1. Chapter 28 The Aggregate Expenditures Model McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Aggregate expenditures for a private closed economy
Characteristics of equilibrium real GDP in a private closed economy
Changes in equilibrium real GDP and the multiplier
Adding the government and international sectors
Recessionary and inflationary expenditure gaps

3. Model Simplifications
Private closed economy
Consumption and investment only
Prices are fixed
Excess capacity exists
Unemployed labor exists
Disposable income = real GDP
No taxes

4. Model Simplifications
Investment demand vs. schedule
Investment Demand Curve
Investment Schedule
Investment
Demand
Curve
Investment
Schedule 20 Ig
r and i (percent)
Investment (billions of dollars) 8 20 20 ID 20
Investment (billions of dollars)
Real GDP (billions of dollars)

5. Equilibrium GDP Real GDP = C + Ig Aggregate expenditures
Equal to C + Ig
Aggregate expenditures schedule
Quantity goods produced = quantity goods purchased
Disequilibrium
Only 1 equilibrium level of GDP

6. Equilibrium GDP In millions …in Billions of Dollars (2) Real Domestic
Output
(and
Income)
(GDP=DI)
(3)
Con-
sump-
tion
(C)
(4)
Saving (S)
(1) – (2)
(5)
Investment
(Ig)
(6)
Aggregate
Expenditures
(C+Ig)
(7)
Unplanned
Changes in
Inventories
(+ or -)
(8)
Tendency of
Employment,
Output, and
Income
(1)
Employ-
ment
In millions
…in Billions of Dollars 40 45 50 55 60 65 70 75 80 85
$370
390
410
430
450
470
490
510
530
550
$375
390
405
420
435
450
465
480
495
510
$-5 5 10 15 20 25 30 35 40 20
$395
410
425
440
455
470
485
500
515
530
Increase
Equilibrium
Decrease
$-25
-20
-15
-10 -5 +5
+10
+15
+20

7. Equilibrium GDP Equilibrium Point (C + Ig = GDP) Aggregate
530
510
490
470
450
430
410
390
370
45°
Disposable Income (billions of dollars)
Consumption (billions of dollars)
(C + Ig = GDP)
C + Ig C
Equilibrium
Point
Aggregate
Expenditures
Ig = $20 Billion
C = $450 Billion

8. Equilibrium GDP Saving equals planned investment
Leakage
Injection
No unplanned inventory changes

9. Changes in Equilibrium GDP
510
490
470
450
430
45°
Real GDP (billions of dollars)
Aggregate Expenditures (billions of dollars)
(C + Ig)1
(C + Ig)0
(C + Ig)2
Increase in
Investment by 5
Decrease in
Investment by 5
The Multiplier
Effect

10. International Trade 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

11. Net Exports and Equilibrium GDP
Real GDP (billions of dollars)
Aggregate Expenditures
(billions of dollars)
510
490
470
450
430
45°
C + Ig+Xn1
C + Ig
Aggregate
Expenditures
with Positive
Net Exports
C + Ig+Xn2
Aggregate
Expenditures
with Negative
Net Exports
Real
GDP +5 -5
Net Exports Xn
(billions of
Dollars)
Positive Net Exports
Xn1
450
470
490
Xn2
Negative Net Exports

12. Net Exports of Goods Select Nations, 2006 -881 Negative Net Exports
Positive Net Exports
Canada
+31
-45
France
Japan
+70
-27
Italy
Germany
+203
-171
United Kingdom
-881
United States
Source: World Trade Organization

13. Adding the Public Sector
GDP = Cd + Ig + Xn + G
Lump sum taxes
Taxes affect disposable income
Consumption and the MPC
Leakages = Sd + M + T
Injections = Ig + X + G
Sd + M + T = Ig + X + G

14. Adding the Public Sector
(1)
Level of
Output
and
Income
(GDP=DI)
(2)
Consump-
tion
(C)
(3)
Saving (S)
(4)
Investment
(Ig)
(5)
Net Exports
(Xn)
(6)
Government
(G)
(7)
Aggregate
Expenditures
(C+Ig+Xn+G)
(2)+(4)+(5)+(6)
Exports
(X)
Imports
(M)
…in Billions of Dollars
$370
390
410
430
450
470
490
510
530
550
$375
390
405
420
435
450
465
480
495
510
$-5 5 10 15 20 25 30 35 40
$20 20 10 10 20
$415
430
445
460
475
490
505
520
535
550

15. Government Spending Effect
45°
Real GDP (billions of dollars)
Aggregate Expenditures (billions of dollars)
C + Ig + Xn + G
C + Ig + Xn C
Government
Spending of
$20 Billion
$20 Billion Increase
in Government
Spending Yields an
$80 Billion Increase
In GDP

16. Lump Sum Tax Effect $20 Billion Increase in Taxes Yields a
45°
Real GDP (billions of dollars)
Aggregate Expenditures (billions of dollars)
C + Ig + Xn + G
Cd + Ig + Xn + G
$15 Billion Decrease
In Consumption From
a $20 Billion (MPC=.75)
Increase in
Taxes
$20 Billion Increase
in Taxes Yields a
$60 Billion Decrease
In GDP

17. Recessionary Expenditure Gap
GDP is below full employment
Real GDP (billions of dollars)
Aggregate Expenditures
(billions of dollars)
550
530
510
490
470
45°
AE0
$5 Billion
Gap Yields
$20 Billion
GDP
Change
AE1
Recessionary
Expenditure
Gap = $5 Billion
Full
Employment

18. Inflationary Expenditure Gap
GDP is above full employment
Real GDP (billions of dollars)
Aggregate Expenditures
(billions of dollars)
550
530
510
490
470
45°
AE2
AE0
Inflationary
Expenditure
Gap = $5 Billion
$5 Billion
Gap Yields
$20 Billion
GDP
Change
Full
Employment

19. The Complete Model GDP and full employment Multiplier effects
Government spending
Lump sum taxes
Recessionary gap
Policy options
Inflationary gap
Demand pull inflation

20. Application U.S. economy late 1990’s Aggregate expenditure falls
Too much investment
Stock market bubble
Consumer debt
Fraudulent business practice
Aggregate expenditure falls
U.S. recession of 2001
Terror attacks prolonged recession

21. The Great Depression Classical economics Say’s Law
Mills and Ricardo
Prices adjust to maintain full employment
Say’s Law
Supply creates its own demand
Depression challenged the theory
New theory developed
Keynes
Aggregate expenditure model

22. Key Terms planned investment investment schedule
aggregate expenditures schedule
equilibrium GDP
leakage
injection
unplanned changes in inventories
net exports
lump-sum tax
recessionary expenditure gap
inflationary expenditure gap

23. Next Chapter Preview…
Aggregate Demand
and Aggregate Supply