1. 9
The Aggregate Expenditures
Model
O 9.1

2. Chapter Objectives
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

3. Consumption and Investment
Simplifications
Private Closed Economy
Planned Investment
Investment 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)

4. Consumption and Investment
Equilibrium GDP:
C + Ig = GDP
Real Domestic Output
Aggregate Expenditures
Aggregate Expenditures Schedule
Equilibrium GDP
Disequilibrium
W 9.1

5. Consumption and Investment
(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 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
$-25
-20
-15
-10 -5 +5
+10
+15
+20
Increase
Equilibrium
Decrease
Graphically…

6. Consumption and Investment
Equilibrium GDP
530
510
490
470
450
430
410
390
370
45°
Disposable Income (billions of dollars)
Consumption (billions of dollars)
C + Ig
(C + Ig = GDP) C
Equilibrium
Point
Aggregate
Expenditures
Ig = $20 Billion
C = $450 Billion
G 9.1

7. Other Features… Equilibrium GDP Saving Equals Planned Investment
Leakage
Injection
No Unplanned Changes in Inventories

8. Changes in Equilibrium GDP
…and the Multiplier
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
Decrease in
Investment

9. 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

10. Aggregate Expenditures
International Trade
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

11. International Trade Net Exports of Goods - Select Nations, 2004
GLOBAL PERSPECTIVE
Net Exports of Goods - Select Nations, 2004
Negative Net Exports
Positive Net Exports
Canada
+37
-17
France
Germany
+195 -2
Italy
Japan
+111
-117
United Kingdom
-707
United States
Source: World Trade Organization

12. Adding the Public Sector
Government Purchases and GDP
(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

13. Adding the Public Sector
Government Spending and GDP
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

14. Adding the Public Sector
Lump-Sum Tax Increase and GDP
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

15. Adding the Public Sector
Cd + Ig + Xn + G = GDP
Leakages
Injections
No Planned Inventory Changes
Sd + M + T = Ig + X + G
W 9.2
G 9.2

16. Equilibrium Versus Full-Employment GDP
Recessionary Expenditure Gap
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

17. Equilibrium Versus Full-Employment GDP
Inflationary Expenditure Gap
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

18. Equilibrium Versus Full-Employment GDP
W 9.3
Application:
U.S. Recession of 2001
Inflationary Expenditure Gap
U.S. Inflation in the Late 1980s
Full-Employment Output with Large Negative Net Exports
Negative Net Exports

19. Equilibrium Versus Full-Employment GDP
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”

20. Say’s Law - The Great Depression and Keynes
Last
Word
Classical School – Automatic Self-Adjustment to Full Employment – Mill, Ricardo
Views Based Upon “Say’s Law” - J.B. Say ( ) – 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

21. 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

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