1. Aggregate Expenditures10
C H A P T E R
Aggregate Expenditures
The Multiplier,
Net Exports,
and Government
AE = C + Ig + G = Xn
Multiplier = change in real GDP / initial change in spending
Xn and G are now added to the model to make it complete; I.e. GDP = C + Ig + G + Xn..

2. CHANGES IN EQUILIBRIUM GDP
AND THE MULTIPLIER
Equilibrium GDP
at Ig1 level of investment
Equilibrium GDP
at Ig0 level of investment
510
490
470
450
430
(C + Ig ) 1
(C + Ig ) 0
Increases
in the level
of C + Ig
Private spending (billions of dollars)
A $5b increase in Ig = $20b > in GDP 45 o o
Real domestic product, GDP (billions of dollars)

3. CHANGES IN EQUILIBRIUM GDP at Ig2 level of investment
AND THE MULTIPLIER
Equilibrium GDP
at Ig2 level of investment
510
490
470
450
430
(C + Ig ) 0
(C + Ig ) 2
Private spending (billions of dollars)
Decreases
in the level
of C + Ig
Conversely, < in Ig (or other areas of consumption) will lower GDP 45 o o
Real domestic product, GDP (billions of dollars)

4. Inverse relationship between
THE MULTIPLIER EFFECT
Multiplier =
Change in Real GDP
Initial Change in Spending
Change
in GDP =
Multiplier x
initial change
in spending
The Multiplier Effect and the Marginal Propensities
Multiplier effect = a change in AE leads to a larger change in equilibrium GDP.
The multiplier determines how much larger the change will be.
“initial change in spending” usually means investment spending, because it is so volatile yet it can be C, G, or Xn. Causes upward or downward shift of AE.
Multiplier is based on two facts:
Continuous flows of expenditures and income; income received by Jones comes from money spent by Smith.
Any change in income causes C & S to vary in the same direction. The fractional amount of C is MPC and fraction of S is MPS
The size of MPC is directly related; the size of MPS is inverse. I.e. the larger the MPC the larger the multiplier and the smaller the MPS the larger the Multiplier.
Inverse relationship between
Multiplier & MPS

5. = = x MPC and the Multiplier THE MULTIPLIER EFFECT or 1 Multiplier MPS
Change in
GDP =
Multiplier x
initial change
in spending
MPC and the Multiplier
MPC
Multiplier .9 .8
.75
.67 .5 10 5 4 3 2

6. INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT
Net Exports
Positive if exports > imports
Negative if imports > exports
Net Exports and Aggregate Expenditures
C + Ig + ( X – M )
Xn = ( X – M )
C + Ig + Xn
Xn = X – M.
Amount of Xn is reflected in GDP. With greater M, GDP drops meaning production, investment, output, employment.

7. INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT
Net Export Schedule
Net Exports and Equilibrium GDP
Positive Net Exports
Negative Net Exports
Graphically…

8. INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT
510
490
470
450
430
Aggregate Expenditures
with Positive Net Exports
C + Ig + Xn1
C + Ig
Private spending (billions of dollars) 45 o o
Real domestic product, GDP (billions of dollars) +5 -5
(billions of dollars)
Net Exports, Xn
Real GDP

9. INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT
510
490
470
450
430
Aggregate Expenditures
with Negative Net Exports
C + Ig
C + Ig + Xn2
Private spending (billions of dollars) 45 o o
Real domestic product, GDP (billions of dollars) +5 -5
(billions of dollars)
Net Exports, Xn
Real GDP

10. INTERNATIONAL ECONOMIC
LINKAGES
Prosperity Abroad
Tariffs
Exchange Rates
Prosperity Abroad usually raises our exports as those countries currency is strong – transferring their prosperity to us. Reverse in a recession.
Tariffs on our goods reduce exports and depress our economy causing retaliation. Smoot-Hawley Tariffs discourage trade and consequently reduce GDP.
Depreciation of USD lowers costs of American products and encourages exports. Appreciation of the USD has the opposite effect. Show on board.

11. GLOBAL PERSPECTIVE NET EXPORTS OF GOODS, 1999 Negative Net Exports
Positive Net Exports
Canada
France
Germany
Italy
Japan
United Kingdom
United States
-400
-140
-100
-60
-20 20 60
100
Billions of Dollars
Source: World Trade Organization

12. ADDING THE PUBLIC SECTOR
Simplifying Assumptions
Investment and Net Exports are Independent of the Level of GDP
Government Purchases Do Not Affect Private Spending
All Taxes are Personal
Tax Collections are Fixed
Unless Stated Otherwise, Price Level is Constant
Investment and Xn are not included in current level of GDP.
G purchases do not impact private spending.
Net taxes are derived from personal taxes hence, GDP, NI and PI are =.
Tax collections are independent of GDP level.
Neither inflation nor deflation exist.

13. ADDING THE PUBLIC SECTOR
Government Purchases and Equilibrium GDP
Government
Spending of
$20 Billion
C + Ig + Xn + G
C + Ig + Xn C
Aggregate Expenditures (billions of dollars)
Multiplier = change in GDP / change in spending. Also, M = 20b / (1/1-.75) = 4 45 o o
Real domestic product, GDP (billions of dollars)

14. ADDING THE PUBLIC SECTOR
Lump-Sum Tax and Equilibrium GDP
$15 Billion Decrease
in Consumption from
a $20 Billion Increase
in Taxes
C + Ig + Xn + G
Ca + Ig + Xn + G
Aggregate Expenditures (billions of dollars)
Essentially, S+M+T = I+X+G
Injections; investment is the potential replacement for the leakage of saving.
Leakage; the withdrawal from spending.
For the expanded or open economy, savings, taxes and imports are leakages, they do not involve consumption.
However, exports, investment and government spending make up for the lack of spending generated by the leakage.
Hence leakages = injections 45 o o
Real domestic product, GDP (billions of dollars)

15. ADDING THE PUBLIC SECTOR
Injections
Leakages
Unplanned Changes in Inventories
Balanced Budget Multiplier
Recessionary Gap
Inflationary Gap
Unplanned Changes are handled by increasing or decreasing production (which includes employment and output)
Balanced Budget multiplier = 1. Rise in G spending = amount of tax that provides the spending.
Recessionary Gap = AE at full employment GDP fall short of those required to achieve the full employment GDP.
Inflationary Gap = the amount by which AE at full employment GDP exceed those necessary to achieve full employment GDP.

16. FULL-EMPLOYMENT GDP Recessionary Gap Recessionary Gap = $5 Billion
AE0
530
510
490
AE1
Recessionary Gap
= $5 Billion
Aggregate Expenditures (billions of dollars)
A recessionary gap exists when equilibrium GDP is below full employment GDP.
Full Employment 45 o o
Real domestic product, GDP (billions of dollars)

17. FULL-EMPLOYMENT GDP Inflationary Gap Inflationary Gap = $5 Billion
AE2
Inflationary Gap
= $5 Billion
AE0
530
510
490
Aggregate Expenditures (billions of dollars)
An inflationary gap exists when aggregate expenditures exceed full employment GDP.
Full Employment 45 o o
Real domestic product, GDP (billions of dollars)

18. The End of the Japanese Growth “Miracle”
APPLICATIONS OF THE MODEL
Great Depression
Vietnam War Inflation
The End of the Japanese Growth “Miracle”
Great Depression
Overcapacity & business indebtedness resulted from excessive expansion in the 20”s prosperity. Auto industry expansion ended because the market was saturated. This affected related industries, oil, rubber, steel, glass, textiles.
Decline in residential construction.
Stock market crash causing pessimism and unfavorable conditions for obtaining added investment funds.
Money subblly fell as result of Fed. Policies and other forces.
Vietnam War Inflation
Johnson/Kennedy terms called for fiscal incentives to > AD. Tax credit for captial investment and cutting personal and corporate tax.
Unemployment fell 1% from 1964 to 1965.
War > Govt. spending 40%. Draft causes another 1% fall in unemployment.
Boom in Investment along with Govt spending = large inflationary gap.
End of Japanese Growth
Huge growth 9.7% & 4% because of 15% S and 85% C & low unemployment. i.e. operating at Yf with huge I. Unplanned inventory rise caused cut-backs in inventory leading to recessionary gap. Hard to change this cycle.

19. Does Not Show Price-Level Changes
LIMITATIONS OF THE MODEL
Does Not Show Price-Level Changes
Ignores Premature Demand-Pull Inflation
Bars Real GDP Beyond Full-Employment
Does Not Deal With Cost-Push Inflation
Doesn’t measure inflation. It shows demand pull (figure 10.8b) $5b. That amount doesn’t indicate what the % of inflation will be.
Demand Pull can occur before Yf. Model indicates inflation occurs only after Yf.
Model doesn’t indicate how economy can expand beyond Yf level. We know from past chapters that it can. Overtime
Model doesn’t deal with cost push.
Ch 11 deals with these matters.

20. CHAPTER
CONCLUSIONS

21. balanced-budget multiplier recessionary gap inflationary gap
KEY TERMS
multiplier
net exports
lump-sum tax
balanced-budget multiplier
recessionary gap
inflationary gap
BACK
END
Copyright McGraw-Hill/Irwin, 2002

22. AGGREGATE DEMAND AND AGGREGATE SUPPLY
Coming Next:
AGGREGATE DEMAND
AND
AGGREGATE SUPPLY
CHAPTER 11