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CHAPTER NINE BUILDING THE AGGREGATE EXPENDITURES MODEL INSTRUCTIONAL OBJECTIVES After completing this chapter, students should be able to: 1. Explain the basics of the classical view that the economy would generally provide full employment levels of output. 2. Recognize, construct, and explain the consumption, saving, and investment schedules. 3. Identify the determinants of the location of the consumption and saving schedules. 4. Differentiate between the average and marginal propensities to consume (and save). 5. Identify the immediate determinants of investment and construct an investment demand curve. 6. Identify the factors that may cause a shift in the investment-demand curve or schedule. 7. Describe the reasons for the instability in investment spending. 8. Explain verbally and graphically the equilibrium level of GDP. 9. Explain why above-equilibrium or below-equilibrium GDP levels will not persist. 10. Describe the leakages-injections approach to determining equilibrium GDP. 11. Trace the changes in GDP that will occur when there is a discrepancy between saving and planned investment. 12. Define and identify terms and concepts at the end of the chapter. LECTURE NOTES I. Introduction A. This chapter and Chapter 10 focus on the development of an analytical model called the aggregate expenditures model. We use the definitions and facts from previous chapters to shift our study to the analysis of the economy. The aggregate expenditures model is one tool in this analysis. B. The chapter begins with the historical backdrop to the model. C. The focus is on the relationship between income and consumption and savings. D. Investment spending, an important part of aggregate expenditures, is also examined. E. Finally, these spending categories are combined to explain the equilibrium levels output and employment in a private (no government), domestic (no foreign sector) economy. II. Classical Economics and Say’s Law A. Until the Great Depression of the 1930, most economists going back to Adam Smith had believed that a market system would ensure full employment of the economy’s resources except for temporary, short-term upheavals. B. If there were deviations, they would be self-correcting. A slump in output and employment would reduce prices, which would increase consumer spending; would lower wages which 113
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Building the Aggregate Expenditures Model would increase employment again; and would lower interest rates which would expand investment spending. C. Say’s law , attributed to the French economist J. B. Say in the early 1800s, summarized the view in a few words: “Supply creates its own demand.” D. Say’s law is easiest to understand in terms of barter. The shoemaker produces shoes in order to trade for other needed products and services. All the shoes produced would be traded for something, or else there would be no need to make them. Thus, supply creates its own demand.
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