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Chapter Objectives

- Economists Combine Consumption and Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy
- Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy
- AE = Output
- Saving = Investment
- No Unplanned Changes in Inventories
- How Changes in Equilibrium Real GDP Occur and Relate to Multiplier
- Integrate Public sector and Foreign Sectors into AE
- Recessionary and Expansionary Expenditure Gaps

Consumption and Investment

- Simplifications
- Private Closed Economy
- Planned Investment
- Investment Schedule

Investment Demand Curve

Investment Schedule

Investment

Demand

Curve

Investment

Schedule

Ig

20

Investment (billions of rand)

rand i (percent)

8

20

20

ID

20

Investment (billions of rand)

Real GDP (billions of rand)

Consumption and Investment

- Equilibrium GDP:

C + I = GDP

Y = C + I

Y = Co +cYd + I

- Real Domestic Output (Yd)
- Aggregate Expenditures (Y)
- Aggregate Expenditures Schedule
- Equilibrium GDP
- Disequilibrium

17.1

(5)

Investment

(I)

(6)

Aggregate

Expenditures

(C+I)

(7)

Unplanned

Changes in

Inventories

(+ or -)

(1)

Real

Domestic

Output

(and

Income)

(GDP=Yd)

(4)

Saving

(S)

(1-2)

(2)

Con-

sump-

tion

(C)

(8)

MPC

Consumption and Investment(3

(Co)

…in Billions of rand

R370

390

410

430

450

480

490

510

530

550

R377.5

392.5

407.5

422.5

437.5

460.0

467.5

482.5

497.5

512.5

R100

100

100

100

100

100

100

100

100

100

R-7.5

-2.5

2.5

7.5

12.5

20

22.5

27.5

32.5

37.5

20

20

20

20

20

20

20

20

20

20

R397.5

412.5

427.5

442.5

457.5

480

487.5

502.5

517.5

532.5

R-27.5

-22.5

-17.5

-12.5

-7.5

0

+2.5

+7.5

+12.5

+17.5

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

Graphically…

Consumption and Investment

- Mathematical Calculations

530

510

490

480

450

430

410

390

370

Consumption (billions of rand)

45°

388 400 420 440 460 480 500 520 540 560

Disposable Income (billions of rand)

Consumption and InvestmentEquilibrium GDP

C + I

C + I = GDP)

C

Equilibrium

Point

Aggregate

Expenditures

I= R20 Billion

C = R460 Billion

17.1

Equilibrium GDP

- Other Features…
- Saving Equals Planned Investment
- Leakage
- Injection
- No Unplanned Changes in Inventories

Savings and Investment

- Mathematical Calculations

510

490

470

450

Aggregate Expenditures (billions of rand)

45°

440 460 480 500 520

Real GDP (billions of rand)

Changes in Equilibrium GDP…and the Multiplier

(C + Ig)1

(C + Ig)0

(C + Ig)2

Increase in

Investment

Decrease in

Investment

Adding the Public Sector

C + Ig + G = GDP

- Leakages
- Injections
- No Planned Inventory Changes

S + T = Ig + G

17.2

17.2

(5)

Investment

(I)

(6)

Exogenous

Public sector

Spending

(G)

(7)

Aggregate

Expenditure

(C+I+G)

(1)

Real

Domestic

Output

(and

Income)

(GDP=Yd)

(4)

Saving

(S)

(1-2)

(2)

Con-

sump-

tion

(C)

Adding the Public SectorPublic sector Purchases and GDP

(3

(Co)

…in Billions of rand

20

20

20

20

20

20

20

20

20

20

20

R417.5

432.5

447.5

462.5

477.5

500

507.5

522.5

537.5

552.5

560

20

20

20

20

20

20

20

20

20

20

20

R370

390

410

430

450

480

490

510

530

550

560

R377.5

392.5

407.5

422.5

437.5

460.0

467.5

482.5

497.5

512.5

520

R100

100

100

100

100

100

100

100

100

100

100

R-7.5

-2.5

2.5

7.5

12.5

20

22.5

27.5

32.5

37.5

40

Graphically…

Aggregate Expenditures (billions of rand)

45°

470 550

Real GDP (billions of rand)

Adding the Public SectorPublic sector Spending and GDP

C + I + G

C + I

C

Public sector

Spending of

R20 Billion

R20 Billion Increase

in Public sector

Spending Yields an

R80 Billion Increase

In GDP

Adding the Public sector

- Mathematical Calculations

Adding the Public sector (S=I+G)

- Mathematical Calculations

Adding G and the Multiplier

- Mathematical Calculations

lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllll

lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllAdding G and the Multiplier

- Mathematical Calculations

(6)

Investment

(I)

(7)

Exogenous

Public sector

Spending

(G)

(8)

Aggregate

Expenditure

(C+I+G)

(1)

Real

Domestic

Output

(and

Income)

(GDP=Yd)

(3)

Con-

sump-

tion

(C)

(5)

Saving

(S)

Adding the Public SectorPublic sector Taxes and the GDP

(2)

Taxes

(T)

(4)

(Co)

…in Billions of rand

20

20

20

20

20

20

20

20

20

20

20

20

R402.5

417.5

432.5

447.5

462.5

485.0

492.5

500

507.5

522.5

537.5

545.0

20

20

20

20

20

20

20

20

20

20

20

20

R370

390

410

430

450

480

490

500

510

530

550

560

R362.5

377.5

392.5

407.5

422.5

445.0

452.5

460

467.5

482.5

497.5

505

R100

100

100

100

100

100

100

100

100

100

100

100

R-12.5

-7.5

-2.5

2.5

7.5

15.0

17.5

20

22.5

27.5

32.5

35.0

20

20

20

20

20

20

20

20

20

20

20

20

Graphically…

Aggregate Expenditures (billions of rand)

45°

500 560

Real GDP (billions of rand)

Adding the Public SectorLump-Sum Tax Increase and GDP

C + I + G

C + I + G (with T)

R15 Billion Decrease

In Consumption From

a R20 Billion (MPC=.75)

Increase in

Taxes

R20 Billion Increase

in Taxes Yields a

R60 Billion Decrease

In GDP

Adding the Public sector

- Mathematical Calculations

Adding the Public sector (S+T=I+G)

- Mathematical Calculations

Adding T and the Multiplier

- Mathematical Calculations

540

520

500

480

460

Aggregate Expenditures

(billions of rand)

45°

460 480 500 520 540

Real GDP (billions of rand)

+5

0

-5

Net Exports Xn

(billions of

rand)

Real

GDP

International TradeNet Exports and Equilibrium GDP

C + I +G +Xn1

C + I +G

Aggregate

Expenditures

with Positive

Net Exports

C + I + G +Xn2

Aggregate

Expenditures

with Negative

Net Exports

Positive Net Exports

Xn1

480

500

520

Xn2

Negative Net Exports

International Trade

- Net Exports and Aggregate Expenditures
- Net Exports Schedule
- Net Exports and Equilibrium GDP
- Positive Net Exports
- Negative Net Exports

GLOBAL PERSPECTIVE

-700 200 150 100 50 0 50 100 150 200 250

International TradeNet Exports of Goods - Select Nations, 2004

Negative Net Exports

Positive Net Exports

+37

Canada

-17

France

Germany

+195

-2

Italy

Japan

+111

-117

United Kingdom

-707

United States

Source: World Trade Organization

550

530

510

490

470

Aggregate Expenditures

(billions of rand)

45°

490 510 530

Real GDP (billions of rand)

Equilibrium Versus Full-Employment GDPRecessionary Expenditure Gap

AE0

R5 Billion

Gap Yields

R20 Billion

GDP

Change

AE1

Recessionary

Expenditure

Gap = R5 Billion

Full

Employment

550

530

510

490

470

Aggregate Expenditures

(billions of rand)

45°

490 510 530

Real GDP (billions of rand)

Equilibrium Versus Full-Employment GDPInflationary Expenditure Gap

AE2

AE0

Inflationary

Expenditure

Gap = R5 Billion

R5 Billion

Gap Yields

R20 Billion

GDP

Change

Full

Employment

Equilibrium Versus Full-Employment GDP

- Limitations of the Model
- Does Not Show Price Level Changes
- Ignores Premature Demand-Pull Inflation
- Limits Real GDP to the Full-Employment Level of Output
- Does Not Deal with Cost-Push Inflation
- Does Not Allow for “Self-Correction”

Say’s Law - The Great Depression and Keynes

Last

Word

- Classical School – Automatic Self-Adjustment to Full Employment – Mill, Ricardo
- Views Based Upon “Say’s Law” - J.B. Say (1767-1832) – Supply Creates its Own Demand
- Great Depression Caused Questions
- Keynes Answered in his General Theory of Employment, Interest, and Money
- Income and Saving Discrepancies
- Volatility in Investment Spending
- Cyclical Unemployment Can Occur
- Public sector Should Be Active in the Recovery Process

17.2

planned investment

investment schedule

aggregate expenditures schedule

equilibrium GDP

leakage

injection

unplanned changes in inventories

lump-sum tax

net exports

recessionary-expenditure gap

inflationary-expenditure gap

Key Terms
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