Ch.28 The Aggregate Expenditures Model

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fixed, Great Depression

The aggregate expenditures model views the total amount of spending in the economy as the primary factor determining the level of real GDP that the economy will produce. The model assumes that the price level is BLANKED. Keynes made this assumption to reflect the general circumstances of the BLANK BLANK, in which declines in output and employment, rather than declines in prices, were the dominant adjustments made by firms when they faced huge declines in their sales.

expenditures, output, investment, disinvestment

For a private closed economy the equilibrium level of GDP occurs when aggregate BLANKS and real BLANK are equal or, graphically, where the C + Ig line intersects the 45° line. At any GDP greater than equilibrium GDP, real output will exceed aggregate spending, resulting in unplanned BLANK in inventories and eventual declines in output and income (GDP). At any below-equilibrium GDP, aggregate expenditures will exceed real output, resulting in unplanned BLANK in inventories and eventual increases in GDP.

leakages, injections

At equilibrium GDP, the amount households save (BLANKS) and the amount businesses plan to invest (BLANKS) are equal. Any excess of saving over planned investment will cause a shortage of total spending, forcing GDP to fall. Any excess of planned investment over saving will cause an excess of total spending, inducing GDP to rise. The change in GDP will in both cases correct the discrepancy between saving and planned investment.

unplanned

At equilibrium GDP, there are no BLANKED changes in inventories. When aggregate expenditures diverge from real GDP, that kind of change in inventories occurs. Those increases in inventories are followed by a cutback in production and a decline of real GDP. Those decreases in inventories result in an increase in production and a rise of GDP.

saving

Actual investment consists of planned investment plus unplanned changes in inventories and is always equal to BLANK.

investment, multiplier

A shift in the BLANK schedule (caused by changes in expected rates of return or changes in interest rates) shifts the aggregate expenditures curve and causes a new equilibrium level of real GDP. Real GDP changes by more than the amount of the initial change in investment. This BLANK effect (GDP/Ig) accompanies both increases and decreases in aggregate expenditures and also applies to changes in net exports (Xn) and government purchases (G).

exports, imports

The net export schedule in the model of the open economy relates net exports (BLANKS minus BLANKS) to levels of real GDP. For simplicity, we assume that the level of net exports is the same at all levels of real GDP.

Positive, Negative

BLANK net exports increase aggregate expenditures to a higher level than they would if the economy were "closed" to international trade. BLANK net exports decrease aggregate expenditures relative to those in a closed economy, decreasing equilibrium real GDP by a multiple of their amount. Increases in exports or decreases in imports have an expansionary effect on real GDP, while decreases in exports or increases in imports have a contractionary effect.

Government

BLANK purchases in the model of the mixed economy shift the aggregate expenditures schedule upward and raise GDP.

Taxation

BLANK reduces disposable income, lowers consumption and saving, shifts the aggregate expenditures curve downward, and reduces equilibrium GDP.

unplanned

In the complete aggregate expenditures model, equilibrium GDP occurs where Ca + Ig + Xn + G = GDP. At the equilibrium GDP, leakages of after-tax saving (Sa), imports (M), and taxes (T) equal injections of investment (Ig), exports (X), and government purchases (G): Sa + M + T = Ig + Xn + G. Also, there are no BLANKED changes in inventories.

equilibrium, full-employment, demand-pull

The BLANK GDP and the BLANK-BLANK GDP may differ. A recessionary expenditure gap is the amount by which aggregate expenditures at the full-employment GDP fall short of those needed to achieve the full-employment GDP. This gap produces a negative GDP gap (actual GDP minus potential GDP). An inflationary expenditure gap is the amount by which aggregate expenditures at the full-employment GDP exceed those just sufficient to achieve the full-employment GDP. This gap causes BLANK-BLANK inflation.

increasing, lowering, inflation

Keynes suggested that the solution to the large negative GDP gap that occurred during the Great Depression was for government to increase aggregate expenditures. It could do this by BLANKING its own expenditures (G) or by BLANKING taxes (T) to increase after-tax consumption expenditures (Ca) by households. Because the economy had millions of unemployed workers and massive amounts of unused production capacity, government could boost aggregate expenditures without worrying about creating BLANK.

full-employment

The stuck-price assumption of the aggregate expenditures model is not credible when the economy approaches or attains its BLANK-BLANK output. With unemployment low and excess production capacity small or nonexistent, an increase in aggregate expenditures will cause inflation along with any increase in real GDP.

planned investment

The amount that firms plan or intend to invest.

investment schedule

A curve or schedule that shows the amounts firms plan to invest at various possible values of real gross domestic product.

aggregate expenditures schedule

A schedule or curve showing the total amount spent for final goods and services at different levels of real GDP.

equilibrium GDP

The gross domestic product at which the total quantity of final goods and services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve.

leakage

(1) A withdrawal of potential spending from the income-expenditures stream via saving, tax payments, or imports; (2) a withdrawal that reduces the lending potential of the banking system.

injection

An addition of spending to the income-expenditure stream: investment, government purchases, and net exports.

unplanned changes in inventories

Changes in inventories that firms did not anticipate; changes in inventories that occur because of unexpected increases or decreases of aggregate spending (or of aggregate expenditures).

net exports

Exports minus imports.

lump-sum tax

A tax that collects a constant amount (the tax revenue of government is the same) at all levels of GDP.

recessionary expenditure gap

The amount by which the aggregate expenditures schedule must shift upward to increase the real GDP to its full-employment, noninflationary level.

inflationary expenditure gap

The amount by which the aggregate expenditures schedule must shift downward to decrease the nominal GDP to its full-employment noninflationary level.

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