Transcript Building the Aggregate Expenditures Model

What is an aggregate expenditure?
 Aggregate – “Total” or “Combined”
 Expenditure – “spending”
 Now, put them together, and what do we have?
 Total Spending!!!!
 Yeah!!!!
 Basically, the aggregate expenditures model refers to
the economy’s total spending.
 This model is used to illustrate the equality between
spending (consumption and investment) and output
(GDP)
 Remember….OUTPUT = GDP!
Background Info.
 Two theories about Agg. Ex.
 1. Classical Economic Theory
 Supported by Say’s Law – “Supply creates it’s own Demand”
 Production of one good/service automatically generates the
income necessary to demand other goods/services.
 A true market system will ensure full employment and high
output.
 Economic hardships will be self-corrected through continual
production, no government intervention needed whatsoever.
Keynesian Economic Theory
 Pronounced “Cane-Sian”
 Created by in John Maynard Keynes in 1936 as a result
of economic analysis regarding the Great Depression.
 Notes that due to circumstances beyond the control of
the economy (war, debt, overspending,
underspending, natural disasters), there will always be
brief/sustained periods when all income will not be
spent on the output from which it is produced.
 So, The GOVERNMENT must intervene or “stimulate”
the economy during these times of economic hardship.
 Yeah!!!!!
So, what are we actually looking at
with the Agg. Exp. Model?
 The Agg. Exp. Model is a basic Macroeconomic theory
that states:
 the amount of goods and services
produced and therefore the level of
employment depends directly on the
level of total or aggregate expanditures.
Let’s build ourselves a model!
 Income-consumption-savings relationships
 Basic Assumption from graph
 Any point on the reference line is a point in which C =
DI
 Therefore, any point below the reference line is a
period of savings, any point above the reference line is
a period of “dissavings”
 Yeah!!!!
What does this mean?
 The relationship between Consumption, Savings, and
Income can be broken down into two categories:
 1. Average Propensity
 2. Marginal Propensity
Average Propensity
 The fraction, or percentage, of any total income which
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is consumed/saved is the average propensity to do so
Average Propensity to Consume (APC)
Equals Consumption / Income
Average Propensity to Save (APS)
Equals Saving / Income
APC + APS = 1
Marginal Propensity
 The proportion, or fraction, of any change in income
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consumed is the marginal propensity to consume/save
Marginal Propensity to Consume (MPC) – the ratio of
change between consumption and income
Equals Change in consumption / Change in income
Marginal Propensity to Save – the ratio of change
between savings and income
Equals Change in saving / change in income
MPC + MPS = 1
Yeah!!!!
Let’s see what you can do so far!!!!
 Worksheet Time….Yeah!!!!!
Part Deuce: Investment and
Equilibrium GDP
 To refresh:
 GDP/output = Production
 Aggregate Expenditures = Cost
 Producers are willing to offer any level of output that is
at least equal to it’s costs of production
Equilibrium GDP
 Equilibrium GDP is that output where production will
create total spending that is equal to it’s output.
 Another way of saying the same thing:
 Equilibrium level of GDP occurs where the total output,
measured by GDP, and aggregate expenditures, C + I, are
equal
 In other words, where Real GDP = Aggregate
Expenditures
 Why can’t other levels of GDP be feasible sustained?
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Below Equilibrium
If an economy is producing real GDP at 300 billion
And it’s consumption is at 290 billion
And Investment is at 25 billion
Then Aggregate Expenditures = 315 billion
There is a difference of 15
This number (15) is negative because “people” are
consuming and investing goods and services at a faster rate
than they are being produced….
 How could an economy cope with this to achieve
equilibrium?
 Increase employment!!!
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Above Equilibrium
If an economy is producing real GDP at 300 billion
And it’s consumption is at 240 billion
And Investment is at 25 billion
Then Aggregate Expenditures (C + I) = 265 billion
There is a difference of 35 billion
This number is positive because the economy/producer is
producing at a faster rate than consumers are consuming
(buying) and investing….
 How could an economy cope with this to achieve
equilibrium?
 Decrease employment!!!
Investment
 Two types
 1. Planned
 Does not account for unintended or “unplanned”
investment
 2. Actual
 Equal to savings
 Planned investment + unplanned investment
Homework, #10
Possible Levels
of Employment
Real GDP, in
billions
Consumption,
billions
40
240
244
45
260
260
50
280
276
55
300
292
60
320
308
65
340
324
70
360
340
75
380
356
80
400
372
Savings, billions
Possible Levels
of Employment
Real GDP, in
billions
Consumption,
billions
Savings, Billions
40
240
244
-4
45
260
260
0
50
280
276
4
55
300
292
8
60
320
308
12
65
340
324
16
70
360
340
20
75
380
356
24
80
400
372
28
Now let’s add
Investment….calculate Agg. Exp.
And determine Equilibrium GDP
Levels of
Employme
nt
GDP
C
S
Investment
Aggregate
Expenditures
40
370
375
?????
40
?????
45
390
390
40
50
410
405
40
55
430
420
40
60
450
435
40
65
470
450
40
70
490
465
40
75
520
480
40
80
550
495
40