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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’’
                                                                                              downward-sloping AD curve.
                                                                           AD

                                                                                                                               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
                                                                                    from AD to AD’. At the prevailing
                                             e                                      price level of 130, real GDP
Price level




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

                  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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