CHAPTER12Aggregate Expenditure andOutput in the Short RunChapterOutlineandLearningObjectives12.1TheAggregateExpenditureModel12.2DeterminingtheLevelofAggregateExpenditureintheEconomyIntel12.3 GraphingMacroeconomicEquilibrium12.4 The Multiplier Effect12.5TheAggregateDemandCurveAppendix:TheAlgebra ofMacroeconomicEguilibrium
1 Chapter Outline and Learning Objectives 12.1 The Aggregate Expenditure Model 12.2 Determining the Level of Aggregate Expenditure in the Economy 12.3 Graphing Macroeconomic Equilibrium 12.4 The Multiplier Effect 12.5 The Aggregate Demand Curve Appendix: The Algebra of Macroeconomic Equilibrium CHAPTER 12 CHAPTER Aggregate Expenditure and Output in the Short Run
TheAggregateExpenditureModel12.1LEARNINGOBJECTIVEUnderstandhowmacroeconomicequilibriumis determined intheaggregateexpendituremodel@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 2 The Aggregate Expenditure Model 12.1 Understand how macroeconomic equilibrium is determined in the aggregate expenditure model
AggregateExpenditureModelIn this chapter, we will build up a simple mathematical model of theeconomy known as the aggregate expenditure model.Aggregate expenditure model: A macroeconomic model thatfocuses on the short-run relationship between total spending and reaGDP, assuming that the price level is constant.Aggregate expenditure (AE): Total spending in the economy: thesum of consumption,planned investment,government purchases,and net exports.This model will focus on short-run determination of total output in aneconomy.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 3 Aggregate Expenditure Model In this chapter, we will build up a simple mathematical model of the economy known as the aggregate expenditure model. Aggregate expenditure model: A macroeconomic model that focuses on the short-run relationship between total spending and real GDP, assuming that the price level is constant. Aggregate expenditure (AE): Total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports. This model will focus on short-run determination of total output in an economy
FourComponents of Aggregate ExpenditureThe four components in our model will be the same four that weintroduced in a previous chapter as the components of GDP:: Consumption (C): Spending by households on goods and services: Planned investment (): Planned spending by firms on capitalgoods, and by households on new homesGovernment purchases (G): Spending on all levels of governmentongoodsandservicesNet exports (NX): The value of exports minus the value of importsAggregate expenditure is the sum of these:AE=C+I+G+NX@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 Four Components of Aggregate Expenditure The four components in our model will be the same four that we introduced in a previous chapter as the components of GDP: • Consumption (C): Spending by households on goods and services • Planned investment (I): Planned spending by firms on capital goods, and by households on new homes • Government purchases (G): Spending on all levels of government on goods and services • Net exports (NX): The value of exports minus the value of imports Aggregate expenditure is the sum of these: AE = C + I + G + NX
Planned Investmentys.ActuallnvestmentOur aggregate expenditure model uses planned investment, ratherthan actual investment; in this way, the definition of aggregateexpenditures is slightly different from GDP.The difference is that planned investment spending does not includethe build-up of inventories: goods that have been produced but notyet sold:Plannedinvestment=Actualinvestment-unplannedchangeininventoriesAlthough the Bureau of Economic Analysis measures actualinvestment, we will assume that their measurement is close enoughto planned investment to use in our estimates of aggregateexpenditures.2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 5 Planned Investment vs. Actual Investment Our aggregate expenditure model uses planned investment, rather than actual investment; in this way, the definition of aggregate expenditures is slightly different from GDP. The difference is that planned investment spending does not include the build-up of inventories: goods that have been produced but not yet sold: Planned investment = Actual investment – unplanned change in inventories Although the Bureau of Economic Analysis measures actual investment, we will assume that their measurement is close enough to planned investment to use in our estimates of aggregate expenditures
MacroeconomicEquilibriumEquilibrium in the economy occurs when spending on output is equalto the value of output produced; that is:Aggregateexpenditure=GDPWe know from previous chapters that GDP is generally changing-growing-fromyear toyear;for simplicity,we will assumeinthischapter that the economy is not growing.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 6 Macroeconomic Equilibrium Equilibrium in the economy occurs when spending on output is equal to the value of output produced; that is: Aggregate expenditure = GDP We know from previous chapters that GDP is generally changing— growing—from year to year; for simplicity, we will assume in this chapter that the economy is not growing
Adjustmentsto Macroeconomic EquilibriumJust like markets for a particular product may not be in equilibrium(quantity supplied may not equal quantity demanded at the currentprice), the economy may not be in equilibrium.Ifthen.and.aggregateexpenditureisthe economyisinequaltoGDPinventoriesareunchangedmacroeconomicequilibrium.GDP and employmentaggregateexpenditureislessthanGDPinventories risedecrease.GDP and employmentaggregate expenditure isgreater thanGDPinventoriesfallincrease.Table12.1The relationshipbetweenaggregateexpenditureandGDP@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 7 Adjustments to Macroeconomic Equilibrium Just like markets for a particular product may not be in equilibrium (quantity supplied may not equal quantity demanded at the current price), the economy may not be in equilibrium. The relationship between aggregate expenditure and GDP Table 12.1 If . . . then . . . and . . . aggregate expenditure is equal to GDP inventories are unchanged the economy is in macroeconomic equilibrium. aggregate expenditure is less than GDP inventories rise GDP and employment decrease. aggregate expenditure is greater than GDP inventories fall GDP and employment increase
MakingThe Effect of Unplanned Changes in InventoriestheConnectionFirmslikeApple don'twant tokeeptoo much inventory on hand. Notonly is it expensive, but technologyquickly becomes outdated.Appleforecastsits saleseachmonth,and plans to have adeguateinventory to cover sales.If sales arestronger than expected, it initiallycovers the extra sales through fallinginventories.The falling inventories signal toApple that it should hire moreworkersinordertoincreaseproduction.@2015Pearson Education,Inc
© 2015 Pearson Education, Inc. 8 Making the Connection The Effect of Unplanned Changes in Inventories Firms like Apple don’t want to keep too much inventory on hand. Not only is it expensive, but technology quickly becomes outdated. Apple forecasts its sales each month, and plans to have adequate inventory to cover sales. If sales are stronger than expected, it initially covers the extra sales through falling inventories. • The falling inventories signal to Apple that it should hire more workers in order to increase production
DeterminingtheLevelof AggregateExpenditureintheEconomy12.2LEARNINGOBJECTIVEDiscussthedeterminantsofthefourcomponentsof aggregateexpenditureanddefinemarginal propensitytoconsumeandmarginal propensityto save.@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 9 Determining the Level of Aggregate Expenditure in the Economy 12.2 Discuss the determinants of the four components of aggregate expenditure and define marginal propensity to consume and marginal propensity to save
Componentsof RealAggregateExpenditureThe table below shows the values of the components of expenditurein 2012, with prices in 2009 dollars.Real Expenditure(billionsof2009dollars)ExpenditureCategory$10,518Consumption2,436Plannedinvestment2,963Governmentpurchases-431Net exportsTable12.2Components ofrealaggregateexpenditure,2012Clearly consumption is the largest portion, with investment andgovernment expenditures being roughly similarly sized.Net exports were negative in 2012: the value of U.S. imports wasgreaterthan the value of U.S.exports.For the next several slides,we will examine each component in moredetail.10@2015PearsonEducafion.lnc
© 2015 Pearson Education, Inc. 10 Components of Real Aggregate Expenditure The table below shows the values of the components of expenditure in 2012, with prices in 2009 dollars. Components of real aggregate expenditure, 2012 Table 12.2 Expenditure Category Real Expenditure (billions of 2009 dollars) Consumption $10,518 Planned investment 2,436 Government purchases 2,963 Net exports −431 Clearly consumption is the largest portion, with investment and government expenditures being roughly similarly sized. Net exports were negative in 2012: the value of U.S. imports was greater than the value of U.S. exports. For the next several slides, we will examine each component in more detail