Aggregate Expenditures Model

what are the two variables when a firm considers buying new capital goods?

1) expected rate of return 2) Opportunity Cost

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-fixed GDP. When an economy is in equilibrium, real GDP equals income Y.

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.

Which is better, a smaller or larger multiplier?

A smaller because with a larger multiplier the booms will be larger, but the recessions will be deeper. With a smaller multiplier, the good times wont be quite so good, but the bad times won't be quite so bad.

Equilibrium in the economy occurs when....?

Aggregate Expenditures are equal to the amount produced, 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.

Why does the expenditure multiplier effect have a larger effect than the tax multiplier, like an MPC of .8 which has an expenditure multiplier of 5 and a tax multiplier of -4?

Because If the government uses $100 for government purchases, $100 in output (newly produced goods and services) is being produced in the economy in exchange for that money. If the government reduces taxes by $100- for example, by giving everyone a slightly larger tax refund, nothing new is initially created in the economy. that money is given by the government to the people, but no output is produced in the process. Output begins to increase once citizens use that money to buy something new, after they have saved a portion of the refund. According to the MPC example, $500 would be produced in output using the expenditure multiplier and $400 would be produced as output using the tax multiplier.

Aggregate Expenditures Model

By increasing expenditure, a country could increase output and reduce unemployment. Relates income and expenditure in an economy such that, in equilibrium, total expenditures in the economy will be equal to total output.

How to you calculate the equilibrium line for a consumption schedule?

Draw a line through the origin with a slope of 1, AKA 45-degree line.

capital goods

Durable goods that are used to produce other goods and services. Sometimes referred to simply as capital.

Firms will invest when...?

Expected rate of return is greater than or equal to the real interest rate

government purchases schedule

In the aggregate expenditure 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.

equilibrium line

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

When real GDP is in an equation...

It can represent income, aggregate expenditure, or aggregate value of output produced. This is because when the economy is in equilibrium, we see that income, expenditure, and output all equal one another.

The slope of the consumption schedule is the same as the slope of aggregate expenditures which is:

MPC found by dividing rise (change in Y or AE) over run (change in consumption)

Investment

Occurs when a firm or individual purchases new capital , like machinery (for a firm) or a new home (for a household) People invest so they can make capital purchases today

Is the relationship between income and consumption positive or negative?

POSITIVE

Y=____?

Real GDP and Income and output

Marginal Benefit (MB)

The additional benefit associated with one or more units of an activity

Marginal Cost (MC)

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

Summary of real GDP and G, I, and NX

The aggregate expenditure model assumes there is no such positive relationship between real GDP and spending and I, G, and NX. It assumes that these three component, Investments, Government Purchases, and Net Exports, are determined independently of real GDP, so changes in real GDP does not effect them.

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.

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.

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 intro three categories: business fixed invest, residential investment, and inventory investment. Sometime referred to simply as investment.

marginal propensity to save (MPS)

The fraction of each additional dollar of income that is saved MPS = change in Savings OVER 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 OVER change in Income

optimization

The idea that people make choices in order to maximize 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 inflations equals zero; the inflation-adjusted return, equal to the nominal interest rate minus the inflation rate.

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 long-run equilibrium.

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.

savings schedules slopes which way?

UP

consumption schedule

a graph showing the relationship between income and consumption

savings schedule

a graph showing the relationship between income and savings

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

A=____

autonomous consumption

What is the AE=Y line?

crosses through origin at zero, a 45-degree line

X=___

exports

Optimization Rule for an activity

if MB is greater than or equal to MC, then do it If MB is less than MC, then don't do it

Optimization rule for investment

if expected rate of return is greater than or equal to the cost of interest, then invest If expected rate of return is less than the cost of interest, then don't invest

M=____

imports

net exports schedule

in the aggregate expenditures model, a horizontal line showing the relationship between NX and real GDP (Y)

MPC equals rise over run which is change in consumption over change in income.

know that

The consumption/saving Identity

marginal propensity to consume plus the marginal propensity to save equals 1 MPC + MPS = 1

If any part of AE increases such as G, I, or NX then the AE curve will...?

shift up, resulting in a higher equilibrium real GDP in the economy.

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. the multiplier tells how by how much real GDP will be effected by changes in the AE equation like G, I,C, or NX.

output gap

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

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.

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.

autonomous consumption

the level of consumption expenditure when income is equal to zero. Autonomous consumption is funded by drawing on savings or by borrowing. It's called this because it is independent of your income since you make no income.

Investment demand

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

interest rate

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

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.

Saving

when households or firms take some of their income or profit and put it in a savings account, in the stock market, or in some other asset, hoping to make a return on their money and spend it in the future. People save so they can make purchases in the future