CHAPTER 11

The Aggregate Expenditures Model

CHAPTER CONTENTS
Assumptions and Simplifications
Consumption and Investment Schedules
Equilibrium GDP: C + lg = GDP
Other Features of Equilibrium GDP
Changes in Equilibrium GDP and the Multiplier
Adding International Trade
Adding the Public Sector
Equilibrium versus Full-Employment GDP
11-2
ASSUMPTIONS AND SIMPLIFICATIONS
Use the Keynesian aggregate expenditures model.
“Stuck price” model.
GDP = DI.
Begin with private, closed economy:
• Consumption spending
• Investment spending

11-3
LO11.1
THE INVESTMENT DEMAND CURVE AND
THE INVESTMENT SCHEDULE
In billions

(1) (2)

Expected rate of return, r, and real interest rate, i

Level of Real Investment (lg)
Investment
Output and Income

Investment (billions of dollars)

demand
$370 $20 curve Investment
schedule

(percents)
390 20
410 20 20 Ig
430 20
8
450 20 20
20
470 20
490 20 ID
510 20 0 20 0
530 20 Investment Real domestic product, GDP
(billions of dollars) (billions of dollars)
550 20
(a) (b)
Investment demand curve Investment schedule 11-4
LO11.2
DETERMINATION OF THE EQUILIBRIUM LEVELS OF EMPLOYMENT,
OUTPUT, AND INCOME: A PRIVATE CLOSED ECONOMY
(1) (2) (6) (7) (8)
Possible Real Domestic (3) (4) (5) Aggregate Unplanned Tendency of
Levels of Output (and Consumption Saving Investment Expenditures Changes in Employment,
Employment, Income) (GDP (C), (S), (Ig), (C + Ig), Inventories, Output, and
Millions = DI),* Billions Billions Billions Billions Billions (+ or −) Income
(1) 40 $370 $375 $−5 $20 $395 $−25 Increase
(2) 45 390 390 0 20 410 −20 Increase
(3) 50 410 405 5 20 425 −15 Increase
(4) 55 430 420 10 20 440 −10 Increase
(5) 60 450 435 15 20 455 −5 Increase
(6) 65 470 450 20 20 470 0 Equilibrium
(7) 70 490 465 25 20 485 +5 Decrease
(8) 75 510 480 30 20 500 +10 Decrease
(9) 80 530 495 35 20 515 +15 Decrease
(10) 85 550 510 40 20 530 +20 Decrease
If we assume that depreciation and net foreign factor income are zero, government is ignored, and all saving occurs in the household sector of the economy, then GDP as a measure of domestic output is
equal to NI, PI, and DI. This means that households receive a DI equal to the value of total output, real GDP.
11-5
LO11.3
EQUILIBRIUM GDP IN A PRIVATE CLOSED ECONOMY
530
(C + Ig = GDP) C + Ig
510

490 Equilibrium C
point

Aggregate expenditures, C + Ig (billions of dollars)

470 Aggregate
expenditures
450
Ig = $20 billion
430

410

390
C = $450 billion
370

45°

0 370 390 410 430 450 470 490 510 530 550

Real domestic product, GDP (billions of dollars)

11-6
LO11.3
OTHER FEATURES OF EQUILIBRIUM GDP
Saving equals planned investment:
• Saving is a leakage of spending.
• Investment is an injection of spending.
No unplanned changes in inventories: Firms do not
change production.

11-7
LO11.4
CHANGES IN THE AGGREGATE EXPENDITURES SCHEDULE
AND THE MULTIPLIER EFFECT
510
(C + Ig)1
(C + Ig)0
(C + Ig)2
490

Aggregate expenditures (billions of dollars)

Increase in Decrease in
470 investment investment

450

430

45°

0 430 450 470 490 510

Real domestic product, GDP (billions of dollars) 11-8

LO11.5
ADDING INTERNATIONAL TRADE
Include net exports spending in aggregate
expenditures: private, open economy.
Exports create production, employment, and income.
Subtract spending on imports.
Xn can be positive or negative.

11-9
LO11.6
TWO NET EXPORT SCHEDULES
In billions
(2) (3)
(1) Net Exports, Net Exports,
Level of GDP Xn1 (X > M) Xn2 (X < M)
$370 $+5 $–5
390 +5 –5
410 +5 –5
430 +5 –5
450 +5 –5
470 +5 –5
490 +5 –5
510 +5 –5
530 +5 –5
550 +5 –5
11-10
LO11.6
NET EXPORTS AND EQUILIBRIUM GDP

11-11
LO11.6
GLOBAL PERSPECTIVE 11.1
NET EXPORTS OF GOODS, SELECTED NATIONS, 2017

11-12
LO11.6
Source: The World Factbook, Central Intelligence Agency
INTERNATIONAL ECONOMIC LINKAGES
Prosperity abroad: Can increase U.S. exports.
Exchange rates: Depreciate the dollar to increase
exports.
A caution on tariffs and devaluations:
• Other countries may retaliate.
• Lower GDP for all.

11-13
LO11.6
ADDING THE PUBLIC SECTOR
Government purchases and equilibrium GDP:
Government spending is subject to the multiplier.
Taxation and equilibrium GDP:
• Lump sum tax.
• Taxes are subject to the multiplier.
• DI = GDP.

11-14
LO11.7
THE IMPACT OF GOVERNMENT PURCHASES ON EQUILIBRIUM GDP
(1) (5) (7)
Real Domestic Net Exports Aggregate
Output and (2) (3) (4) (Xn), Billions (6) Expenditures
Income Consumption Saving Investment Government (C + Ig + Xn + G),
(GDP = DI), (C), (S), (Ig), Exports Imports Purchases Billions
Billions Billions Billions Billions (X) (M) (G), Billions (2) + (4) + (5) + (6)
(1) $370 $375 $−5 $20 $10 $10 $20 $415
(2) 390 390 0 20 10 10 20 430
(3) 410 405 5 20 10 10 20 445
(4) 430 420 10 20 10 10 20 460
(5) 450 435 15 20 10 10 20 475
(6) 470 450 20 20 10 10 20 490
(7) 490 465 25 20 10 10 20 505
(8) 510 480 30 20 10 10 20 520
(9) 530 495 35 20 10 10 20 535
(10) 550 510 40 20 10 10 20 550

11-15
LO11.7
GOVERNMENT PURCHASES AND EQUILIBRIUM GDP

C + Ig + Xn + G
C + Ig + Xn

Aggregate expenditures (billions of dollars)

C

Government
spending
45° of $20 billion

0 470 550

Real domestic product, GDP (billions of dollars)

11-16
LO11.7
DETERMINATION OF THE EQUILIBRIUM LEVELS OF
EMPLOYMENT, OUTPUT, AND INCOME: PRIVATE AND PUBLIC
SECTORS
(1)
Real (3) (9)
(7)
Domestic Disposable (5) (8) Aggregate
Net Exports
Output and (2) Income (4) Savings (6) Government Expenditures
(Xn), Billions
Income Taxes (DI), Consumption (Sa), Investment Purchases (C + Ig + Xn + G),
(GDP = NI), (T), Billions (Ca), Billions (Ig), Exports Imports (G), Billions
Billions Billions (1) – (2) Billions (3) – (4) Billions (X) (M) Billions (4) + (6) + (7) + (8)
(1) $370 $20 $350 $360 $−10 $20 $10 $10 $20 $400
(2) 390 20 370 375 −5 20 10 10 20 415
(3) 410 20 390 390 0 20 10 10 20 430
(4) 430 20 410 405 5 20 10 10 20 445
(5) 450 20 430 420 10 20 10 10 20 460
(6) 470 20 450 435 15 20 10 10 20 475
(7) 490 20 470 450 20 20 10 10 20 490
(8) 510 20 490 465 25 20 10 10 20 505
(9) 530 20 510 480 30 20 10 10 20 520
(10) 550 20 530 495 35 20 10 10 20 535
11-17
LO11.7
TAXES AND EQUILIBRIUM GDP
C + Ig + Xn + G
Ca + I g + X n + G

Aggregate expenditures (billions of dollars)

$15 billion
decrease in
consumption
from a
$20 billion
increase
in taxes

45°

0 490 550

Real domestic product, GDP (billions of dollars)

11-18
LO11.7
EQUILIBRIUM VERSUS FULL-EMPLOYMENT
Recessionary expenditure gap:
• Insufficient aggregate spending
• Spending below full-employment GDP
• Increase G and/or decrease T
Inflationary expenditure gap:
• Too much aggregate spending
• Spending exceeds full-employment GDP
• Decrease G and/or increase T
11-19
LO11.8
RECESSIONARY AND INFLATIONARY EXPENDITURE GAPS

AE2
AE0 AE0
530 530
AE1

Aggregate expenditures
Aggregate expenditures

(billions of dollars)
(billions of dollars)

Recessionary Inflationary
510 expenditure 510 expenditure
gap = $5 billion gap = $5 billion

490 Full 490

employment Full
employment
45° 45°

0 490 510 530 0 490 510 530

Real GDP Real GDP
(a) (b)
Recessionary expenditure gap Inflationary expenditure gap
11-20
LO11.8
APPLICATION: THE RECESSION OF 2007–09
December 2007 recession began.
Aggregate expenditures declined:
• Consumption spending declined.
• Investment spending declined.
• Recessionary expenditure gap.

11-21
LO11.8
KEYNESIAN POLICIES
Federal government undertook Keynesian policies:
• Tax rebate checks
• $787 billion stimulus package

11-22
LO11.8
LAST WORD: SAY’S LAW, GREAT DEPRESSION, KEYNES
Classical economics:
• Say’s Law.
• Economy will automatically adjust.
• Laissez-faire.
Keynesian economics:
• Cyclical unemployment can occur.
• Economy will not correct itself.
• Government should actively manage macroeconomic
instability.
11-23