Aggregate expenditure and Aggregate demand Aggregate expenditure line

Aggregate expenditure and Aggregate demand • • • Aggregate expenditure line Real GDP demanded Changes in aggregate expenditure Simple spending multiplier Changes in the price level Aggregate demand curve

Components of aggregate expenditure (AE) AE = C + I + G + (X – M) Aggregate expenditure line: A relationship tracing, for a given price level, planned spending at each level of income or real GDP

Aggregate expenditure (trillions of dollars) Income-expenditure line Incomeexpenditure line 450 0 At every point on this line, planned spending is equal to real GDP—so unplanned investment is zero Real GDP (trillions of dollars)

Actual versus planned investment Haley’s Hammers 2007 Investment Plans Planned spending for new plant and equipment. . . . . $95, 000 Planned inventory investment. . . . 0 Actual inventory investment. . . 3, 500 Actual investment. . . . . $98, 500 Remember, that: Actual I = Planned I + Unplanned I

We normally cut back on production when we see our inventories piling up.

Aggregate expenditure (trillions of dollars) Deriving the real GDP demanded for a given price level d 15. 0 C+I+G+(X-M) 14. 8 c e 14. 0 13. 2 b 13. 0 a Real GDP demanded for a given price level is found where aggregate expenditure equals aggregate output – that is, where spending equals the amount produced, or real GDP. This occurs at point e, where the aggregate expenditure line intersects the 45 -degree line. 45° 0 13. 0 14. 0 15. 0 Real GDP (trillions of dollars) 6

When Real GDP = $14 trillion • Planned spending of households, firms, government units, and foreigners is equal to real output; thus the plans of producing and spending units “match up. ” • Firms on average experience zero unplanned investment. • Firms on average have nor reason to ‘scale up’ or ‘scale down’ production.

Effect of an increase in investment on real GDP demanded Aggregate expenditure (trillions of dollars) C+I’+G+(X-M) e’ 14. 5 h j i f 14. 1 A $0. 1 trillion increase in investment shifts the AE line up vertically by $0. 1 trillion. Real GDP increases until it equals spending at point e’. As a result of the $0. 1 trillion increase in investment, real GDP demanded increases by $0. 5 trillion, to $14. 5 trillion. k g 14. 0 C+I+G+(X-M) e 0. 1 45° Real GDP (trillions of dollars) The economy is initially at point e, where spending=real GDP demanded = $14. 0 trillion. 0 14. 1 14. 5 8

Tracking the rounds of spending following a $100 billion increase in investment (billions of dollars) Assume that MPC = 0. 8 and MPS = 0. 6 Round 1 2 3. . . 10. . . ∞ New spending this round 100 80 64. . . 13. 4. . . 0 Cumulative new spending 100 180 244. . . 446. 3. . . 500 New saving this round 20 16. . . 3. 35. . . 0 Cumulative new saving 20 36. . . 86. 6. . . 100 9

Simple spending multiplier (k) Note that:

The income-expenditure approach and the AD curve AE” (P=120) Aggregate expenditure (trillions of dollars) (a) e’’ AE (P=130) AE’ (P=140) e At the higher price level of 140, the AE line shifts down to AE’, and real GDP demanded falls to $13. 5 trillion: point e’ on panel (b). e’ 45° 0 (b) 13. 5 14. 0 Real GDP At the lower price level of 120, the AE (trillions of dollars) line shifts up to AE’’, and real GDP 14. 5 demanded increases to $14. 5 trillion: point e” on panel (b). e’ Price level 140 130 e 120 e’’ AD 0 At the initial price level =130, the AE line identifies real GDP demanded of $14. 0 trillion: point e on panel (b). 13. 5 14. 0 14. 5 Connecting e, e’, and e’’ yields the downward-sloping AD curve. Real GDP (trillions of dollars) 11

A shift of AE line that shifts the AD curve C+I’+G+(X-M) Aggregate expenditure (trillions of dollars) (a) e’ C+I+G+(X-M) 0. 1 e 45° Price level 0 130 (b) 14. 0 e 14. 5 Real GDP (trillions of dollars) e’ AD 0 14. 5 AD’ A shift of the AE line at a given price level shifts the AD curve. In (a), an increase in investment of $0. 1 trillion, with the price level constant at 130, causes the aggregate expenditure line to increase from C+I+G+(X-M) to C+I’+G+(X-M). As a result, real DGP demanded increases from $14. 0 trillion to $14. 5 trillion. In (b), the aggregate demand curve has shifted from AD to AD’. At the prevailing price level of 130, real GDP demanded has increased by $0. 5 trilion. Real GDP (trillions of dollars)

Aggregate expenditure (trillions of dollars) Effect of a shift of autonomous spending on real GDP demanded 0 e’ C+I’+G+(X-M) C+I+G+(X-M) e $0. 1 An increase in investment, other things constant, shifts the spending line up from C+I+G+(X-M) to C+I’+G+(XM), increasing the quantity of real GDP demanded. 45° Real GDP 14. 0 14. 333 (trillions of dollars) 13