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Lecture 13 - ECO100 - Introduction to Introduction...

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© Gustavo Indart Slide 1 ECO 100Y ECO 100Y Introduction to Introduction to Economics Economics Lecture 13: Lecture 13: Aggregate Expenditure Aggregate Expenditure and Equilibrium Income and Equilibrium Income
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© Gustavo Indart Slide 2 Assumptions Assumptions Price level is fixed ¾ Only changes in real GDP No depreciation and no indirect taxes ¾ GDP = Y
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© Gustavo Indart Slide 3 Aggregate Expenditure Aggregate Expenditure Aggregate expenditure ( AE ) is the total desired expenditure on goods and services in the economy AE = C + I + G + ( X IM ) The AE function does not measure the actual total expenditure on goods and services The AE function measures the desired or planned total expenditure on goods and services in the economy
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© Gustavo Indart Slide 4 Aggregate Expenditure and Aggregate Expenditure and Equilibrium Income Equilibrium Income Desired or planned total expenditure on goods and services means the total expenditure that households, firms, governments, and foreigners wish to make at each level of income ¾ Therefore, the AE function relates the level of desired AE to the level of real income There is a level of income ( Y* ) at which AE is equal to the actual level of output Æ Y = AE ¾ i.e., actual expenditure is equal to desired expenditure Y* is the equilibrium level of income or output for the economy
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© Gustavo Indart Slide 5 Aggregate Expenditure and Aggregate Expenditure and Equilibrium Income (continued) Equilibrium Income (continued) If AE = Y , then desired spending is equal to output and the economy is in equilibrium If AE > Y , then there is excess desired spending in the economy and thus the level of output will tend to rise If AE < Y , then there is insufficient desired spending in the economy and thus the level of output will tend to fall
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© Gustavo Indart Slide 6 Aggregate Expenditure and Aggregate Expenditure and Equilibrium Income (continued) Equilibrium Income (continued) The implicit assumption is that aggregate expenditure determines the amount of goods and services produced in the economy When AE differs from Y , equilibrium can’t be restored through a change in the price level since the price level is assumed fixed ¾ If AE > Y , then output will have to increase to restore equilibrium ¾ Similarly, if AE < Y , then output will have to decrease to restore equilibrium
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© Gustavo Indart Slide 7 Simple Model: Consumption and Simple Model: Consumption and Investment Investment AE = C + I The consumption function describes the total desired personal consumption expenditure The investment function describes the total desired investment expenditure
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© Gustavo Indart Slide 8 Consumption Function Consumption Function The consumption function is a description of the total desired personal consumption expenditure by all households in the economy Consumption depends on several variables such as disposable income , wealth , interest rates , and expectations about the future ¾ For simplicity, we will assume all these variables constant except disposable income ¾
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