# Aggregate expenditure and Aggregate demand

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```					    Aggregate expenditure and Aggregate demand

•   Aggregate expenditure line
•   Real GDP demanded
•   Changes in aggregate expenditure
•   Simple spending multiplier
•   Changes in the price level
•   Aggregate demand curve
AE = C + I + G + (X – M)

Aggregate expenditure line: A
relationship tracing, for a given
price level, planned spending at
each level of income or real GDP
Aggregate expenditure
(trillions of dollars)

Income-
expenditure line

450

0
Real GDP
At every point on this line, planned spending is                (trillions of dollars)
equal to real GDP—so unplanned investment is
zero
Haley’s Hammers 2007 Investment
Plans
Planned spending for new plant
and equipment . . . . . . . . . . . . . . . . . . . . . .\$95,000

Planned inventory investment . . . . . . . . . . . . . . . . .0

Actual inventory investment . . . . . . . . . . . . . .3,500

Actual investment . . . . . . . . . . . .. . . . . . . . \$98,500

Remember, that:

Actual I = Planned I + Unplanned I
We normally cut back on
production when
we see our inventories piling
up.
Deriving the real GDP demanded for a given price level

d
15.0
Aggregate expenditure (trillions of dollars)

C+I+G+(X-M)
14.8
c          Real GDP demanded for a given
price level is found where
e                     aggregate expenditure equals
14.0
aggregate output – that is, where
spending equals the amount
b                              produced, or real GDP.
13.2
This occurs at point e, where the
13.0                                   aggregate expenditure line
a                         intersects the 45-degree line.
45°

0    13.0     14.0   15.0        Real GDP
(trillions of dollars)

6
When Real GDP = \$14 trillion
• Planned spending of households, firms,
government units, and foreigners is equal to
real output; thus the plans of producing and
spending units “match up.”
• Firms on average experience zero unplanned
investment.
• Firms on average have nor reason to ‘scale up’
or ‘scale down’ production.
Effect of an increase in investment on real
GDP demanded
C+I’+G+(X-M)
Aggregate expenditure (trillions of dollars)

e’         C+I+G+(X-M)
14.5
j                          A \$0.1 trillion increase in
h           k                  investment shifts the AE line up
f               i
14.1                                                      vertically by \$0.1 trillion.
g                          Real GDP increases until it equals
14.0                                                      spending at point e’.
e                                  As a result of the \$0.1 trillion
0.1                                                increase in investment, real GDP
demanded increases by \$0.5
trillion, to \$14.5 trillion.
45°
Real GDP
0               14.0 14.1
(trillions of dollars)            14.5
The economy is initially at point e, where spending=real GDP demanded = \$14.0 trillion.
8
Tracking the rounds of spending following a \$100
billion increase in investment (billions of dollars)
Assume that MPC = 0.8 and MPS = 0.6
New spending   Cumulative     New saving   Cumulative
Round   this round     new spending   this round   new saving
1         100            100             -            -
2          80            180            20           20
3          64            244            16           36
.          .             .              .            .
.          .             .              .            .
.          .             .              .            .
10        13.4          446.3          3.35         86.6
.          .             .              .            .
.          .             .              .            .
.          .             .              .            .
∞          0             500             0          100

9
1    1
k        
1  MPC MPS
Note that:

1                       1
GDP  I           \$0.1trillion           \$0.5trillion
1  MPC                  1  0.8
The income-expenditure approach and the AD
curve            AE” (P=120)
(a)                                                              At the initial price level =130, the AE
e’’
AE (P=130)     line identifies real GDP demanded
Aggregate expenditure

AE’ (P=140)    of \$14.0 trillion: point e on panel
(trillions of dollars)

e                                              (b).
At the higher price level of 140, the
e’                                                      AE line shifts down to AE’, and real
GDP demanded falls to \$13.5 trillion:
point e’ on panel (b).
45°

Real GDP At the lower price level of 120, the AE
0           (b)    13.5       14.0       14.5
(trillions of dollars) line shifts up to AE’’, and real GDP

140                              e’                                                 demanded increases to \$14.5 trillion:
point e” on panel (b).
Price level

130                                          e

120                                                                                 Connecting e, e’, and e’’ yields the
e’’

11
0                  13.5       14.0       14.5           Real GDP (trillions of dollars)
A shift of AE line that shifts the AD curve
(a)                                  C+I’+G+(X-M)
e’
C+I+G+(X-M)
Aggregate expenditure

A shift of the AE line at a given price
(trillions of dollars)

0.1                                             level shifts the AD curve.
e
In (a), an increase in investment of
\$0.1 trillion, with the price level
constant at 130, causes the
aggregate expenditure line to
increase from C+I+G+(X-M) to
45°                                              C+I’+G+(X-M). As a result, real DGP
Real GDP
demanded increases from \$14.0
0          (b)          14.0   14.5                               trillion to \$14.5 trillion. In (b), the
(trillions of dollars)
aggregate demand curve has shifted
e                                      price level of 130, real GDP
Price level

130                                         e’
demanded has increased by \$0.5
trilion.

0                       14.0   14.5         Real GDP (trillions of dollars)
Effect of a shift of autonomous spending on
real GDP demanded

C+I’+G+(X-M)
e’
Aggregate expenditure

C+I+G+(X-M)
An increase in investment,
(trillions of dollars)

other things constant, shifts
e
the spending line up from
C+I+G+(X-M) to C+I’+G+(X-
M), increasing the quantity of
\$0.1                                            real GDP demanded.
45°

Real GDP
0                       14.0 14.333
(trillions of dollars)

13

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 views: 10 posted: 11/2/2012 language: Unknown pages: 13