in some prior editions of this book chapter 10 and chapter 11 for one chapter so it's really like we were just turning the page and keeping on talking about what we had been talking about we had developed or begun to develop the aggregate expenditures model aggregate expenditures meaning add all the spending together so remember the sea is consumption spending the IG is businesses spending on capital the G was government spending and X in was net exports exports minus imports and all that spending together and you have aggregate expenditures in the last chapter we just looked at consumption we introduced investment we didn't talk about it a lot and we didn't do any government or net exports so we're gonna add all that together in this chapter so I told you several chapters ago in the beginning anyway that we had started out the semester by looking at Adam Smith as the economic philosopher that our nation was built on a lazy fair economy where the government ideally would not play a large role in the economy but as we move to this part of the semester we're moving away from Adam Smith lacing fair philosophy into John Maynard Keynes philosophy so this topic in the last chapter in this chapter and through the rest of the semester is very Keynesian Keynesian based on John Maynard Keynes philosophy and his philosophy was that the government had an absolute mandate to interfere to be a part of the economy that if the economy was sliding into recession it was the government's responsibility to do something or if inflation was beginning to be a problem that it was the government's responsibility to do something so we're laying the groundwork here for chapter 13 and 14 and 15 and 16 in order to see what could the government do how could the government effect a change in the economy when we use the aggregate expenditures model it's a fixed price model I like the term better fix than stock but I get why they're saying stuck the stuck prices it's like we're we where we are at the moment but we're not letting prices change as we develop this model so when we get to chapter 12 we'll take the same learning but we'll let prices change so in this model prices are stuck wherever they are at the moment we're still assuming that GDP equals disposable income and we talked at the beginning of the last lecture that that's a bit of an abstraction from the real world we know it doesn't exactly equal but it approximates it and it helps our learning so we're going to leave that that assumption in place we start out with private closed economy because we haven't yet introduced government and we haven't yet introduced net exports so right now we just have consumption spending and investment spending that's right where we left off at the end of chapter 10 so we have looked at an investment demand curve based on that investment schedule so here they've given us a schedule of GDP and investment so they're saying if investment is twenty percent twenty billion I'm sorry if investment is twenty billion at all levels of GDP look at that so here's our investment demand curve there's the twenty billion level I don't know if you can remember from the last chapter but the chart in the last chapter showed us that at interest rates of eight percent there would be twenty billion dollars worth of investment projects that yielded an eight percent rate of return so if we're gonna add that on to this aggregate expenditures model it's going the investments going to come in as a straight line because investment is not dependent on GDP investment was dependent on interest rates and rates of return but remember on our vertical axis in the aggregate expenditures model we had consumption now we're going to add investment but investment doesn't change as GDP changes so it's just this horizontal line so when we add it and when we add investment to the consumption schedule we're going to keep the slope of the consumption function that slope was the MPC remember and we're just gonna shift it up by the twenty billion dollars of investment okay here's another long chart and I know it looks very overwhelming but it's very logical so and you've already learned some of it so we don't want to get it too heavy we can do this so column one is just level seven point of employment skip that for a second and go to column two and see that's that GDP equals disposable income that was our column one in last chapters chart so the way you would read this is that if we're going to produce three hundred and seventy billion dollars worth of GDP would need 40 million people employed to do that and we're gonna produce it the 390 level of GDP would need 45 million people to do that okay so we're just adding the number of employees needed to produce that level of GDP the third column is consumption which is household spending fourth column savings household savings fifth column investment how much businesses are going to spend we didn't see that in the last chapter this is a new column investment that we know that it cut is 20 percent because the interest rate they gave us to work with was 8 percent so we'd go back to that investment schedule or the investment demand curve whichever we had and say well if interest rates are 8 percent investment is 20 billion because investment didn't pin did not depend on GDP it does not change anywhere down along these rows it's 20 billion all the way down because investments dependent on the interest rates and the rates of return not on GDP then the sixth column now it's time to get aggregate expenditures we're going to add something together aggregate expenditures just means add the spending right now the only spending we have is consumption and gross investment in a minute we're going to get government and net exports but on this chart we just have consumption and investments so we're just going to add those two columns together while consumption is column three that's household spending investments column five that's business is spending on capital equipment so we're just going to add them together 375 plus 20 is 390 three ninety plus 20 is 4 10 405 plus 20 is 4 25 so you see we're just adding columns 3 & 5 consumption and investment to get aggregate spending column 7 that's a new column 2 and it's an interesting column I want you to think about it unplanned changes in inventory so GDP is how much we're producing aggregate expenditures is how much people are buying of what we produced so to get unplanned changes in inventories you're going to take the GDP and subtract what people are buying so when we produced three hundred and seventy billion dollars worth of GDP people bought 395 they bought more than we produce how can that happen well this is not the first year we've produced so we had some existing inventory at the beginning of January first there's always a inventory on Walmart shelves right if you think of a giant Walmart that houses literally everything we produce in the nation that's you know seems like it's true sometimes so there's already some inventory on the shelves in the in the ensuing year then we produced 370 billion dollars more GDP but they came in and they bought 395 that means some of the inventory that was on the shelves is depleted we don't have as much inventory on the Shelf at the end of the year as we had at the beginning of the year on row one we're 25 billion dollars less okay so let's go down to column 10 let's look at the amina wrote in i'm sorry let's go down to wrote in and look at the flip side on row 10 we produce five hundred and fifty five hundred and fifty billion dollars worth of GDP bottom up column two and they came in and they bought five hundred and thirty billion dollars worth of GDP bottom up column six so he produced 550 they only bought 5:30 so now there's 20 billion dollars more inventory on the shelves then we had at the beginning of the year so I want to go ahead and look at column eight so tendency of employment output and income all three of these will move together even if outputs going up then employments going up so income is going up if output meaning GDP is going down then employments going down and income is going down they'll all move in the same direction so let's go back to our unplanned changes in inventory column if it's a negative number in other words if GDP that we produced is less than what people bought then we're going to get a negative and plan changes in inventory inventories went down if inventories go down don't you expect that businesses will respond to that and increase the amount they produce in the next period well yes so they're gonna produce more output more GDP to do that they're gonna have to employ more people and when we employ more people the income will go up so when we have negative and planned changes in inventory we expect employment and output and income all to increase on the flip side on rows 7 through 10 GDP is a bigger number than aggregate expenditures so when we did GDP - aggregate expenditures to get unplanned changes in inventory we got a positive number that positive number means there's additional inventory on the Shelf that businesses didn't plan to be on their shelves so if they've got more inventory than they plan does it stand to reason that they're going to decrease the amount they produce well yes so now GDP output will be going down well if we're not going to produce as much we don't need to hire as many people as a matter of fact we need to lie some people off so producing less means we're going to decrease our employment and when we lay people off the national income is going to those people are not going to make as much money okay so let's look and find equilibrium I want you to remember this forever and always I want you to remember that when we're getting equilibrium what is going to be true what we're always looking for in an equilibrium condition equilibrium and see if I get a Q out of that equilibrium equals R is when let's do that sorry I don't like that equal son that's really not true equilibrium is when GDP equals aggregate expenditures that's your definition of equilibrium please hang on to that you'll you'll read or hear some other things but this one will hold you all the time equilibrium is when GDP equals aggregate expenditures okay so here's our equilibrium highlighted and bolded and all that when GDP equals aggregate expenditures that's our equilibrium okay so when we are at equilibrium it is a true condition that unplanned changes in inventory will be zero because we're producing and selling the exact same amount so inventories will not have changed so now we're starting to add on to our aggregate expenditures model so all of the spending is on the vertical axis notice right now we have consumption and gross investment right now that's the only two kinds of spending we have we're going to add government and net exports but right now we have a private closed economy private meaning there's no government closed meaning there's no net exports so ste and I to spending are gonna be added together on the vertical axis and GDP real domestic product on the horizontal last chapter when we just had consumption we had disposable income on the horizontal axis but now that we have two categories of spending consumption and gross investment we're moving instead of calling it disposable income we're going to call it all of GDP remember we had to put in a 45 degree reference line that just bisects that 90 degree angle into two equal pieces so that we can see that when a data point falls on the 45-degree line what's on the vertical axis equals what's on the horizontal axis so first just look at the I guess the more gray of the two lines and that one's just consumption that came from the chart back in the last chapter that showed us what consumption was although I think it was repeated again in our last slide then we add investment to it remember investment is not dependent on GDP so investment does not effect the slope of the consumption function the slope of the consumption function was the marginal propensity to consume the MPC that we calculated in the last chapter so now we're going to add investment to it and so it's just going to shift that consumption curve upward by the amount that they tell us investment is and they told us investment was twenty billion so we shift the consumption curve up by twenty billion to get our consumption plus investment curve right now that's the only two kinds of spending so that's our aggregate expenditures model the equilibrium GDP we only had consumption was down here or it crossed the 45-degree then we added investment and so now the equilibrium GDP is where that higher consumption plus investment curve crosses the 45 so then equilibrium goes out here to the axis and it'll be that 470 and goes down to the bottom axis and we'll notice it's going to come in at the same 470 again so at the 470 level of GDP the amount we're spending to purchased it is the exact same amount as is being produced so the unplanned changes in inventory will be zero so there's some other features of equilibrium GDP but I do want you to remember that equilibrium GDP we always are going to use the formula so equally Ameobi virtualize wish I could write better with that mouse whose GDP equals aggregate expenditures that's the very definition of equilibrium GDP where GDP equals aggregate expenditures or what's being produced equals how much is being spent to purchase what was produced there are some other conditions for example savings equals planned investment if you look back a couple of charts you'll see the savings column and the investment column and an equilibrium that Ladin that was highlighted at 470 savings an investment would be the same amount that's not what I want you to concentrate on for equilibrium because it's too easy to miss when you're working the problems concentrate on the condition that equilibrium GDP is where GDP equals aggregate expenditures and then that's going to be true that means there's no unplanned changes in inventories merci that was a lot of lines that came on the chart at one time I wish I had them coming in one at a time so you saw the 45-degree line first that's fine good then it's just showing us some changes in GDP so let's look at this so we have the light grey line in the middle c + IG zero so that first equilibrium point is right here where it crosses the 45 degree line so we started at an equilibrium GDP of 470 let's say we increased investments so that they're talking about increasing investment would be shifting this line upward and when we increased investment we shift that line upward that caused the new equilibrium point to be up here okay so how much did gdp change when we shifted this line up well the original gdp this this original number i'm gonna label it with the zero here was 470 the new one when we shifted up investment invested more brought us to 490 so wants you to think about this we calculated last chapter what multiplier they were using so let's just use what they used last chapter if our MP c equals point c they use seventy five point seven five if our MDC is 0.75 what does that make our MPs mmm if you spend seventy five cents of a dollar how much do you have left so that would make our MPs 0.25 okay because those two added together give us our whole dollar and then if you'll remember the multiplier formula multiplier formula was one divided by MPs so then what's our multiplier so that next time out supplier of fork right and then what was that change in GDP formula well let's do our change in GDP equalled the multiplier I'm gonna abbreviate that I'm trying to try to do that multiplier times change in spending okay so this would have been the change in investment spending that we just look at remember that triangle means change it's a Greek letter Delta it always represents change in a math or science class all right so we know some stuff we know the change in GDP went from 470 to 490 so that was 20 I should have put change right here change in GDP was at 20 we know our multiplier is 4 so what was that change in investment spending okay we could restate this formula to be change in investment spending equals change in GDP divided by multiplier or we can do it like we did in third grade and draw a box and see what's missing 4 times what is 20 so that would be 4 times 5 so this change in investment spending would have have to bend 5 billion to have when we shifted it up to have caused this 20 billion dollar change in GDP if our MPC is 0.75 that's the same thing if it decreased so if we move from c plus IG 0 from that original line to c plus IG 2 now here's our new equilibrium notice that instead of 470 it went down to 450 so that time the change in GDP was a negative 20 so then this must have been a negative 5 meaning the decrease of investment of the decrease of GDP okay so we're still moving on that's a good thing we had our aggregate expenditures model in the last graph just had consumption and gross investment and now we're ready to add international trade spending to that aggregate expenditures line so how do we calculate net exports remember it's exports minus imports we want to count everything that's produced here in the United States we don't want to count the imports so when we do that calculation exports minus imports the number the net exports could be a positive number or a negative number if we import more than we export which we do in the real world then net exports will be a negative number but in your problems they could be positive or negative this graphic just shows that it says here's all the levels of GDP assume net exports as a positive number and column to assume that exports is a negative number in column 3 all that you really need to get the idea here is that it's not dependent on GDP net exports just is what it is exports minus imports it doesn't matter what the level of GDP is so the next graph that we looked at will the next craft we will look at shows us what net exports would look like on the graph when we add it as positive and what it would look like on the graph and we add it as negative okay so here's our graphic so the light gray line in the middle shows us where our original C + IG line was that we just looked at so here's our equilibrium it was at 470 remember and now we're going to add that positive five net exports so just like when we increased investment if net exports is a positive number it's going to shift this curve up if it's positive if net exports is a negative number it's gonna shift the original line down so more spending shifts the line up left spending shifts the line down it changes GDP just like the investment change that we looked at in the last slide you'd have to know what the MPC is to get the MPS to get the multiplier and then put it in that change in GDP formula so just a fun graphic that shows you some net export information and on a global basis and then we think about what can affect net exports what could cause our exports to go up our exports to go down so the first thing we think about is prosperity in the nations that we send our exports to for example Canada buys a lot of our exports so if Kenda is in a prosperous time they'll buy even more and that would increase our export but if Canada goes into a recession then they're gonna buy less of their own stuff and less of our stuff and that would decrease our exports another fun thing to think about I think it's fun is the exchange rate so as we send our kids and services out all over the world then we're trading our US dollars for their currency and vice versa as we import and export so the exchange rates matter so they for a minute about if the dollar gets stronger so the value of the dollar goes up against any world currency that that we have to look at them one by one by one just to say the dollar goes up against the peso is the Mexican peso it's not to say the dollar does up against the Canadian dollar or the Chinese won or whatever it its currency by currency so let's say the dollar goes up against the Canadian dollar what would that mean well that would mean we could buy more of their stuff but they couldn't buy as much of our stuff because their currency didn't buy as much as it did before so changes in the exchange rates can affect our imports and our exports to tariffs our taxes on imported goods if tariffs go up it makes the imports more expensive and so we might not buy as much of that import remember that this is a political topic and so when we increase tariffs let's say against the cars coming in from Japan and then they're going to increase tariffs against the goods that we send into Japan perhaps the rice so we have now consumption and we have net in gross investment and we have net exports into the aggregate expenditures model we're just missing one more sector the public sector government so now we're going to add government into the model so this chart gives us a chart of absolutely everything now which is fun because let's see column one here's our GDP column which can also be thought of as disposable income though let's call it GDP as we've got the whole model built then we have consumption that's household spending then look over to column four we have gross investment that's businesses spending on capital equipment then look at these two columns of 5 we have exports and imports remember net exports as exports minus imports well in this particular chart they gave us they made exports and imports the same amount so our net exports is zero I wish they hadn't have done that but so be it and then government spending so now they're telling us that government spending is going to be 20 billion well government spending just is what they tell us it's going to be it's not dependent on GDP or interest rates or rates of return or anything else that we've looked at it's just whatever they tell us government purchases are going to be it's a matter of Congress and the president arguing back and forth until they get a number for the budget so government purchases or 20 so now let's look at that last column aggregate expenditures c plus IG plus XM plus g we usually say g plus xn but it doesn't make any difference they're all added so look across the columns you're going to add to get aggregate expenditures you're gonna add consumption column to you're gonna add investment column four you're gonna add net exports exports minus imports but in this case that's zero and then you're going to add government purchases so if we look at column one that would be adding 375 220 plus zero plus 20 4:15 so look at this chart and see where you find equilibrium GDP what was that definition of equilibrium GDP right it was where GDP equals aggregate expenditures so where do you see that happen in this chart let's all the way down at the bottom in net so all the way down at the bottom we have GDP is 550 and aggregate expenditures is 550 so the equilibrium level of GDP on this chart is 550 so let's build our graph to show that there's our 45 degree reference line just C then C plus IG plus x10 and now C plus IG plus XM plus G now we have the total model built we know equilibrium is where the aggregate expenditures curve intersects the 45 degree line so our aggregate expenditures then intersects 45 degree right here so here's our equilibrium GDP so we can come to the bottom and see that's 550 this new chart adds taxes in so we've got GDP in column one taxes and column two I want you to notice that column to taxes and column eight government purchases is the same number because for the purposes of learning this information in a principals class we're going to assume a balanced government budget when there's a balanced government budget taxes and government purchases will be the same amount there's no deficit there's no surplus so we have disposable income remember disposable income is income after all the taxes have been subtracted so GDP in that first column equals national income then take the taxes out there's disposable income then we have consumption and savings and investment still net exports and government purchases we're still going to get aggregate expenditures the same way that we did before we're going to add the spending together so look at your consumption plus investment plus net exports plus government purchases and you'll see your aggregate expenditures column now remember equilibrium GDP is where GDP equals aggregate expenditures so if you go down this column and you're looking to see where GDP equals AE that's now at 490 so GDP is 490 on row 7 and aggregate expenditures is 490 this is just the graphic that shows the adding of the taxes so government spending was 20 and taxes were 20 well when we added taxes into the model of 20 remember we had an MPC of 0.75 so MPC of 0.75 times 20 means that consumption decreased by 15 billion 75 percent of that total change so consumption decrease that shifted the aggregate expenditures curve downward so where we had seen an equilibrium GDP of 550 consumption decreasing back 15 times the multiplier of 4 is 60 so that gave us that sixty billion dollar decrease in GDP so we use all of this information to analyze recessionary and inflationary gaps in other words if spending is less then the equilibrium GDP that we would need to get to full employment level then we need spending to increase if spending is more than we need for the full employment equilibrium level of GDP then we would need to decrease spending and the government can assist in ways to doing that that's the Keynesian way for the government to assist the economy and times of recessionary or inflationary gaps remember that recessionary means we don't have enough spending the spinnings below the full employment level so the government could increase government spending decrease taxes or a combination of both an inflationary gap means we have too much spending and so the government would want to decrease spending so they can decrease government spending or if they increase taxes that would decrease consumption spending so here's our graphics to show that so the one on the Left notice it's labeled recessionary gap the one on the right is labeled inflationary so on the Left eighties zero intersects the 45 at the 510 level and notice they're pointing to that as being full employment but if spending decreases slides down now we're at AE 1 and spending well only the amount of spending we have an 81 will only generate GDP of 490 and that does that's not enough to get everybody fully employed so we'd have to do something to increase spending to push a e 1 up to a e 0 so we know our multiplier is 4 because all through this chapter we've been dealing with an MPC 0.75 subtract that from 1 gives us an NPS of 0.25 multiplier is 1 divided by point yeah 1 divided by the NPS 1 divided by 0.25 so our multiplier is 4 so we've got that change in GDP of 20 billion 5 10 down to 490 we're trying to get it from 490 back up to 510 that's an increase of 20 billion that we need we know our multipliers for so to calculate that change in spending we can just invert that formula we've been using let me go ahead and write it up here so and spending that way mean so slow change in spending equals the change in GDP that we mean remember we needed a twenty billion dollar change in GDP divided by our multiplier we had a multiplier of four we needed it in this recessionary graph we're looking at we need a spending change 20 so we're trying to get spending to increase we're down at the 490 we want to get up to 510 so we need 20 million dollars more GDP we have a multiplier of 4 so that means we need spending to increase by 5 and that's what they're telling us here we need spending to increase by this five billion so we look at the next graph all right so now it tells us the full employment level is still 5/10 just the same as it was before but we've got excessive spending and we're up at that AE 2 so we're producing at the 530 level because people are spending all this money well the government wants to do something now to decrease spending to move us down from AE 2 to a e0 it's the same calculations because they have that same change in GDP it's just this time we need to decrease GDP by 20 billion our multiplier is still 4 so negative 20 billion divided by 4 means spending needs to go down by 5 billion so this is just the application we have even more recent application of this that you have great knowledge of I'm sure but in 2007 we began to sink into that recession aggregate expenditures we're going down down consumption was going down investment spending is going down and get this aggregate I mean this recessionary expenditure gap so Keynesian says government needs to do something about it so government started sending tax rebate checks out money to people's houses stimulus package give them more money to spend so consumption will come up and correct that recessionary gap you may have more information about that in 2020 when we dealt with the covin and so we begin to close businesses down and slide into that recessionary gap and government started sending stimulus package package again started sending people checks again so sales law and Adam Smith says leave the economy alone that's classical economics leave it alone the economy will automatically adjust lays a fair leave it alone Adam Smith believe this wrote this in the wealth of nations 1776 a flaw we have the businesses and the households on each side of that graphic and we see it's a closed system and if you have a recession it will self-correct but this doesn't happen as quickly as people would want it to happen and so john maynard keynes says if cyclical employment and not just if but when cyclical unemployment happens because anytime you've got a recession you're going to have a cyclical unemployment it might not correct itself or it might not correct itself as quickly and so government can and Keynesian believes should actively manage that macroeconomic instability meaning increased spending in some way they can increase government spending they could decrease taxes they can send out those stimulus checks we're also going to be able to make some adjustments with monetary policy we'll look at that starting in chapter 14