Aggregate Expenditures Model

3 Key excerpts on "Aggregate Expenditures Model"

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  eBook - ePub

  Economic Principles and Problems

  A Pluralist Introduction

  • Geoffrey Schneider(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Chapter 27 focuses on the aggregate demand and aggregate supply (AD-AS) model, which is the cornerstone of modern New Keynesian analysis. Unlike the demand curve model of microeconomics, which focuses on individual consumers, the macroeconomic aggregate demand curve incorporates purchases by consumers, purchases of capital goods (investment) by firms, government purchases, and net purchases of goods and services from the international sector. Aggregate demand is the demand curve for all sectors of the macroeconomy. Similarly, aggregate supply is the supply curve for the whole economy, reflecting the behavior of all suppliers in all industries. Due to the complexity of the macroeconomy, there is often disagreement about the structure of macroeconomic models. Political economists dispute certain aspects of the AD-AS model, as we will see in this chapter.

  Chapter 28 lays out the Keynesian aggregate expenditure–income model, sometimes called the “Keynesian cross,” with a number of examples and applications. For most of the 20th century, this model was considered the cornerstone of macroeconomics. The chapter goes through how each sector (consumption, investment, government spending, and net exports) fits into the Keynesian model and how changes in the components of aggregate expenditure work with the multiplier. The chapter also includes debates over the Keynesian model.

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  27 Aggregate demand and aggregate supply

  A mainstream economics model of the macroeconomy

  DOI: 10.4324/9781315636924-35

  Aggregate demand and aggregate supply is one of the most important models in mainstream macroeconomics. This chapter will lay out the basic mechanics of how that model works in the short term and the long term.

  As with the supply and demand model developed earlier in the book, the aggregate demand and aggregate supply model works on a consistent set of principles. In the short run, changes in the price level cause the economy to move along the aggregate demand curve and the aggregate supply curve, whereas changes in the determinants of aggregate demand shift the aggregate demand curve and changes in the determinants of aggregate supply shift that aggregate supply curve. The aggregate demand and aggregate supply model can also be used to analyze the long-run adjustment of the economy. However, there are significant debates among economists regarding the long-term functioning of the economy, and it is important for you to understand the basic parameters of the debate.

  This chapter begins by describing the short-run aggregate demand and aggregate supply (AD–AS) model. The chapter then takes up how the multiplier determines the magnitude of shifts in the aggregate demand curve. Subsequently, the chapter discusses the classical and Keynesian models of how the AD–AS model adjusts in the long run and the debate over how the government should intervene during recessions and expansions. The chapter finishes by discussing some of the problems with the AD–AS model according to political economists.

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  real interest rate (nominal interest rate minus the expected rate of inflation) and an increasing function of the level of aggregate output. Formally,

  I = I (r,Y )

  where I is investment spending, r is the real interest rate, and Y is, as usual, aggregate income. This investment function leaves out some important drivers of investment decisions, such as the availability of new and better technology. Nonetheless, it reflects the two most important considerations: the cost of funding (represented by the real interest rate) and the expected profitability of the new capital (proxied by the level of aggregate output).

  Many government spending decisions are insensitive to the current level of economic activity, the level of interest rates, the currency exchange rate, and other economic factors. Thus, economists often treat the level of government spending on goods and services (G ) as an exogenous policy variable determined outside the macroeconomic model. In essence, this means that the adjustments required to maintain the balance among aggregate spending, income, and output must occur primarily within the private sector.

  Tax policy may also be viewed as an exogenous policy tool. However, the actual amount of net taxes (T ) collected is closely tied to the level of economic activity. Most countries impose income taxes or value-added taxes (VAT) or both that increase with the level of income or expenditure. Similarly, at least some transfer payments to the household sector are usually based on economic need and are hence inversely related to aggregate income. Each of these factors makes net taxes (T ) rise and fall with aggregate income, Y . The government’s fiscal balance can be represented as:

  where is the exogenous level of government expenditure and t (Y ) indicates that net taxes are an (increasing) function of aggregate income, Y . The fiscal balance decreases (smaller deficit or larger surplus) as aggregate income (Y ) increases, and increases as income declines. This effect is called an automatic stabilizer

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  eBook - ePub

  Essentials of Advanced Macroeconomic Theory

  • Ola Olsson(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  Part III Macroeconomic Policy Passage contains an image

  11 IS—MP, Aggregate Demand, and Aggregate Supply

  DOI: 10.4324/9780203139936-14

  In this third part of the book, we will now shift our focus in order to analyze the effects of macroeconomic policy. Most of this chapter will be based on the IS—MP model of the goods and money markets. This model is not micro-founded since it is not based on optimizing household behavior. Instead, it follows in the Keynesian tradition of assuming certain behaviors of variables at the macro level. Only the specifications of aggregate supply will rely on micro foundations. The analysis in this chapter is therefore quite different from the analysis in most other chapters.

  We start off with the traditional Keynesian framework where we discuss aggregate expenditure and multipliers. We then derive the aggregate demand function from equilibria in the goods and money markets. We also elaborate on the properties of the aggregate supply function under varying assumptions of price and wage stability and provide an overview of the Lucas critique of traditional Keynesian economic policy. After that, we present a new model that introduces financial intermediation into the standard IS—MP framework. Finally, we also present some of the main ideas in the so-called new Keynesian paradigm.

  11.1 Aggregate Expenditure and the Multiplier

  The traditional Keynesian model focuses to a great extent on aggregate demand. The typical starting point is an equation describing the user side of the economy. Let total output be Y, then total expenditure in a closed economy model (we assume away exports X and imports M) is Et = Ct + It + Gt . In equilibrium, we should have that total expenditure equals total output so that Et = Yt . As noted in Chapter 8 , the Keynesian consumption function is often described as

  C t

  =

  c a

  +

  c mpc

  Y t d

  =

  c a

  +

  c mpc

  ( 1 − τ )

  Y t

  ,

  where ca > 0 is referred to as the autonomous part of consumption, which is independent of income, cmpc ∈ (0, 1) is the marginal propensity to consume (MPC), τ is the (percentage) income tax rate, and Yd

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