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Aggregate Expenditure Model for GDP Determination

Explore the factors influencing GDP fluctuations over time and the impact of consumption on savings in the Aggregate Expenditure Model. Learn about consumption schedules and the relationship between disposable income and spending.

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Aggregate Expenditure Model for GDP Determination

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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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