Professor Paul Dickinson
Discussion Questions #3
The Basics of the Short-Run Macro Model
1. Desired Versus Actual Expenditure.
From national income accounting (Chapter 20), we know that actual national income equals actual
national expenditure and also equals actual national production. But central to the theory of
national-income determination is the distinction between “desired” aggregate expenditure and
“actual” aggregate income. All measures of income here are real as opposed to nominal (since the
price level is assumed to be constant. Also, the model at the moment has no government and no
a) Explain the concept of desired consumption expenditure and how it relates to actual national income.
b) Explain the concept of desired investment expenditure and how it relates to actual national
c) Now explain what desired aggregate expenditure is and how it relates to actual national income.
d) Imagine a level of actual national income (hereafter GDP) such that desired aggregate
expenditure exceeds GDP. Explain how desired aggregate expenditure can exceed GDP even
though actual aggregate expenditure cannot. Show this distinction in the 45-degree line diagram
that we developed in class. If consumers are actually spending their desired amount, would there be
a contradiction here? Explain why/whynot.
e) Now imagine a level of GDP such that desired aggregate expenditure is less than GDP. Explain
how desired aggregate expenditure can be less than GDP even though actual aggregate expenditure
cannot be. What is making up the difference? Show this distinction in the 45-degree line diagram
that we developed in class.
2. The 45 Line Diagram.
a) Draw the diagram which has (desired) aggregate expenditure (AE) on the vertical axis and
(actual) national income (Y) on the horizontal axis. What does the AE curve look like? What is the
economic interpretation of its slope?
b) What is the interpretation of the 45 line inthis diagram?
c) Explain the concept of equilibrium national income in this setting (we will call the equilibrium
value of income Y E. Explain why if GDP is less than Y ,Ewe expect GDP to rise in the near future.
What is going on here?
d) If GDP is greater than YE, why do we expect GDP to fallin the near future? What is going on? 2
e) Comment on the following statement:
“Economists are clearly confused. First they say that output always equals
consumption plus investment. In fact, they say this is an accounting
identity. Next they say that equilibrium is where Y = C + I. Then they have
the audacity to say that output isn’t always in equilibrium. It’s amazing that
anybody takes these clowns seriously!”
3. The Consumption Function and AE.
Consider the simple macro model with no government and no international trade. Suppose