Chapter 9 Building the Aggregate Expenditures Model

Chapter 9 Building the Aggregate Expenditures Model -...

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Chapter 9 Building the Aggregate Expenditures Model I. Introduction—What Determines GDP? A. This chapter and the next focus on the aggregate expenditures model. We use the definitions and facts from previous chapters to shift our study to the analysis of economic performance. The aggregate expenditures model is one tool in this analysis. Recall that “aggregate” means total. B. As explained in this chapter’s Last Word, the model originated with John Maynard Keynes (Pronounced Canes). 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. Therefore, GDP=NI=PI=DI in this very simple model. II. Simplifying Assumptions for this Chapter A. We assume a “closed economy” with no international trade. B. Government is ignored; focus is on private sector markets until next chapter. C. Although both households and businesses save, we assume here that all saving is personal. D. Depreciation and net foreign income are assumed to be zero for simplicity. E. There are two reminders concerning these assumptions. 1. They leave out two key components of aggregate demand (government spending and foreign trade), because they are largely affected by influences outside the domestic market system. 2. With no government or foreign trade, GDP, national income (NI), personal income (PI), and disposable income (DI) are all the same. III. Tools of Aggregate Expenditures Theory: Consumption and Saving A. The theory assumes that the level of output and employment depend directly on the level of aggregate expenditures. Changes in output reflect changes in aggregate spending. B. Consumption and saving: Since consumption is the largest component of aggregate spending, we analyze its determinants.
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1. Disposable income is the most important determinant of consumer spending (see Figure 9- 1 in text which presents historical evidence). a. What is not spent is called saving. b. Therefore, DI – C = S or C + I = DI 2. In Figure 9-1 we see a 45-degree line which represents all points where consumer spending is equal to disposable income; other points represent actual C, DI relationships for each year from 1980-2000. 3. If the actual graph of the relationship between consumption and income is below the 45- degree line, then the difference must represent the amount of income that is saved. 4. Look at 1996 where consumption was $5238 billion and disposable income was $5678 billion. Hence, saving was $440 billion. 5. The graph illustrates that as disposable income increases both consumption and
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Chapter 9 Building the Aggregate Expenditures Model -...

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