Aggregate expenditures

1
Aggregate expenditures aggregate demand

• Chapters 10 and 11

2
Aggregate Expenditures approach

• Simplifications
• Closed private economy
• GDPDI
• No exports, Govt
• Aggregate expenditures doesnt impact price

3
INVESTMENT DEMAND SCHEDULE
Investment Demand Curve
Investment Schedule
Ig
20
Investment (billions of dollars)
Expected rate of return, r, and real interest
rate, i (percents)
8
20
20
I D
20
Investment (billions of dollars)
Real Domestic Product, GDP (billions of dollars)
4
EQUILIBRIUM GDP
(C I g GDP)
C Ig
530 510 490 470 450 430 410 390 370
Equilibrium
C
Ig 20 Billion
Private spending, C I g (billions of dollars)
C 450 Billion
o
370 390 410 430 450 470 490 510
530 550
Real domestic product, GDP (billions of dollars)
5
CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER
510 490 470 450 430
(C Ig ) 1
(C Ig ) 0
Increases in the level of C Ig
Private spending (billions of dollars)
o
430 450 470 490
510
Real domestic product, GDP (billions of dollars)
6
CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER
Equilibrium GDP at Ig2 level of investment
510 490 470 450 430
(C Ig ) 0
(C Ig ) 2
Private spending (billions of dollars)
Decreases in the level of C Ig
o
430 450 470 490
510
Real domestic product, GDP (billions of dollars)
7
INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES
510 490 470 450 430
Aggregate Expenditures with Negative Net Exports
C Ig
C Ig Xn2
Private spending (billions of dollars)
o
430 450 470 490
510
Real domestic product, GDP (billions of dollars)
5 0 -5
Net Exports, Xn (billions of dollars)
Real GDP
430 450 470 490
510
8
ADDING THE PUBLIC SECTOR
Government Purchases and Equilibrium GDP
C Ig Xn G
Government Spending of 20 Billion
C Ig Xn
C
Aggregate Expenditures (billions of dollars)
o
470 550
Real domestic product, GDP (billions of dollars)
9
ADDING THE PUBLIC SECTOR
Lump-Sum Tax and Equilibrium GDP
15 Billion Decrease in Consumption from a 20
Billion Increase in Taxes
C Ig Xn G
Ca Ig Xn G
Aggregate Expenditures (billions of dollars)
o
490 550
Real domestic product, GDP (billions of dollars)
10
FULL-EMPLOYMENT GDP
Recessionary Gap
AE0
530 510 490
AE1
Recessionary Gap 5 Billion
Aggregate Expenditures (billions of dollars)
Full Employment
o
490 510 530
Real domestic product, GDP (billions of dollars)
11
FULL-EMPLOYMENT GDP
Inflationary Gap
AE2
Inflationary Gap 5 Billion
AE0
530 510 490
Aggregate Expenditures (billions of dollars)
Full Employment
o
490 510 530
Real domestic product, GDP (billions of dollars)
12
PROBLEMS WITH AGGREGATE EXPENDITURES APPROACH

• Does Not Show Price-Level Changes
• Ignores Premature Demand-Pull Inflation
• Limited Real GDP to the Full-Employment Level
• Does not Deal with Cost-Push Inflation
• Does not Allow for Self-correction

13
AGGREGATE DEMAND

• Defined
• Amounts of Real Output
• Buyers Collectively Desire
• At Each Possible Price Level

• Aggregate Demand Curve
• Down Sloping Due To
• Real-Balances Effect
• Interest-Rate Effect
• Foreign Purchases Effect

Graphically
14
AGGREGATE DEMAND CURVE
Price level
AD
Real domestic output, GDP
15
Shifts in Aggregate Demand Caused by Non-Price
Level Factors

• Factors that Shift the Curve

16
Change in Consumer Spending

• Consumer Wealth
• Consumer Expectations
• Household Indebtedness
• Taxes

17
Change in Investment Spending

• Interest Rates
• Profit Expectations
• Business Taxes
• Technology
• Degree of Excess Capacity

18
Change in Government Spending

• Desire to add or deduct from government supported
  programs.

19
Net Export Spending

• Increased exports----Increased AD
• Based on
• 1- national income abroad
• 2-exchange rates

20
AGGREGATE SUPPLY

• Defined
• Levels of Real Domestic Output
• At Each Possible Price Level
• Long-run Supply Curve
• Wages and Resource Prices Match Price Level
• Short-run Supply Curve
• Wages and Resource Prices Do Not Match Price
  Level

21
AGGREGATE SUPPLY
Long Run
P
ASLR
Price level
Long-run Aggregate Supply
Full-Employment
Q
Qf
Real domestic output, GDP
22
AGGREGATE SUPPLY
Short Run
P
AS
Aggregate Supply Short-run
Price level
Full- Employment
Q
Qf
Real domestic output, GDP
23
Shifts in Aggregate Supply Caused by Non-Price
Level Factors

• Factors that Shift the Curve

24
Change in Input Prices

• Domestic Resource Availability
• Prices of Imported Goods
• Market Power

25
Change in Productivity

• Effect of Training Programs
• Technology Gains

26
Change in Legal-Institutional Environments

• Business Taxes
• Business Subsidies
• Government Regulation

27
EQUILIBRIUM AND CHANGESIN EQUILIBRIUM
P
AS
Price Level
Equilibrium Real Output
100
a
b
92
AD
Q
510
502
514
Real Domestic Output, GDP
28
INCREASES IN AD DEMAND-PULL INFLATION
P
AS
AD1
AD2
P2
Price Level
P1
Q
Q1
Q2
Qf
Real Domestic Output, GDP
29
DECREASES IN AD RECESSION CYCLICAL
UNEMPLOYMENT
AD1
AD2
P
AS
b
a
P1
Price Level
c
Q
Q1
Qf
Real Domestic Output, GDP
30
Ratchet Effect

• At full employment
• AD declines
• GDP declines but price does not
• sticky prices
• Wage contracts
• Efficiency wages
• Min. wage
• Menu cost
• Fear price wars

31
DECREASES IN AS COST-PUSH INFLATION
AS2
P
AS1
b
P2
Price Level
a
P1
AD1
Q
Q1
Qf
Real Domestic Output, GDP
32
INCREASES IN AS FULL EMPLOYMENT
With Price-Level Stability
P
AS1
AS2
P3
b
P2
P1
a
Price Level
AD2
AD1
Q
Q2
Q1
Q3
Real Domestic Output, GDP