Aggregate Expenditures Model and Macroeconomic Equilibrium
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Alright, So let's take what we've learned about GDP and apply it to the aggregate expenditures model. This is an important one for this class. So let's get into it. Alright, So aggregate expenditures. When I say aggregate expenditures, remember aggregate, well, that's aggregate is in total, right? The total amount of expenditures. Well, it represents represents the total spending in an economy, Right? Aggregate expenditures, total spending. It's just a synonym there. So, we're gonna use the acronym A. E. For aggregate expenditures. Aggregate expenditures model is the E model. Okay, so when we talk about the aggregate expenditures model, what are we looking at? We're gonna be looking at spending. Right. So we're gonna be taking the relationship between the spending. So the money being spent in an economy and what's being produced. So production. Okay, So, it's not always gonna be necessarily true that what gets spent in an economy was produced that year, right? Maybe some of the production came from other years or during this year. Um So the spending and production don't necessarily have to line up. So when we talk about the aggregate expenditures model, um we're making this key assumption that prices are sticky. We've used this idea sticky prices before, and that just means that they're fixed, Right? They're sticky. They're not gonna be moving. So we're not gonna worry about prices when we deal with this model. So when we discuss this model, the idea here, the key idea is that in any particular year, the level of GDP, how much is going to be produced in that year, it's gonna be determined by the amount of spending, right? If there's a lot of money being spent by consumers, by businesses, by government, um well then there's going to be needed production to keep up with that spending. So that's what the idea of this model, the production has to keep up with our spending. Cool. So we learned about GDP, remember our formula here, consumption plus investment, plus government purchases, plus net exports. That's how we define G. D. P. When we first studied it. Right. And if that's not sticking with you, we'll definitely go back and refresh yourself on GDP because it's going to be important throughout this discussion. Alright, so aggregate expenditures, guess what? We're going to say that aggregate expenditures, expenditures, the money spent is gonna be the same thing, consumption plus investment plus government purchases plus net exports. Those are going to be the components here of aggregate expenditures. So, you're saying how now, is there a difference here, what's the difference between aggregate expenditures? GDP they look like the same exact thing. Well, guess what, when we're in equilibrium, when the, when the economy is in equilibrium, the spending and the production are going to be the same, so aggregate expenditures equals GDP in equilibrium. Okay, and when we talk about GDP, we're talking about real GDP, right, because we're not gonna let prices get into the way and Real GDP is just uh we're keeping prices constant when we use real GDP, so a equals GDP um That that is the key point we're gonna be looking for on a lot of these graphs, the amount of spending during a period is equal to the production during the period. So when when we're looking at this model, I want you to think like this, I want you to think of aggregate aggregate expenditures as the spending and G. D. P. As the production. Okay, so when we're looking for equilibrium, we want these equal, so what is the amount of spending and the amount of production that's going to equal the amount of spending? Right? We need to find that point on the graph. Okay, so we want these to be equal. And when we when we discuss aggregate expenditures, we're gonna have our four components, right, aggregate expenditures equals consumption plus investment, plus government purchases plus net exports, right? Just like we discussed above. Well, let's go ahead and define these terms a little more. Remember when we discussed the consumption function, the consumption function was just that we have our um our base level of consumption, we'll just say a is some base level of consumption that we have. Um If we had no income, right? And remember what we discussed about consumption as we have more money, we're gonna consume more, right? The more disposable income that we have, we're gonna consume more. And what did we consume more? We consumed more by this marginal propensity to consume, right? The marginal propensity to consume, tells us that for each extra dollars we have, how much of that dollar are we going to spend and how much of that dollar are we gonna save? So the marginal propensity to consume is of that dollar. How much of it are we going to consume? So let's say the marginal propensity was 0.8 right? That they would have to tell you something like that, right? And that would mean that if you had one more dollar, you'd spend 80 cents out of that dollar and save 20 cents out of that dollar. So what we do is the marginal propensity to consume times are disposable income, which will say is y de disposable income. Right? So this is the equation of a line right here, right? Just like when we studied consumption function as as we have more disposable income, we're going to consume more. So there was an upward slope on that line. Now, investment, government purchases and net exports, they're not going to have this kind of upward slope. They're just gonna be constant. Okay, there's going to be a constant amount of investment, a constant amount of government purchases and a constant amount of net exports, at least in this class. Right? We're not gonna make it more complicated than that. We're just gonna be given a number. This is the amount of investment um during this year, this is the amount of government purchases, this is the amount of net exports consumption is going to go up as there's more income as there's more GDP right? The more GDP there is, well, there's more income being made, right? Because there's more production, there's more people being hired more income. So consumption is related to G. D. P. As GDP goes up while consumption goes up with it. Okay, and we're gonna keep the other one's constant. Now, what happens if we have a change in one of these other ones investment, government purchases or net exports? Well, we're gonna have the multiplier effect and we're gonna talk about that more in other videos Where we're going to see how they can be affected by the multiplier where a change in investment or a change in government purchases, say like a boost of $5 million dollars in investment. Well, that's going to have a multiplier effect on the amount of GDP that comes out of it. Alright, we'll talk about how that looks in further videos, but for now, let's just know that those are going to be affected by the multiplier concern um is going to have that, that linear equation. And the other ones are just constants. Cool. So this is the basics of the aggregate expenditures model, right? We're gonna be looking at spending and production. Okay, so let's go ahead and look at an example, kind of a numerical example and then we'll discuss this in more detail in the next video. Cool, let's keep
Numerical Aggregate Expenditures
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Alright. So let's try this numerical example of our aggregate expenditures model. So what we're going to notice here is that we've got our real GDP and we're solving for our aggregate expenditures, notice it gives us consumption investment, government purchases and net exports at different levels of GDP. So why is there going to be different levels of consumption um at these different levels of GDP, notice that the other three are staying constant, right? Investment. Just like I said, we're going to keep these constant investment, government purchase and net exports are staying constant at different levels of GDP. But what about consumption? Remember as there's more production being being produced is that there's more goods being produced in the economy. What we need to hire more people, there's gonna be more people making money, right? So what we're seeing is that wages are, there's more income being made as GDP goes up because we're producing more stuff. So people have to be earning that money. And what did we learn about consumption as we learn more as we earn more money, we spend more money, right? That's the consumption idea that we learned with the consumption function and that has to do with that marginal propensity to consume. So notice here, when we went up from 16,000 to 18,000 in G. D. P. There was this $2000 increase in GDP. Well it didn't totally go up by 2000, it didn't go from 12 400 to 14. 400. No because we earned more money, but we didn't spend it all, We saved some as well and we spent some. So that's the idea is this consumption is going to be going up, but not as fast as the GDP, because there's gonna be some of it being saved as well. So let's go ahead and use our consumption investment, government purchases and net exports to calculate our aggregate expenditures. Remember, we're defining aggregate expenditures as the sum of these four. Real GDP is what's being produced, and we're worried about what's being spent. Remember when we define GDP previously, we used an expenditures approach where we defined it as everything that's being spent consumption, investment, government purchases in that export. So those are our aggregate expenditures in our economy. So what we wanna do is find that balance between how much we should produce in the economy and how much is being spent in the economy at that level of production. So, let's go ahead and check this out. Let's go ahead and calculate aggregate expenditures at these different levels. So, let me grab my calculator here and buy calculator. I mean, cell phone. So let's go ahead and do the first one here at a level of Real GDP of 16,000. Well, there's this much consumption, 12,400 plus our investment, 3500. Government purchases 3200 minus 1000. Net exports gets us to 18,100. So, notice our aggregate expenditures and Real GDP are not an equilibrium here, Right? They don't equal each other, there's more spending in the economy than there is production. So, if we increase the production to 18,000, well, there's gonna be a little more consumption because there's more money being made and we're keeping the other things constant here. So let's go ahead and see at a level of 18,000. Do we reach our equilibrium? 13,700 in consumption plus 3500 plus 3200 minus 1000. That gets us to aggregate expenditures of 19,400 here, right, 19,400. So, we're still not an equilibrium, there's still more spending than there is production. So, we up production again, let's see what happens when there's 20,000 of production. We're gonna have 15,000 in consumption plus 3500 plus 3200 minus 1000 That gets us to 20,700. We're getting close here, right, 20,700. But it's a little more, there's still a little more spending than there is um production in the economy. Remember we're thinking of real GDP as our production in the economy. What's being produced and aggregate expenditures as what is being spent in the economy? Alright, so we want to match these up, let's go ahead and try the next 1, 38,300 in consumption plus 3500 plus 3200 minus 1000. Well, what do you know, eventually it works out how, how come these numbers work, so? Well, for us, who knows? Well, this is what we've got, we've got an equilibrium here at 22,000 of production. We have our equilibrium amount of aggregate expenditures as well. Okay, so real GDP and aggregate expenditures are equal at this state. So what does that mean? Everything produced during this, during this year at a level of 22,000 will be purchased right? With 22,000 of spending. So let's go ahead and round out our table here with the last one at Real GDP of 24,000. Well, there's 17 600 in consumption plus 3500 plus 3200 minus 1000. That's 23,300 notice in this case? Well, there's less spending right now, we're at a point where there's less spending than there is production. So there's things being produced that are not being purchased. So what's happening in these first years where we're spending more than we're producing, What's happening is we're digging into our inventories maybe in previous years, we had produced things that we hadn't sold, Well, we're gonna start selling those things that have been produced previously. Not produced this year, produced previously, but are being sold this year. So what's happening to our inventories? These are called unplanned changes in inventory because we didn't expect this to happen. Right? So they're unplanned changes, meaning the spending was 18,100 when Real GDP was 16,000, Right, We didn't we didn't we would have produced everything that we would sell, Right, a business wants to produce just as much as they would sell. They don't wanna overproduce or under produced, they want to have just the right amount. So this would be an unplanned change And this would be -2100, right? This would be the 18,100 minus what's produced of 34,100 minus 16,000 is 2100. That's coming out of inventories, Right. We're taking stuff from previous years selling it now. So what about the next 1, 19,400 was purchased, were only 18,000 was produced. So, we have an unplanned change of inventory of 1400 in this case, Right. 1400 worth of goods are being pulled out of inventories. And in the next case, what we're still spending more than we're producing. So, again, we're pulling out of inventory 700 now, in our equilibrium, look what happens, we bought everything that was produced this here. So there's no change in inventory where we're in equilibrium, we're selling everything that was produced. And finally, in the final case, well, they're producing more than they're spending. Right, The production is more than the spending, so they produce things that were not sold. So those things that were not sold are going to be in our inventories now. So there's an unplanned increase in the inventories? In this case? So what does that matter? How does this idea of the inventory, The unplanned changes of these inventories? How does that work into this model? Well, let's think about our equilibrium first when we're in equilibrium down here. If E equals GDP right, our equilibrium. Well, this, this means that inventories do not change, right? Just like we saw there in our example, everything produced is sold and the economy is an equilibrium. But if we're not an equilibrium, we're gonna be moving towards our equilibrium, things are gonna start adjusting in the economy to try and make our way to equilibrium. So in this first case, if if aggregate expenditures is less than GDP, So what's happening in this situation? Remember aggregate expenditures is spending and this is production, Right? So production is more right than what we purchased is not everything that was produced. Like in this final case where there's 24,000 produced, 23,300 spent, right? So there's more being produced. Well, inventories increase in this case, right? Because not everything was sold. So what happens if these inventories increase? Well, in future years, we're not gonna need to produce that inventory, right? It's already being produced this year. So what's gonna happen to GDP and employment? Well, they're gonna decrease in future years in future years, that the economy is gonna start to adjust and we're gonna lay people off, we're like, hey, we've got too much inventory. We don't need people producing more stuff. We've already got inventories left over so that there will be less employment, less GDP um leading to a decrease, trying to find that equilibrium level, right? Because um The economy is always gonna be adjusting to find equilibrium there. So in this case the purchases are less than production, right? So the opposite happens in these first few examples 16,018,000. In these cases the spending is more than GDP, right? The spending is more than what's being produced. So in these cases the inventories decreased, right? We're pulling things that were produced in previous years and we're selling them this year. So in this case, let me get out of the way. So in this case, what's gonna happen to GDP and employment? Well, we're gonna see the firms are seeing that their inventories are falling, there's a bunch of purchases being made, they're going to increase their production and when they increase their production, their increasing GDP. And to do that to do that, they're gonna need to hire more people. Right? So in those cases it's increasing while we're finding our equilibrium G. D. P. So purchases in this case are more than production I wrote less than than production. So purchases are less than production, purchases are more than production in that case. Okay, so this is how the aggregate expenditures model works. We're trying to find the equilibrium being between what's being produced in the economy and what's being purchased, right? The spending in the economy. Those aggregate expenditures. Cool. So let's go ahead and move on to the next video.