Lecture Notes: Aggregate Expenditures Model and Keynesian Economics

Introduction

• Chapters 10 and 11 were previously one chapter in some editions.
• Continuing discussion on the Aggregate Expenditures Model.

Aggregate Expenditures Model

• Aggregate Expenditures = total spending (C + IG + G + Xn)
  • C: Consumption spending
  • IG: Investment spending by businesses
  • G: Government spending
  • Xn: Net exports (exports - imports)
• In the previous chapter:
  • Focused on consumption and introduced investment.
  • Did not cover government spending or net exports.

Philosophical Shift: Adam Smith to John Maynard Keynes

• Earlier part of the course focused on Adam Smith's laissez-faire philosophy.
• Current focus is on John Maynard Keynes' philosophy:
  • Government intervention is necessary during economic instability.
  • Government must act during recessions or inflationary periods.

Key Concepts of Aggregate Expenditures Model

• Fixed price model: Prices do not change within the model.
• GDP is assumed to equal disposable income for learning purposes.
• Model starts with a private closed economy (consumption + investment).

Investment and GDP

• Investment Demand Curve:
  • Investment is not dependent on GDP but on interest rates and rates of return.
• Aggregate Expenditures Model includes a horizontal investment line.

Equilibrium in the Aggregate Expenditures Model

• Equilibrium is when GDP equals Aggregate Expenditures.
• Equilibrium GDP means no unplanned changes in inventory.
• Changes in inventory reflect mismatch between production and consumption.

Adding International Trade

• Net Exports = Exports - Imports, can be positive or negative.
• Net exports are not dependent on GDP.

Government and Aggregate Expenditures Model

• Government spending added as a non-GDP dependent factor.
• Taxes and government spending are assumed equal for simplicity (balanced budget).

Equilibrium and Government Interventions

• Equilibrium GDP occurs when aggregate expenditures equal GDP.
• Government can intervene to close recessionary or inflationary gaps:
  • Recessionary Gap: Increase spending or decrease taxes.
  • Inflationary Gap: Decrease spending or increase taxes.

Application of Keynesian Economics

• Example of 2007 recession and government interventions.
• Recent application during COVID-19 pandemic with stimulus checks.

Classical vs Keynesian Economics

• Classical (Adam Smith): Economy self-corrects, laissez-faire
• Keynesian (John Maynard Keynes): Active government intervention needed to manage economic instability.

Conclusion

• Upcoming topics include further details on government interventions and monetary policy in chapter 14.