Lecture 6 and 7:
The Aggregate Expenditures Model
Reference - Chapter 7

learning OBJECTIVES

1. The factors that determine consumption expenditure and saving. 2. The factors that determine investment spending. 3. How equilibrium GDP is determined in a closed economy without a government sector. 4. What the multiplier is and its effects on changes in equilibrium GDP. 5. How adding international trade affects equilibrium output. 6. How adding the public sector affects equilibrium output. 7. The distinction between equilibrium versus full-employment GDP.

I. Introduction

A. This chapter focuses on the aggregate expenditures model. We use the definitions and facts from previous chapters to shift our study to the analysis of economic performance. The aggregate expenditures model is one tool in this analysis. Recall that “aggregate” means total.

B. As explained in this chapter’s Last Word, the model originated with John Maynard Keynes (Pronounced Canes).

II. Simplifying Assumptions for the Simple Model

A. We assume a “closed economy” with no international trade.

B. No Government. C. Although both households and businesses save, we assume here that all saving is personal.

D. Depreciation and net foreign income are assumed to be zero for simplicity.

E. 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. The Aggregate Expenditures Model: Consumption and Saving

A. The theory assumes that the level of output and employment