This is called planned investment ip the rm will

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Unformatted text preview: planned investment (Ip ). The firm will project their sales and year end inventories. At the end of the period the firm will realize their actual investment which is based on their actual (not predict) inventories. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 9 / 43 PAE Investment Investment Example At the begin of the period a firm plans on selling $1,000,000 in goods, having $100,000 in inventories, and making capital investments totaling $500,000. This firm has planned investment of $600,000 (100,000+500,000). At the end of the period the firm has sales totalling $900,000. Which is $100,000 less than their expectations. Instead of having $100,000 in inventories the firm will find $200,000. Actual investment is calculated by added together capital investments and actual inventories. In this case actual investment, I , equals $700,000. if I > Ip , GDP will increase, but next period firms will produce less. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 10 / 43 PAE Investment GDP and PAE GDP includes realized investment: Y = C + I + G + NX . Planned aggregate expenditures includes planned investment: PAE = C + I p + G + NX (1) If Y > PAE than firms have overproduced and will reduce future production. If Y < PAE than firms have underproduced and will increase future production. The economy will be in equilibrium when PAE = Y . Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 11 / 43 PAE Consumption Consumption Consumer spending is the largest part of GDP and aggregate expenditures. Consumption accounts for nearly 70% of GDP. In our model we are going to look at consumption as a function of: After-tax income: Consumption is positively related to after-tax income. Wealth (changes in asset prices): A higher level of wealth will increase consumption....
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