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Chapter 9

Chapter 9. Building the Aggregate Expenditure Model. What determine the level of the GDP given the economy’s production capacity? What causes GDP r to fluctuates over time? We use “Aggregate Expenditure Model”. Assumptions:. 1. Two-sector economy: households and business:

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Chapter 9

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  1. Chapter 9 Building the Aggregate Expenditure Model Alomar_111_11

  2. What determine the level of the GDP given the economy’s production capacity? • What causes GDPr to fluctuates over time? • We use “Aggregate Expenditure Model” Alomar_111_11

  3. Assumptions: 1. Two-sector economy: households and business: • Aggregate spending = C + I only • No G, No T: DI = PI 2. All savings are personal saving: • No business savings Alomar_111_11

  4. 3. Depreciation = 0 • Gross I = Net I 4. Net foreign factor income = 0 • Citizens earn as much abroad as foreigners earn inside. 5. No X, No M: Closed economy. Alomar_111_11

  5. Therefore: Disposable income = Personal income Gross investment = Net investment • Aggregate spending = C + I • GDP = NI = PI = DI Alomar_111_11

  6. Therefore: Aggregate spending = C + I • And: GDP = NI = PI = DI Alomar_111_11

  7. In the aggregate expenditure model, the amount of goods and services produced and therefore the level of employment depend directly on the level of aggregate expenditure (AE) • Businesses will produce only level of output that they think they will sell. Alomar_111_11

  8. When AE fall, total output and employment decrease • When AE rise, total output and employment increase. Alomar_111_11

  9. Consumption and Saving • What determine consumption spending? • Note that DI = C + S, or: C= DI - S, thus, what determine C affects S too. • The most important factor is: 1. Disposable Income (DI): Alomar_111_11

  10. The 45o line:C = DI C 45o DI Alomar_111_11

  11. The Consumption Schedule • DI = C + S • How much goes to C and S? • We use consumption and saving schedule: (Check the complete table (9.1) p.161) Alomar_111_11

  12. Alomar_111_11

  13. If C > DI, then there is a decline in savings (Dissaving) • When DI = C, then S = 0. • This is “Break-even” income. • What if DI=0? Will C=0 too? • Autonomous consumption: level of C when DI =0. (Independent C) Alomar_111_11

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