(Key Question 9)Chapter 9 Aggregated Expenditure ModelAssumptions and SimplificationsA.Keynes developed the aggregate expenditures model during the Great Depression because previous economic theory predicted that prices would fall to boost spending and move the economy to full-employment.1.Prices did not fall sufficiently during the Great Depression.
2. Keynes’ model is based on fixed prices and the adjustment of employment and GDP to economic shocks when prices are inflexible. B. We first assume a “closed economy” with no international trade. C. Government is ignored. D. Although both households and businesses save, we assume here that all saving is personal. E. Depreciation and net foreign income are assumed to be zero for simplicity. F. 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, personal income (PI), and disposable income (DI) are all the same. III. Consumption and Investment Schedules 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. In a closed private economy the two components of aggregate expenditures are consumption and gross investment. C. The consumption schedule was developed in Chapter 8 (see Figure 8.2a). D. In addition to the investment demand schedule, economists also define an investment schedule that shows the amounts business firms collectively intend to invest at each possible level of GDP or DI. 1. In developing the investment schedule, it is assumed that investment is independent of the current income. The line I g (gross investment) in Figure 9.1b shows this graphically related to the level determined by Figure 9.1a. 2. The assumption that investment is independent of income is a simplification, but will be used here. 3. Figure 9.1a shows the investment schedule from GDP levels given in Table 8.1. IV. Equilibrium GDP: C+I g = GDP A. Look at Table 9.2, which combines data of Tables 8.1 and 9.1. B. Real domestic output in column 2 shows ten possible levels that producers are willing to offer, assuming their sales would meet the output planned. In other words, they will produce $370 billion of output if they expect to receive $370 billion in revenue. C. Ten levels of aggregate expenditures are shown in column 6. The column shows the amount of consumption and planned gross investment spending (C + I g ) forthcoming at each output level. 1. Recall that consumption level is directly related to the level of income and that here income is equal to output level. 2. Investment is independent of income here and is planned or intended regardless of the current income situation.
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- Winter '08
- Inflation, Gdp, gross domestic product, Canada.