Aggregate Aggregate

8/8/2019 Aggregate Aggregate

http://slidepdf.com/reader/full/aggregate-aggregate 1/28

1

Aggregate Expenditureand Aggregate Demand

CHAPTER

25

© 2003 South-Western/Thomson Learning



2

Aggregate Expenditure and Income

Here we build on the income-consumption connection to uncover thetie between income and total spending

AssumptionsNo capital depreciation

No business saving

Each dollar spent on production translates

directly into a dollar of aggregate income

GDP equals aggregate income

Investment, government purchases, and netexports are autonomous independent of the level of income



3

Components of Aggregate Expenditure

To develop the aggregate demandcurve, we begin by asking howmuch aggregate output would bedemanded at a given price level

Our objective is to analyze therelationship between aggregate

spending in the economy andaggregate income, or real GDP



4

Aggregate Expenditures

Aggregate expenditures equals theamount that households, firms,governments, and the rest of theworld plan to spend on U.S. output

at each level of real GDPConsumption, C

Planned investment, I

Government purchases, G

Net exports, X – MConsumption is the only spendingcomponent that varies with the level of real GDP



5

Exhibit 1: Table for Real GDP With Net Taxes and

Government Purchases (trillions of dollars)

Suppose the price level in the economy is 130 30% higher than in the base year

First column lists a range of possible levels of real GDP symbolized by Y

When we subtract net taxes, column (2), we get disposable income in column (3)

Households only have two possible uses for disposable income

Consumption, MPC assumed to be 4/5Saving, MPS assumed to be 1/5

Real

GDP

(Y)

(1)

Net

Taxes

(NT)

(2)

Disposable

Income

(Y-NT)

(3)=(1)-2)

Consumption

(C)

(4)

Saving

(S)

(5)

Planned

Investment

(I)

(6)

Government

Purchases

(G)

(7)

Net

Exports

(X-M)

(8)

PlannedAggregate

Expenditur

e

(AE)

(9)

UnintendedInventory

Adjustment

(Y-AE)

(10)=(1)-

(9)

9.0 1.0 8.0 7.5 0.5 0.8 1.0 -0.1 9.5 -.02

9.5 1.0 8.5 7.9 0.6 0.8 1.0 -0.1 9.6 -0.1

10.0 1.0 9.0 8.3 0.7 0.8 1.0 -0.1 10.0 0.0

10.5 1.0 9.5 8.7 0.8 0.8 1.0 -0.1 10.4 +0.1

11.0 1.0 10.0 9.1 0.9 0.8 1.0 -0.1 10.8 +0.2



6

Real

GDP

(Y)

(1)

Net

Taxes

(NT)

(2)

Disposable

Income

(Y-NT)

(3)=(1)-2)

Consumption

(C)

(4)

Saving

(S)

(5)

Planned

Investment

(I)

(6)

Government

Purchases

(G)

(7)

Net

Exports

(X-M)

(8)

Planned

AggregateExpenditur

e

(AE)

(9)

Unintended

InventoryAdjustment

(Y-AE)

(10)=(1)-

(9)

9.0 1.0 8.0 7.5 0.5 0.8 1.0 -0.1 9.5 -.02

9.5 1.0 8.5 7.9 0.6 0.8 1.0 -0.1 9.6 -0.1

10.0 1.0 9.0 8.3 0.7 0.8 1.0 -0.1 10.0 0.0

10.5 1.0 9.5 8.7 0.8 0.8 1.0 -0.1 10.4 +0.1

11.0 1.0 10.0 9.1 0.9 0.8 1.0 -0.1 10.8 +0.2

Columns (6), (7), and (8) list the injections into the circular flow: planned investment,

government purchases and net exports.

Government purchases equals net taxes government’s budget is balanced

The final column lists any unplanned inventory adjustment which equals real GDP minus

planned aggregate expenditures

When the amount people plan to spend equals the amount produced, there are no

unplanned inventory adjustments. In our example, this occurs where planned aggregateexpenditures and real GDP equal 10.0



If, however, real GDP is $9.0 trillionPlanned aggregate expenditure is $9.2 trillion firms must reduce inventories to make up the

shortfall in output

When the amount produced exceeds planned spending, firms get stuck with unsold goods which

become unplanned increases in inventories

For example, if real GDP is $11.0 trillion, planned aggregate expenditure is only $10.8 trillion

$0.2 million in output remains unsold firms respond by reducing output and do so untilthey produce the amount that people want to buy

Real GDP (Y)(1)

NetTaxes(NT)(2)

DisposableIncome(Y-NT)(3)=(1)-2)

Consumption(C)(4)

Saving(S)(5)

PlannedInvestment(I)(6)

GovernmentPurchases(G)(7)

NetExports(X-M)(8)

Planned

AggregateExpenditure(AE)(9)

Unintended

InventoryAdjustment(Y-AE)(10)=(1)-(9)

9.0 1.0 8.0 7.5 0.5 0.8 1.0 -0.1 9.5 -.02

9.5 1.0 8.5 7.9 0.6 0.8 1.0 -0.1 9.6 -0.1

10.0 1.0 9.0 8.3 0.7 0.8 1.0 -0.1 10.0 0.0

10.5 1.0 9.5 8.7 0.8 0.8 1.0 -0.1 10.4 +0.1

11.0 1.0 10.0 9.1 0.9 0.8 1.0 -0.1 10.8 +0.2

Exhibit 1: Table for Real GDP With Net Taxes and

Government Purchases (trillions of dollars)



Exhibit 2: Deriving Aggregate Output

Real GDP(trillions of dollars)

0

C + I + G + (X – M)

e10.0

10.0

45º

A

ggrega

teexpend

iture

(trillionsofdoll

ars)

This graph is often called the income-expenditure model. The aggregate

expenditure line reflects the sum of consumption, investment, government

purchases, and net exports

Planned aggregate expenditure

is measured on the vertical

axis. Real GDP , measured on

the horizontal axis, can be

viewed in two ways: 1) the

value of aggregate output ,and 2) as the aggregate income

generated by that level of

output for a given price level




Real GDP

(trillions of dollars)

0

C + I + G + (X – M)

e10.0

10.0

45º

A

ggrega

teexpend

iture

(trillionsofdoll

ars)

The special feature of the 45-

degree line is that it identifies all points where planned expenditure

equals real GDP.

Aggregate output demanded at

any given price level occurs where

real GDP equals planned

aggregate expenditure, at point e



Real GDP


0

C + I + G + (X – M)

e10.0

10.0

45º

9.0 a

9.0

9.2b

A

ggrega

teexpend

iture

(trillionsofdoll

ars)


Consider what happens when realGDP is initially less than $10.0

trillion, say $9.0 trillion. Planned

aggregate expenditures of $9.2

trillion (point b) exceed real GDP:

planned expenditures exceed the

amount that firms produce.

Because we assume prices will

remain constant, firms will

reduce inventories. But

unplanned inventory reductions

cannot continue indefinitely;

firms will increase employment

increasing income increasing consumer spending.

This process will continue until

planned spending equals real

GDP at point e




Real GDP


0

C + I + G + (X – M)e

10.0

10.0

45º

d

11.0

10.811.0

c

A

ggrega

teexpend

iture

(trillionsofdoll

ars)

When aggregate

expenditures exceed real

GDP - for example at

$11.0 - planned spending

(point c on the AE line)

falls short of production

(point d). Since real GDP

exceeds the amount people

want to spend, unsold

goods accumulate. Rather

than allow inventories to

pile up indefinitely, firmsreduce production, which

reduces employment and

income.



Simple Spending Multiplier

If we continue to assume that theprice level remains unchanged, wecan trace the effects of changes inplanned spending on aggregate

output demanded

The key point is that like a stonethrown into a still pond, the effect of

any shift in planned spending ripplesthrough the economy, generatingchanges in aggregate output thatmay far exceed the initial shift inplanned spending



13

Exhibit 3: Effect of an Increase In Autonomous

Investment on Real GDP Demanded

Aggregateexpenditure(trill

ionsofdollars)

0

10.0

10.5

10.0

e

Real GDP(trillions of dollars)

10.5

45º

0.1

10.1a

Assume that we begin at

equilibrium at point e

and that firms become

more optimistic about

future prospects. As a

result they increase their

planned investment,

from I to I'.

In our example,

investment is assumed to

have increased by $0.1trillion per year. What is

important to note is that

real GDP increased by

$0.5 trillion.

C+I´+G+(X-M)

C+I+G+(X-M)

e´



14

Exhibit 3: Autonomous Increase In Investment

C + I + G + (X – M)

Aggregateexpenditure(trill

ionsofdollars)

0

10.0

10.5

10.0

e

Real GDP


10.5

45º

g c

d

e'

10.1

f

0.1

10.1a

b

Round 1: The upward shift

of the AE line means that at

the initial real GDP level of

$10.0 trillion, planned

spending now exceeds output

by $0.1 trillion: e a

Initially, inventories may bereduced, prompting firms to

expand production: a b

e b shows the first round

in the multiplier process.Those who receive this

additional income spend

some of it and save the rest,

laying the basis for round

two of spending and income.

C + I' + G + (X – M)



17


The cumulative spending resulting from aninfinite series of rounds equals

1 / (1 – MPC) which in our example where theMPC was 0.8 1 / 0.2 5

Thus, the initial increase in plannedinvestment of $100 billion will eventuallyboost real GDP by 5 times this $100 billion,or $500 billion

Simple Spending Multiplier =1/(1–MPC)



18


The multiplier depends on the valueof the MPC

Specifically, the larger the fraction of

an increase in income that is spenteach round, the larger the spendingmultiplier the larger the MPC, thelarger the simple multiplier

With an MPC of 0.8, the multiplier is 5With an MPC of 0.9, the multiplier is 10

With an MPC of 0.75, the multiplier is 4



19


Recall from previous discussionsthat the MPC and the MPS mustadd up to 1

Therefore, we can define the simplespending multiplier in terms of the

MPS as follows:

Simple spending multiplier = 1 /MPS



20


In our example, the multiplierprocess started because of anincrease in investment

The same impact would occur if anyone of the components of aggregate expenditures changed

Finally, if the higher level of planned investment is notsustained in future years, real GDPwould fall back and the multiplier

process would work in reverse



21

Deriving the Aggregate Demand Curve

Thus far we have used the aggregate

expenditure line to determine real GDPdemanded for a given price level

What happens to the aggregate

expenditure line if the price levelchanges

As will be seen, for each price levelthere is a specific aggregateexpenditure line which yields a uniquereal GDP demanded by altering theprice level, we can derive theaggregate demand curve



22

A Higher Price Level

What is the effect of a higher price levelon the economy’s aggregate expenditureline and, in turn, on real GDP demanded?

A higher price levelreduces consumption because it reduces thereal value of dollar-denominated assets heldby households

increases the market rate of interest whichreduces investment

makes U.S. goods relatively more expensiveabroad imports rise and exports fall



23

Exhibit 5: Income-Expenditure and Aggregate Demand

0 Real GDP (trillions of dollars)

0

140

Aggregat e

exp

enditure

(trillionsofdollar

s)

e

AE (P = 130)

e

130

10.0

10.0 Real GDP (trillions of dollars)

45°

(a) Income-expenditure model

(b) Aggregate demand curve

In panel (a), the AE

function intersects the 45

degree line at point e to

yield $10.0 trillion in real

GDP demanded.

Panel (b) shows more

directly the link between

real GDP demanded and the

price level. When the price

level is 130, real GDPdemanded is $10.0 trillion.

This combination of price

level and real GDP is

identified by point e on the

aggregate demand curve.

Pricelevel



24

0 Real GDP (trillions of dollars)

0

140

AD

Aggregat e

exp

enditure

(trillionsofdollar

s)

AE' (P = 140)

e'

e'

9.5

9.5

e

AE (P = 130)

e

130

10.0

10.0 Real GDP (trillions of dollars)

120

AE" (P = 120)

e"

e"

10.5

10.5

45°

If the price level increases to 140?

As a result of the decrease in

planned spending, real GDP

demanded declines from e e'

Exhibit 5: Income-Expenditure and Aggregate Demand

It increases consumption,

planned investment, and net

exports, as reflected panel (a) by

the upward shift in the spending

line from AE to AE"

The increase in planned spending at

each income level increases real GDP

demanded increases from e e"

(a) Income-

expenditure

model

Pricelevel

(b) Aggregate

demand curve

It reduces consumption,investment, and net exports, as

reflected in panel (a) by the

downward shift from AE to AE'

If the price level declines to120?



25

Aggregate Demand and Expenditures

The aggregate expenditure line andthe aggregate demand curve portrayreal output from different perspectives

The aggregate expenditure line shows, fora given price level, how planned spendingrelates to the level of real GDP in theeconomy

The aggregate demand curve shows, forvarious price levels, the quantities of realGDP demanded



26

Multiplier and Aggregate Demand

Suppose we return to the situationwhere the price level is assumed to beconstant

What we want to do now is tracethrough the effects of a shift in any of the components of spending onaggregate demand, while assuming

that the price level does not change,e.g., we want to look at the multiplierand shifts in aggregate demand



27

Exhibit 6: Shifts

Aggregat

eexpenditure

(trillionso

fdollars)

0 10.0 Real GDP (trillions of dollars)

C + I + G + (X – M)

45º

e

0 10.0 Real GDP (trillions of dollars)

AD

130

Pricelevel

10.5

e'

C + I' + G + (X – M)

0.1

10.5

AD'

At a price level of 130, theaggregate expenditure line

intersects the 45 degree line at

point e in panel (a), and yields

point e on the aggregate demand

curve in panel (b)

When one component of

aggregate expenditure increases,

the AE function shifts upward.

Because the price level is

assumed constant, the aggregatedemand curve shifts from AD to

AD' and the new point of

equilibrium is shown as e' in both

panels.

e e´

(a) Income-

expenditure

model

(b) Aggregate

demand curve



28

Limitations of the Multiplier

Our discussion of the simple spending

multiplier exaggerates the actual effectwe might expect from a given shift inthe aggregate expenditure line

We have assumed that the price level

remains constant. However, as we will seelater, once we incorporate aggregate supplyinto the analysis, changes in the price levelreduce the impact of the multiplier

Leakages such as higher income taxes and

increased spending on imports all reduce thesize of the multiplier

The spending multiplier takes time to work itself out the process does not occurinstantly

Aggregate Aggregate

Documents

Transcript of Aggregate Aggregate