Chapter 11 notes - Chapter 11 Notes Output and Expenditure...

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Chapter 11 Notes Output and Expenditure in the Short Run Aggregate Expenditure (AE) : total amount of spending in the economy: the sum of consumption, planned investment, government purchases, and net exports. The Aggregate Expenditure Model : A macroeconomic model that focuses on the relationship between total spending and real GDP, assuming the price level is constant. In any particular year, the level of GDP is determined mainly by the level of aggregate expenditure. Aggregate Expenditure Four categories of AE that together equal GDP o Consumption : spending by households on goods and services, such as automobiles and haircuts. o Planned Investment : planned spending by firms on capital goods, such as factories, office buildings, and machine tools, and by households on new homes. o Government Purchases : spending by local, state, and federal governments on goods and services, such as aircraft carriers, bridges, and salaries of FBI agents. o Net Exports : spending by foreign firms and households on goods and services produced in the US minus spending by US firms and households on goods and services produced in other countries. o AE = C + I + G + NX The Difference Between Planned Investment and Actual Investment Inventories : goods that have been produced but not yet sold. Changes in inventories are included as part of investment spending. Businesses always spend the amount they planned on machinery and office buildings, but the amount they plan to spend on inventories may be different than the amount they actually spend. o Example: If DoubleDay prints 1.5 million copies of a novel and sells all, their inventory is unchanged; if they only sell 1.2 million, then they have an unplanned increase in inventory. o Changes in inventories depend on sales of goods, which firms cannot always forecast with perfect accuracy. o Actual investment > planned investment when there is an unplanned increase in inventories. o Actual investment will equal planned investment when there is no unplanned change in inventories. Macroeconomic Equilibrium Macroeconomic equilibrium occurs where total spending (AE) equals total production, or GDP. Adjustments in Macroeconomic Equilibrium If sales are unexpectedly high, then there can be a decrease in inventory. When AE is greater than GDP, inventories will decrease and total employment and GDP will increase.
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When AE is less than GDP, inventories will increase and total employment and GDP will decrease. Only when AE equals GDP will firms sell what they expected to sell; inventories will remain unchanged and there will be no incentive to increase/decrease production. When economists forecast that AE is likely to decline and that the economy is headed for a recession, the federal government may implement macroeconomic policies.
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