Building the Aggregate Expenditure Model

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Chapter 9

• Building the Aggregate Expenditure Model

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• What determine the level of the GDP given the
  economys production capacity?
• What causes GDPr to fluctuates over time?
• We use Aggregate Expenditure Model

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Assumptions

• 1. Two-sector economy households and business
• Aggregate spending C I only
• No G, No T DI PI
• 2. All savings are personal saving
• No business savings

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• 3. Depreciation 0
• Gross I Net I
• 4. Net foreign factor income 0
• Citizens earn as much abroad as foreigners earn
  inside.
• 5. No X, No M
• Closed economy.

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• Therefore
• Disposable income Personal income
• Gross investment Net investment
• Aggregate spending C I
• GDP NI PI DI

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• Therefore
• Aggregate spending C I
• And
• GDP NI PI DI

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• In the aggregate expenditure model, the amount of
  goods and services produced and therefore the
  level of employment depend directly on the level
  of aggregate expenditure (AE)
• Businesses will produce only level of output that
  they think they will sell.

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• When AE fall, total output and employment
  decrease
• When AE rise, total output and employment
  increase.

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Consumption and Saving

• What determine consumption spending?
• Note that DI C S, or C DI - S, thus, what
  determine C affects S too.
• The most important factor is
• 1. Disposable Income (DI)

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The 45o line C DI

• C
• 45o
  DI

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The Consumption Schedule

• DI C S
• How much goes to C and S?
• We use consumption and saving schedule
• (Check the complete table (9.1) p.161)

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• If C gt DI, then there is a decline in savings
  (Dissaving)
• When DI C, then S 0.
• This is Break-even income.
• What if DI0? Will C0 too?
• Autonomous consumption level of C when DI 0.
  (Independent C)