Consumption and Investment Equilibrium GDP and the Multiplier

Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms 9 The Aggregate Expenditures Model End Show O 9. 1 9 -1 Copyright 2008 The Mc. Graw-Hill Companies

Chapter Objectives Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -2 • Economists Combine Consumption and Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy • Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy – AE = Output – Saving = Investment – No Unplanned Changes in Inventories • How Changes in Equilibrium Real GDP Occur and Relate to Multiplier • Integrate Government and Foreign Sectors into AE • Recessionary and Expansionary Expenditure Gaps Copyright 2008 The Mc. Graw-Hill Companies

Consumption and Investment – Private Closed Economy – Planned Investment – Investment Schedule Investment Demand Curve 8 20 ID Key Terms 20 End Show Investment (billions of dollars) 9 -3 Copyright 2008 The Mc. Graw-Hill Companies Investment Schedule Investment (billions of dollars) Investment Demand Curve r and i (percent) Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word • Simplifications Investment Schedule 20 Ig Real GDP (billions of dollars)

Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -4 • Equilibrium GDP: C + Ig = GDP • Real Domestic Output • Aggregate Expenditures –Aggregate Expenditures Schedule • Equilibrium GDP • Disequilibrium Copyright 2008 The Mc. Graw-Hill Companies W 9. 1

Consumption and Investment (2) Consumption Real and Investment (7) (8) Domestic (3) Equilibrium GDP (5) (6) Unplanned Tendency of Output Con. Equilibrium GDP (1) (4) Investment Aggregate Changes in Employment (and sumpand the Employ- Income) tion Saving (S) (Ig) Expenditures Inventories Output and ment (1 -2) (C+Ig) (C) (+ or -) Income (GDP=DI) Multiplier International …in Billions of Dollars Trade Government (1) 40 $375 $-5 20 $395 $-25 Increase Spending and GDP (2) 45 390 0 20 410 -20 Increase Lump-Sum Tax (3) 50 410 405 5 20 425 -15 Increase and GDP (4) 55 430 420 10 20 440 -10 Increase Recessionary Expenditure (5) 60 450 435 15 20 455 -5 Increase Gap (6) 65 470 450 20 20 470 0 Equilibrium Inflationary Expenditure (7) 70 490 465 25 20 485 +5 Decrease Gap Last Word (8) 75 510 480 30 20 500 +10 Decrease Key Terms (9) 80 530 495 35 20 515 +15 Decrease (10) 85 550 510 40 20 530 +20 Decrease Graphically… End Show 9 -5 Copyright 2008 The Mc. Graw-Hill Companies

Consumption and Investment Equilibrium GDP 530 (C + Ig = GDP) 510 Consumption (billions of dollars) Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Equilibrium Point 490 C + Ig C Aggregate Expenditures 470 450 Ig = $20 Billion 430 410 390 C = $450 Billion 370 45° Key Terms 370 390 410 430 450 470 490 510 530 550 End Show Disposable Income (billions of dollars) 9 -6 Copyright 2008 The Mc. Graw-Hill Companies G 9. 1

Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -7 Equilibrium GDP • Other Features… –Saving Equals Planned Investment • Leakage • Injection –No Unplanned Changes in Inventories Copyright 2008 The Mc. Graw-Hill Companies

Changes in Equilibrium GDP Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms Aggregate Expenditures (billions of dollars) …and the Multiplier (C + Ig)1 (C + Ig)0 (C + Ig)2 510 490 Increase in Investment Decrease in Investment 470 450 430 45° 430 End Show 450 470 490 510 Real GDP (billions of dollars) 9 -8 Copyright 2008 The Mc. Graw-Hill Companies

International Trade Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -9 • Net Exports and Aggregate Expenditures • Net Exports Schedule • Net Exports and Equilibrium GDP – Positive Net Exports – Negative Net Exports • International Economic Linkages – Prosperity Abroad – Tariffs – Exchange Rates Copyright 2008 The Mc. Graw-Hill Companies

International Trade Net Exports and Equilibrium GDP Key Terms End Show 9 -10 C + Ig+Xn 1 C + Ig+Xn 2 Aggregate Expenditures (billions of dollars) 510 Aggregate Expenditures 490 with Positive Net Exports Aggregate Expenditures with Negative Net Exports 470 450 430 45° 430 Net Exports Xn (billions of Dollars) Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word +5 0 -5 450 470 490 Positive Net Exports 450 470 490 Real GDP (billions of dollars) Negative Net Exports Copyright 2008 The Mc. Graw-Hill Companies 510 Xn 1 Xn 2 Real GDP

International Trade GLOBAL PERSPECTIVE Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms Net Exports of Goods - Select Nations, 2004 Negative Net Exports Positive Net Exports Canada -17 France Germany Japan -117 -700 9 -11 +195 Italy -2 200 +111 United Kingdom -707 End Show +37 United States 150 100 150 200 250 Source: World Trade Organization Copyright 2008 The Mc. Graw-Hill Companies

Adding the Public Sector Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -12 Government Purchases and GDP (1) (5) Level of (7) Net Exports (2) Output (Xn) Aggregate (4) (6) Consumpand (3) Investment Exports Imports Government Expenditures tion Income (C+Ig+Xn+G) (X) (M) Saving (S) (Ig) (G) (C) (GDP=DI) (2)+(4)+(5)+(6) …in Billions of Dollars (1) $370 $375 $-5 $20 10 10 20 $415 (2) 390 0 20 10 10 20 430 (3) 410 405 5 20 10 10 20 445 (4) 430 420 10 10 20 460 (5) 450 435 15 20 10 10 20 475 (6) 470 450 20 20 10 10 20 490 (7) 490 465 25 20 10 10 20 505 (8) 510 480 30 20 10 10 20 520 (9) 530 495 35 20 10 10 20 535 (10) 550 510 40 20 10 10 20 550 Copyright 2008 The Mc. Graw-Hill Companies

Adding the Public Sector Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms Aggregate Expenditures (billions of dollars) Government Spending and GDP C + Ig + Xn + G C + Ig + Xn C Government Spending of $20 Billion Increase in Government Spending Yields an $80 Billion Increase In GDP 45° 470 End Show 550 Real GDP (billions of dollars) 9 -13 Copyright 2008 The Mc. Graw-Hill Companies

Adding the Public Sector Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms Aggregate Expenditures (billions of dollars) Lump-Sum Tax Increase and GDP C + Ig + Xn + G $20 Billion Increase in Taxes Yields a $60 Billion Decrease In GDP 45° 490 End Show Cd + I g + X n + G $15 Billion Decrease In Consumption From a $20 Billion (MPC=. 75) Increase in Taxes 550 Real GDP (billions of dollars) 9 -14 Copyright 2008 The Mc. Graw-Hill Companies

Adding the Public Sector Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Cd + Ig + Xn + G = GDP W 9. 2 • Leakages • Injections • No Planned Inventory Changes Sd + M + T = Ig + X + G Key Terms End Show G 9. 2 9 -15 Copyright 2008 The Mc. Graw-Hill Companies

Equilibrium Versus Full-Employment GDP Recessionary Expenditure Gap 550 Aggregate Expenditures (billions of dollars) Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 530 510 AE 1 $5 Billion Gap Yields $20 Billion GDP Change Recessionary Expenditure Gap = $5 Billion 490 Full Employment 470 Key Terms 45° 490 End Show 510 530 Real GDP (billions of dollars) 9 -16 Copyright 2008 The Mc. Graw-Hill Companies

Equilibrium Versus Full-Employment GDP Inflationary Expenditure Gap AE 2 550 Aggregate Expenditures (billions of dollars) Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word 530 AE 0 Inflationary Expenditure Gap = $5 Billion Gap Yields $20 Billion GDP Change 510 490 Full Employment 470 Key Terms 45° 490 End Show 510 530 Real GDP (billions of dollars) 9 -17 Copyright 2008 The Mc. Graw-Hill Companies

Equilibrium Versus Full-Employment GDP Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms • Application: – U. S. Recession of 2001 • Inflationary Expenditure Gap – U. S. Inflation in the Late 1980 s – Full-Employment Output with Large Negative Net Exports • Negative Net Exports End Show 9 -18 W 9. 3 Copyright 2008 The Mc. Graw-Hill Companies

Equilibrium Versus Full-Employment GDP Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -19 • Limitations of the Model – Does Not Show Price Level Changes – Ignores Premature Demand-Pull Inflation – Limits Real GDP to the Full. Employment Level of Output – Does Not Deal with Cost-Push Inflation – Does Not Allow for “Self. Correction” Copyright 2008 The Mc. Graw-Hill Companies

Say’s Law - The Great Depression and Keynes Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms End Show 9 -20 t s a L d or W • Classical School – Automatic Self- • • Adjustment to Full Employment – Mill, Ricardo Views Based Upon “Say’s Law” - J. B. Say (1767 -1832) – Supply Creates its Own Demand Great Depression Caused Questions Keynes Answered in his General Theory of Employment, Interest, and Money Income and Saving Discrepancies Volatility in Investment Spending Cyclical Unemployment Can Occur Government Should Be Active in the Recovery Process O 9. 2 Copyright 2008 The Mc. Graw-Hill Companies

Key Terms Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Key Terms • • • planned investment schedule aggregate expenditures schedule equilibrium GDP leakage injection unplanned changes in inventories net exports lump-sum tax recessionary-expenditure gap inflationary-expenditure gap End Show 9 -21 Copyright 2008 The Mc. Graw-Hill Companies

Next Chapter Preview… Consumption and Investment Equilibrium GDP and the Multiplier International Trade Government Spending and GDP Lump-Sum Tax Increase and GDP Recessionary Expenditure Gap Inflationary Expenditure Gap Last Word Aggregate Demand Aggregate Supply Key Terms End Show 9 -22 Copyright 2008 The Mc. Graw-Hill Companies