Building the Aggregate Expenditures Model

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 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 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?

         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!!!

         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

60 65 70 75 80

Possible Levels of Employment

40 45 50 55

Real GDP, in billions

240 260 280 300 320 340 360 380 400

Consumption, billions

244 260 276 292 308 324 340 356 372

Savings, billions