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10 - 1 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show The Aggregate Expenditures Model 10 C H A P T E R

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10 - 2 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show 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

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10 - 3 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INVESTMENT DEMAND & SCHEDULE Expected rate of return, r, and real interest rate, i (percents) Investment (billions of dollars) Investment (billions of dollars) 20 8 Real Domestic Product, GDP (billions of dollars) I D IgIg Investment Demand Curve Investment Schedule 20

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10 - 4 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show EQUILIBRIUM GDP GDP = C + I g Real Domestic Output Aggregate Expenditures Schedule Equilibrium GDP Disequilibrium Graphical Analysis…

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10 - 5 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show Private spending, C + I g (billions of dollars) o 45 o C C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 370 390 410 430 450 470 490 510 530 550 (C + I g = GDP) EQUILIBRIUM GDP C =$450 Billion $530 510 490 470 450 430 410 390 370

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10 - 6 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show EQUILIBRIUM GDP Saving and Planned Investment are Equal Leakage Injection No Unplanned Changes in Inventories Above Equilibrium Below Equilibrium Actual Investment

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10 - 7 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 (C + I g ) 0 (C + I g ) 1 Equilibrium GDP at I g0 leveEquilibrium GDP at I g1 level of investmentl of investment Increases in the level of C + I g

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10 - 8 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 Equilibrium GDP at I g2 level of investment (C + I g ) 0 (C + I g ) 2 Decreases in the level of C + I g

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10 - 9 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Net Exports Positive if exports > imports Negative if imports > exports Net Exports and Aggregate Expenditures C + I g + ( X – M ) X n = ( X – M ) C + I g + X n

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10 - 10 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Net Export Schedule Net Exports and Equilibrium GDP Positive Net Exports Negative Net Exports Graphically…

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10 - 11 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 Aggregate Expenditures with Positive Net Exports C + I g C + I g + X n1 Net Exports, X n (billions of dollars) +5 0 -5 430 450 470 490 510 Real GDP

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10 - 12 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 Aggregate Expenditures with Negative Net Exports C + I g C + I g + X n2 Net Exports, X n (billions of dollars) +5 0 -5 430 450 470 490 510 Real GDP

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10 - 13 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show INTERNATIONAL ECONOMIC LINKAGES Prosperity Abroad Tariffs Exchange Rates

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10 - 14 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show GLOBAL PERSPECTIVE NET EXPORTS OF GOODS, 2001 Source: World Trade Organization -400-140-100-60-2002060100 Negative Net ExportsPositive Net Exports Billions of Dollars United States United Kingdom Canada France Germany Italy Japan

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10 - 15 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show ADDING THE PUBLIC SECTOR Simplifying Assumptions Government Purchases do not Affect Consumption and Investment Spending All Taxes are Personal Tax Collections are Fixed Graphically…

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10 - 16 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show ADDING THE PUBLIC SECTOR Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 470 550 C C + I g + X n C + I g + X n + G Government Spending of $20 Billion Government Purchases and Equilibrium GDP

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10 - 17 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show ADDING THE PUBLIC SECTOR Lump-Sum Tax and Equilibrium GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 490 550 C + I g + X n + G C a + I g + X n + G $15 Billion Decrease in Consumption from a $20 Billion Increase in Taxes

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10 - 18 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show FULL-EMPLOYMENT GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 490 510 530 AE 0 Recessionary Gap AE 1 530 510 490 Recessionary Gap = $5 Billion Full Employment

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10 - 19 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show FULL-EMPLOYMENT GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 490 510 530 AE 0 Inflationary Gap AE 2 530 510 490 Inflationary Gap = $5 Billion Full Employment

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10 - 20 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show Injections Leakages Unplanned Changes in Inventories Recessionary Gap Inflationary Gap FULL-EMPLOYMENT GDP

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10 - 21 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show APPLICATIONS OF THE MODEL U.S. Recession of 2001 U.S. Inflation in the Late 1980s

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10 - 22 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show LIMITATIONS OF THE MODEL 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 “Self- correction”

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

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10 - 24 Copyright McGraw-Hill/Irwin, 2005 Aggregate Expenditures Model Investment Demand and 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 Next Slide End Show Coming Next: AGGREGATE DEMAND AND AGGREGATE SUPPLY CHAPTER 11

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