregate expenditures schedule:

vertically by an amount equal to net exports.

Investment government spending and net exports are affected by:

very different economic variables so any change to government policy will likely affect them differently.

The aggregate expenditures model has aggregate expenditures on the _____ axis and real GDP on the _____ axis.

y, x

When graphing the investment demand, place the interest rate on the _____ _ axis and the quantity of investment on the _____ - axis

y, x

Mathematically, the tax multiplier is equal to:

Δ real GDP/Δ taxes.

Suppose you get $100 for your birthday and you spend $75 on a new smartphone and save the remaining $25. The marginal propensity to save or MPS is equal to _____

.25

Suppose you get $500 for your birthday and you spend $350 and save the remaining $150. The marginal propensity to save or MPS is equal to _____

.3

Positive Shock to Aggregate Demand

A change to one of the determinants of aggregate demand that causes an increase in the aggregate quantity of real GDP demanded at every price level. Graphically, a positive shock is represented by a rightward shift of the aggregate demand curve.

Positive Shock to Aggregate Supply

A change to one of the determinants of aggregate supply that causes an increase in the aggregate quantity of real GDP supplied at every price level. Graphically, a positive shock is represented by a rightward shift of the aggregate supply curve.

Government Purchases Schedule

In the aggregate expenditures model, a horizontal line showing the relationship between government purchases (G) and the level of real GDP (Y) in the economy.

Investment Schedule

In the aggregate expenditures model, a horizontal line showing the relationship between gross investment (I) and the level of real GDP (Y) in the economy.

Net Exports Schedule

In the aggregate expenditures model, a horizontal line showing the relationship between net exports (NX) and the level of real GDP (Y) in the economy.

Equilibrium Line

In the aggregate expenditures model, the 45-degree line through the origin that represents all points at which aggregate expenditure (AE) is equal to output, or real GDP (Y).

Taxes (T)

Revenues collected by the government from individuals and firms.

Disposable Income (DI)

The amount of income available to spend or save after taxes have been paid; calculated as income (Y) minus taxes (T), or DI = Y − T.

Multiplier Effect

The concept that an additional dollar of expenditures will result in the creation of more than one dollar's worth of real GDP.

Net Exports (NX)

The difference between exports (goods made domestically and purchased by foreign consumers) and imports (goods made in other countries and purchased domestically). Net exports equals exports minus imports (NX = X − M).

Inflationary Gap

The difference, or gap, between expenditure when real GDP is above the full-employment level and the level of expenditure at full-employment real GDP.

Recessionary Gap

The difference, or gap, between expenditure when real GDP is below the full-employment level and the level of expenditure at full-employment real GDP.

Gross Investment (I)

The dollar value of all new capital purchased (as investment) and the expansion of inventories in an economy during a given time period. Gross investment is classified into three categories: business fixed investment, residential investment, and inventory investment. Sometimes referred to simply as investment.

Expenditures Multiplier

The effect that a $1 change in expenditure has on real GDP; calculated as the ratio of the total change in real GDP due to a change in initial expenditure. Multiplier = Change in Y / Change in Expenditures Or = 1 / 1-MPC or = 1 / MPS

Tax Multiplier

The effect that a $1 change in taxes has on real GDP; in the aggregate expenditures model, calculated as the change in output divided by an initial change in taxes. Multiplier = Change in Real GDP / Change in Taxes or = change in y / change in t or = -MPC / 1-MPC

Marginal Propensity to Save (MPS)

The fraction of each additional dollar of income that is saved. MPS = Change in Savings / Change in Income

Marginal Propensity to Consume (MPC)

The fraction of each additional dollar of income that is spent on consumption. MPC = Change in Consumption / Change in Income

Autonomous Consumption (A)

The level of consumption expenditure when income is equal to zero. Autonomous consumption is funded by drawing on savings or by borrowing.

Full-Employment Real GDP

The level of real GDP produced in an economy when it is operating at the natural rate of unemployment. Also the level of real GDP when the economy is in a long-run equilibrium

Interest Rate

The payment made to agents that lend or save money, expressed as an annual percentage of the monetary amount lent or saved. Sometimes called nominal interest rate or price of money.

Increasing Marginal Cost

The positive relationship between the marginal cost associated with the use of a good or service and the quantity produced. The more of a good or service that is produced, in a given period of time, the higher the marginal cost associated with each additional unit.

Marginal Decision Making

The process of making choices in increments by evaluating the additional, or marginal, benefit against the additional, or marginal, cost of an action.

Aggregate Expenditures (AE)

The sum of all expenditures made in an economy on consumption, gross investment, government purchases, and net exports. In equilibrium, aggregate expenditures equals income, or real GDP.

The letter used to represent both real GDP and income is:

Y

Real GDP (Y) = Consumption (C) + Gross Investment (I) + Government Purchases (G) + Net Exports (NX)

Y = C + I + G + NX NX = X - M

Aggregate Expenditures Model- Equilibrium

Ye = [(1/1=MPC) x (A + I + G + NX)] + [(-MPC/1-MPC) x T]

Mathematically, the marginal propensity to consume is equal to:

a change in consumption divided by the corresponding change in income.

The sum of the marginal propensities to consume and save equals 1 because:

a fraction of each additional dollar is consumed and the remaining fraction is saved.

The level of consumption that is associated with zero income is called _____ consumption

autonomous

If there are no taxes, the economy is in equilibrium when disposable income equals _____

consumption

Assuming taxes are zero, the equilibrium consumption and disposable income occur where the:

consumption schedule crosses the equilibrium line.

When graphing the consumption schedule, place _____ on the vertical axis and disposable _____ on the horizontal axis.

consumption, income

The money left over after taxes is called _____ income

disposable

In the absence of taxes,:

income and disposable income are equal.

Disposable income is:

income minus taxes. real GDP minus taxes.

Economic _____ takes place when a firm purchases capital goods to replace worn-out equipment or to expand production.

investment

The statement "certain expenditures are in independent of real GDP" is an assumption of:

the aggregate expenditures model.

The statement "output can increase or decrease without causing the price level to change" is an assumption of:

the aggregate expenditures model.

ΔSavings/ΔDisposable Income equals:

the slope of the savings schedule.

The marginal propensities to consume and save vary between countries. (True or False)

true

Keynes reasoned that by understanding what determines expenditures on consumption, gross investment, government purchases, and net exports:

we can explain the level of output in an economy.

During the Great Depression, wages:

were not falling and high levels of unemployment persisted for years.

Marginal Benefit (MB)

The additional benefit associated with one more unit of an activity.

Marginal Cost (MC)

The additional cost associated with one more unit of an activity. For production, it is the change in total cost due to the production of one more unit of output.