Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 1 10 CHAPTER The Aggregate Expenditures Model Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 2 Next Slide Aggregate Expenditures Model Simplifications. . . • A Private Closed Economy • Defer Government & Taxes • Defer Exports and Imports • Real GDP = DI • Excess Production Capacity • Unemployed Labor Exists • More Aggregate Expenditures Doesn’t Affect Price Level Copyright Mc. Graw-Hill/Irwin, 2005

INVESTMENT DEMAND & SCHEDULE Key Terms Expected rate of return, r, and real interest rate, i (percents) Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model End Show 10 - 3 Next Slide Ig 20 8 20 20 Previous Slide Investment Schedule Investment (billions of dollars) Investment Demand Curve Aggregate Expenditures Model Investment (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005 20 ID Real Domestic Product, GDP (billions of dollars)

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 4 Next Slide EQUILIBRIUM GDP Real Domestic Output Aggregate Expenditures Schedule Equilibrium GDP = C + Ig Disequilibrium Graphical Analysis… Copyright Mc. Graw-Hill/Irwin, 2005

EQUILIBRIUM GDP Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 5 Next Slide Private spending, C + I g (billions of dollars) Aggregate Expenditures Model (C + I g = GDP) $530 C + Ig Equilibrium C 510 490 470 Ig = $20 Billion 450 430 410 C =$450 Billion 390 370 o 45 o 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

EQUILIBRIUM GDP Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 6 Next Slide Saving and Planned Investment are Equal • Leakage • Injection No Unplanned Changes in Inventories • Above Equilibrium • Below Equilibrium • Actual Investment Copyright Mc. Graw-Hill/Irwin, 2005

Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 7 Next Slide Private spending (billions of dollars) Aggregate Expenditures Model CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER 510 Equilibrium GDP at Ig 1 Equilibrium level of investment at Ig 0 level of investment (C + Ig ) 1 (C + Ig ) 0 490 Increases in the level of C + Ig 470 450 430 o 45 o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 8 Next Slide Private spending (billions of dollars) Aggregate Expenditures Model CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER 510 Equilibrium GDP at Ig 2 level of investment (C + Ig ) 0 (C + Ig ) 2 490 470 Decreases in the level of C + Ig 450 430 o 45 o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 9 Next Slide INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Net Exports Positive if exports > impor Negative if imports > expo Net Exports and Aggregate Expenditures C + Ig + ( X – M ) Xn = ( X – M ) C + Ig + Xn Copyright Mc. Graw-Hill/Irwin, 2005

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 10 INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Net Export Schedule Net Exports and Equilibrium GDP • Positive Net Exports • Negative Net Exports Next Slide Graphically… Copyright Mc. Graw-Hill/Irwin, 2005

Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Private spending (billions of dollars) Aggregate Expenditures Model INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES 510 Net Exports, Xn (billions of dollars) End Show 10 - 11 Next Slide C + Ig + Xn 1 C + Ig 490 470 450 430 o Key Terms Previous Slide Aggregate Expenditures with Positive Net Exports 45 o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) +5 0 430 -5 Copyright Mc. Graw-Hill/Irwin, 2005 450 470 490 510 Real GDP

Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Private spending (billions of dollars) Aggregate Expenditures Model INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES 510 Net Exports, Xn (billions of dollars) End Show 10 - 12 Next Slide C + Ig + Xn 2 490 470 450 430 o Key Terms Previous Slide Aggregate Expenditures with Negative Net Exports 45 o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) +5 0 430 -5 Copyright Mc. Graw-Hill/Irwin, 2005 450 470 490 510 Real GDP

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model INTERNATIONAL ECONOMIC LINKAGES • Prosperity Abroad • Tariffs Key Terms Previous Slide End Show 10 - 13 Next Slide • Exchange Rates Copyright Mc. Graw-Hill/Irwin, 2005

GLOBAL PERSPECTIVE NET EXPORTS OF GOODS, 2001 Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Negative Net Exports Positive Net Exports Canada France Germany Italy Japan United Kingdom Key Terms United States Previous Slide End Show 10 - 14 Next Slide -400 -140 -100 -60 -20 0 20 60 Billions of Dollars Copyright Mc. Graw-Hill/Irwin, 2005 Source: World Trade Organization 100

ADDING THE PUBLIC SECTOR Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 15 Next Slide Simplifying Assumptions • Government Purchases do not Affect Consumption and Investment Spending • All Taxes are Personal • Tax Collections are Fixed Graphically… Copyright Mc. Graw-Hill/Irwin, 2005

ADDING THE PUBLIC SECTOR Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 16 Next Slide Government Purchases and Equilibrium GDP Aggregate Expenditures (billions of dollars) Aggregate Expenditures Model C + Ig + Xn + G Government Spending of $20 Billion o 45 C + Ig + Xn C o 470 550 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

ADDING THE PUBLIC SECTOR Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 17 Next Slide Lump-Sum Tax and Equilibrium GDP Aggregate Expenditures (billions of dollars) Aggregate Expenditures Model $15 Billion Decrease in Consumption from a $20 Billion Increase in Taxes o 45 C + Ig + Xn + G Ca + I g + X n + G o 490 550 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

FULL-EMPLOYMENT GDP Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 18 Next Slide Recessionary Gap Aggregate Expenditures (billions of dollars) Aggregate Expenditures Model AE 0 AE 1 530 510 Recessionary Gap = $5 Billion 490 Full Employment o 45 o 490 510 530 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

FULL-EMPLOYMENT GDP Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 19 Next Slide Inflationary Gap Aggregate Expenditures (billions of dollars) Aggregate Expenditures Model 530 AE 2 AE 0 Inflationary Gap = $5 Billion 510 490 Full Employment o 45 o 490 510 530 Real domestic product, GDP (billions of dollars) Copyright Mc. Graw-Hill/Irwin, 2005

FULL-EMPLOYMENT GDP Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 20 Next Slide Injections Leakages Unplanned Changes in Inventories Recessionary Gap Inflationary Gap Copyright Mc. Graw-Hill/Irwin, 2005

APPLICATIONS OF THE MODEL Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model • U. S. Recession of 2001 • U. S. Inflation in the Late 1980 s Key Terms Previous Slide End Show 10 - 21 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

LIMITATIONS OF THE MODEL Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Key Terms Previous Slide End Show 10 - 22 Next Slide • Does Not Show Price-Level Changes • Ignores Premature Demand -Pull Inflation • Limited Real GDP to the Full-Employment Level • Does not Deal with Cost. Push Inflation • Does not Allow for “Selfcorrection” Copyright Mc. Graw-Hill/Irwin, 2005

planned investment schedule aggregate expenditures schedule equilibrium GDP leakage injection unplanned changes in inventories net exports lump-sum tax recessionary gap inflationary gap Copyright Mc. Graw-Hill/Irwin, 2005 BACK END

Aggregate Expenditures Model Investment Demand Schedule Equilibrium GDP Changes in Equilibrium GDP and the Multiplier International Trade and Aggregate Expenditures International Economic Linkages Adding the Public Sector Full-Employment GDP Applications of the Model Limitations of the Model Coming Next: AGGREGATE DEMAND AGGREGATE SUPPLY Key Terms Previous Slide End Show 10 - 24 Next Slide CHAPTER 11 Copyright Mc. Graw-Hill/Irwin, 2005