ShortRunModel1 - Aggregate Expenditure and Equilibrium...

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Aggregate Expenditure and Equilibrium Income Slide 1
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Assumptions ± We will assume that: here is no ¾ There is no depreciation ¾ There are no indirect taxes ¾ Net payment to foreign factors of production is nil ± Therefore, GDP , Net Domestic Income , and Gross National Product are all equal ± In other words, output and income are assumed to be equal and we will use the notation Y to refer to Slide 2 both
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Graphical Representation of GDP = National Income (Y) GDP GDP = Y Slope = 1 45º Slide 3 Y
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Assumptions (continued) We will also assume that the price level ( P ) is p fixed herefore this model applies to a situation ¾ Therefore, this model applies to a situation where the economy is in a deep recession aracterized by d characterized by excess capacity and high unemployment ¾ That is, we will consider the so-called short- run Keynesian model Slide 4
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Aggregate Expenditure ± Aggregate Expenditure ( AE ) is the total desired or penditure on goods and services in the planned expenditure on goods and services in the economy, that is: AE = C + I + G + NX ± Using the expenditure approach, we have seen that GDP was equal to: Y = C + I + G + NX DP l h di d d ± GDP is equal to the actual expenditure on goods and services in the economy hat is, equal to Slide 5 ¾ That is, actual expenditure is equal to income ( Y ) since GDP is equal to
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Aggregate Expenditure (cont’d) ± The Aggregate Expenditure function indicates the desired level of expenditure at each level of income ( Y ) ¾ The Aggregate Expenditure function is an increasing function of Y ± Therefore, there must be a level of income at which gregate expenditure ( E is equal to desired aggregate expenditure ( AE ) is equal to actual aggregate expenditure ( GDP = Y ) ± This level of income at which Y = AE is the equilibrium level of output or income ( Y* ) t * e in Slide 6 ¾ At Y* the goods market is in
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Aggregate Expenditure (cont’d) ± If Y AE , then the economy is not in equilibrium ¾ If Y > AE Æ excess supply in the goods market ¾ If Y < AE Æ excess demand in the goods market ± Since P is assumed fixed, then the implicit assumption is that aggregate expenditure determines the amount of ods produced in the economy goods produced in the economy ± That is, Y must change in order to restore equilibrium t h in the economy ¾ Y must increase to eliminate an excess demand Slide 7 ¾ Y must decrease to eliminate an excess supply
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Simple Model A Simple Model ± Consider a simple model of an economy without government sector ( G = 0 ) and without external sector ( X = Q = 0 ) ± Therefore, AE = C + I ± How is equilibrium income ( Y* ) determined in this economy? Slide 8
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