ECN204 STUDY NOTES
CHAPTER ONE: LIMITS, ALTERNATIVES, and CHOICES
Economics examines how individuals, institutions, and society makes choices under conditions of scarcity
The economic way of thinking stresses (a) resource scarcity and the necessity of making choices, (b) the
assumption of purposeful (or rational) behavior, and (c) comparisons of marginal benefit and marginal cost.
In choosing among alternatives, people incur opportunity costs
In choosing the best option, people incur opportunity costs – the value of the next best option
Economists use the scientific method to establish economic theories, cause-effect generalizations about the
economic behavior of individuals and institutions
Microeconomics focuses on specific units of the economy; macroeconomics examines the economy as a
Positive economics deals with factual statements (―what is‖); normative economics involves value judgments
(―what ought to be‖)
Because wants exceed incomes, individuals face an economic problem: they must decide what to buy and
what to forgo
A budget line (budget constraint) shows the various combinations of two goods that a consumer can purchase
with a specific money income
Straight-line budget constraints imply constant opportunity costs associated with obtaining more of wither of
the two goods
Economists categorize economic resources as land, labour, capital, and entrepreneurial ability
The PPC illustrates the (a) scarcity of resources, implied by the area of unattainable combinations of output
lying outside the PPC; (b) choice among outputs, reflected in the variety of attainable combinations of goods
lying along the curve; (c) opportunity cost, illustrated by the downward curve of the slope; and (d) the law of
increasing opportunity costs, reflected in the bowed-outward shape of the curve
A comparison of marginal benefits and marginal costs is needed to determine the best or optimal output mix
on a PPC
Unemployment causes an economy to operate a point inside its PPC
Increases in resource supplies, improvements in resource quality, and technological advances cause economic
growth, which is depicted as an outward shift of the PPC
An economy’s present choice of capital and consumer goods helps determine the future location of its PPC
International specialization and trade enable a nation to obtain more goods than its PPC would indicate
Optimal Allocation: MB = MC
Optimal allocation requires the expansion of a
good's output until its marginal benefit (MB)
and marginal cost (MC) are equal. No resources
beyond that point should get allocated to the
product. Here, allocative efficiency occurs when
200,000 pizzas are produced. Unemployment, Productive Inefficiency, and the
Production Possibilities Curve
Any point inside the production possibilities curve,
such as U, represents unemployment or a failure to
achieve productive efficiency. The arrows indicate
that, by realizing full employment and productive
efficiency, the economy could operate on the curve.
This means it could produce more of one or both
products than it is producing at point U.
Economic Growth and the Production Possibilities Curve
The increase in supplies of resources, the improvements in resource quality, and the technological advances that
occur in a dynamic economy move the production possibilities curve outward and to the right, allowing the
economy to have larger quantities of both types of goods. Present Choices and Future Locations of a Production Possibilities Curve
A nation's current choice favouring ―present goods,‖ as made by Presentville in part (a), will cause a modest
outward shift of the curve in the future. A nation's current choice favouring ―future goods,‖ as made by
Futureville in part (b), will result in a greater outward shift of the curve in the future.
CHAPTER FOUR: INTRODUCTION TO MACROECONOMICS
Macroeconomics studies long-run economic growth and short-run economic fluctuations.
Macroeconomists focus their attention on three key economic statistics: GDP, unemployment, and
inflation. GDP is the dollar amount of all final goods and services produced in a country during a given
period of time. The unemployment rate measures the percentage of all workers who are not able to find
paid employment despite being willing and able to work. The inflation rate measures the extent to which
the overall price level is rising in the economy.
Before the Industrial Revolution, living standards did not show any sustained increases over time.
Economies grew, but any increase in output tended to be offset by an equally large increase in
population, so that the amount of output per person did not rise. By contrast, since the Industrial
Revolution began in the late 1700s, many nations have experienced modern economic growth in which
output has grown faster than population—so that standards of living have risen over time.
Macroeconomists believe that one of the keys to modern economic growth is the promotion of saving and
investment (for economists, the purchase of capital goods). Investment activities increase the economy's
future potential output level. But investment must be funded by saving, which is possible only if people
are willing to reduce current consumption. Consequently, individuals and society face a trade-off
between current consumption and future consumption. Banks and other financial institutions help to
convert saving into investment by taking the savings generated by households and lending them to
businesses that wish to make investments.
Expectations have an important effect on the economy for two reasons. First, if people and businesses are
more positive about the future, they will save and invest more. Second, individuals and firms must adjust
to shocks—situations in which expectations are unmet and the future does not turn out the way people
were expecting. In particular, shocks often imply situations where the quantity supplied of a given good
or service does not equal the quantity demanded of that good or service.
If prices were always flexible and capable of rapid adjustment, then dealing with situations in which
quantities demanded did not equal quantities supplied would always be easy since prices could simply
adjust to the market equilibrium price at which quantities demanded do equal quantities supplied.
Unfortunately, real-world prices are often inflexible (or ―sticky‖) in the short run so that the only way for
the economy to adjust is through changes in output levels. ―Sticky‖ prices combine with shocks to drive short-run fluctuations in output and employment. Consider
a negative demand shock in which demand is unexpectedly low. Because prices are fixed, the lower-
than-expected demand will result in unexpectedly slow sales. This will cause inventories to increase. If
demand remains low for an extended period of time, inventory levels will become too high and firms will
have to cut output and lay off workers. Thus, when prices are inflexible, the economy adjusts to
unexpectedly low demand through changes in output and employment rather than through changes in
prices (which are not possible when prices are inflexible).
Prices are inflexible in the short run for various reasons, two of which are discussed in this chapter. First,
firms often attempt to set and maintain stable prices in order to please customers (who like predictable
prices because they make for easy planning, and who might become upset if prices were volatile).
Second, a firm with just a few competitors may be reluctant to cut its price due to the fear of starting a
price war, a situation in which its competitors retaliate by cutting their prices as well—thereby leaving
the firm worse off than it was to begin with.
The Effect of Unexpected Changes in Demand under
Flexible and Fixed Prices
(a) If prices are flexible, then no matter what demand
turns out to be, Buzzer Auto can continue to sell its
optimal output of 900 cars per week since the
equilibrium price will adjust to equalize the quantity
demanded with the quantity supplied.
(b) By contrast, if Buzzer Auto sticks with a fixed
price policy, then the quantity demanded will vary
with the level of demand. At the fixed price of
$37,000 per vehicle, the quantity demanded will be
700 cars per week if demand is DL, 900 cars per
week if demand is DM, and 1150 cars per week if
demand is DH. CHAPTER FIVE: MEASURING THE ECONOMY’S OUTPUT
Gross domestic product (GDP), a basic measure of economic performance, is the market value of all final
goods and services produced within the borders of a nation in a year.
Final goods are those purchased by end users, whereas intermediate goods are those purchased for resale or
for further processing or manufacturing. Intermediate goods, nonproduction transactions, and second-hand
sales are purposely excluded in calculating GDP.
GDP may be calculated by summing total expenditures on all final output or by summing the income derived
from the production of that output.
By the expenditures approach, GDP is determined by adding consumer purchases of goods and services,
gross investment spending by businesses, government purchases, and net exports: GDP = C + Ig + G + Xn.
Gross investment is divided into (a) replacement investment (required to maintain the nation's stock of capital
at its existing level), and (b) net investment (the net increase in the stock of capital). Positive net investment
is associated with an expanding production capacity, negative net investment with a declining production
Personal consumption expenditures consist of expenditures on goods (durable goods and nondurable goods)
and services. About 60 percent of consumer expenditures in Canada are on services, leading economists to
refer to the Canadian economy as a service economy.
By the income approach, GDP is calculated as the sum of wages and salaries, profits of corporations and
government enterprises before taxes, interest and investment income, net income of farmers and
unincorporated businesses, and the two noninvestment transactions (indirect taxes less subsidies and capital
Price indexes are computed by dividing the price of a specific collection or market basket of output in a
particular period by the price of the same market basket in a base period and multiplying the result (the
quotient) by 100.
The implicit price index, or GDP deflator, is used to adjust nominal GDP for inflation or deflation and
thereby obtain real GDP.
Nominal (current-dollar) GDP measures each year's output valued in terms of the prices prevailing in that
year. Real (constant-dollar) GDP measures each year's output in terms of the prices that prevailed in a
selected base year. Because real GDP is adjusted for price-level changes, differences in real GDP are due
only to differences in production activity.
A chain-weighted index to compute real GDP is constructed using an average of current and past prices as
weights. It is particularly useful in an economy in which the prices of some outputs are declining.
GDP is a reasonably accurate and very useful indicator of a nation's economic performance, but it has
limitations. It fails to account for nonmarket and illegal transactions, changes in leisure and in product
quality, the environmental effects of production, and the composition and distribution of output. GDP should
not be interpreted as a complete measure of well-being.
CHAPTER SIX: ECONOMIC GROWTH
A nation's economic growth can be measured either as an increase in real GDP over time or as an increase in
real GDP per capita over time. Real GDP in Canada has grown at an average annual rate of about 3.3 percent
since 1961; real GDP per capita has grown at roughly a 2.1 percent annual rate over that same period.
Sustained increases in real GDP per capita did not happen until the late 1700s, when England and then other
countries began to experience modern economic growth, which is characterized by institutional structures that
encourage savings, investment, and the development of new technologies. Institutional structures that
promote growth include strong property rights, patents, efficient financial institutions, education, and a
competitive market system.
Because some nations have experienced more than two centuries of economic growth while others have
begun to experience economic growth only recently, some countries today are much richer than other
It is possible, however, for countries that are currently poor to grow more quickly than countries that are
currently rich because the growth rates of rich-country GDPs per capita are limited to about 2 percent per year. In order to continue growing, rich countries must invent and apply new technologies. By contrast, poor
countries can grow much more quickly because they can simply adopt the institutions and cutting-edge
technologies already developed by the rich countries.
The determinants of economic growth responsible for changes in growth rates include four supply factors
(increases in the quantity and quality of natural resources, increases in the quantity and quality of human
resources, increases in the supply (or stock) of capital goods, and improvements in technology); one demand
factor (increases in total spending); and one efficiency factor (increases in how well an economy achieves
allocative and productive efficiency).
The growth of a nation's capacity to produce output can be illustrated graphically by an outward shift of its
production possibilities curve.
Growth accounting attributes increases in real GDP either to increases in the amount of labour being
employed or to increases in the productivity of the labour being employed. Increases in Canada's real GDP
are mostly the result of increases in labour productivity. The increases in labour productivity can be attributed
to technological progress, increases in the quantity of capital per worker, improvements in the education and
training of workers, the exploitation of economies of scale, and improvements in the allocation of labour
across different industries.
Over long time periods, the growth of labour productivity underlies an economy's growth of real wages and
its standard of living.
Canada's real GDP has grown partly because of increased inputs of labour and primarily because of increases
in the productivity of labour. The increases in productivity have resulted mainly from technological progress,
increases in the quantity of capital per worker, improvements in the quality of labour, economies of scale, and
an improved allocation of labour.
Over long time periods, the growth of labour productivity underlies an economy's growth of real wages and
its standard of living.
The post-1995 productivity growth is based on rapid technological change in the form of the microchip and
information technology; new firms, increasing returns, and lower per-unit costs; and heightened global
competition that holds down prices.
The main sources of increasing returns in recent years are (a) use of more specialized inputs as firms grow,
(b) the spreading of development costs, (c) simultaneous consumption by consumers, (d) network effects, and
(e) learning-by-doing. Increasing returns mean higher productivity and lower per-unit production costs.
Skeptics wonder if the rise in the average rate of productivity growth is permanent. They point out that surges
in productivity and real GDP growth have previously occurred but do not necessarily represent long-lived
Critics of rapid growth say that it adds to environmental degradation, increases human stress, and exhausts
the earth's finite supply of natural resources. Defenders of rapid growth say that it is the primary path to the
rising living standards nearly universally desired by people, that it need not debase the environment, and that
there are no indications we are running out of resources. Growth is based on the expansion and application of
human knowledge, which is limited only by human imagination.
CHAPTER SEVEN: BUSINESS CYCLES, UNEMPLOYMENT, and INFLATION
Canada and other industrial economies have gone through periods of fluctuations in real GDP,
employment, and price level. Although they have certain phases in common—peak, recession, trough,
expansion—business cycles vary greatly in duration and intensity.
Although economists explain the business cycle in terms of underlying causal factors such as major
innovations, productivity shocks, money creation, and financial crises, they generally agree that the level
of total spending is the immediate determinant of real output and employment.
The business cycle affects all sectors of the economy, though in varying ways and degrees. The cycle has
greater effects on output and employment in the capital goods and durable consumer goods industries
than in the services and nondurable goods industries.
Economists distinguish among frictional, structural, cyclical, and seasonal unemployment. The full-
employment or natural rate of unemployment, which is made up of frictional and structural
unemployment, is currently 6–7 percent. The presence of part-time and discouraged workers makes it
difficult to measure unemployment accurately. The GDP gap, which can be either a positive or a negative value, is found by subtracting potential GDP
from actual GDP. The economic cost of unemployment, as measured by the GDP gap, consists of the
goods and services forgone by society when its resources are involuntarily idle. Okun's law suggests that
every increase in unemployment by 1 percent above the natural rate causes an additional 2 percent
negative GDP gap.
Unemployment rates vary widely globally. Unemployment rates differ because nations have different
natural rates of unemployment and often are in different phases of their business cycles.
Inflation is a rise in the general price level and is measured in Canada by the Consumer Price Index
(CPI). When inflation occurs, each dollar of income will buy fewer goods and services than before. That
is, inflation reduces the purchasing power of money.
Economists distinguish between demand–pull and cost–push (supply-side) inflation. Demand–pull
inflation results from an excess of total spending relative to the economy's capacity to produce. The main
source of cost–push inflation is abrupt and rapid increases in the prices of key resources. These supply
shocks push up per-unit production costs and ultimately the prices of consumer goods.
Unanticipated inflation arbitrarily redistributes real income at the expense of people with a fixed income,
creditors, and savers. If inflation is anticipated, individuals and businesses may be able to take steps to
lessen or eliminate adverse redistribution effects.
When inflation is anticipated, lenders add an inflation premium to the interest rate charged on loans. The
nominal interest rate thus reflects the real interest rate plus the inflation premium (the expected rate of
Cost–push inflation reduces real output and employment. Proponents of zero inflation argue that even
mild demand–pull inflation (1–3 percent) reduces the economy's real output. Other economists say that
mild inflation may be a necessary by-product of the high and growing spending that produces high levels
of output, full employment, and economic growth.
Hyperinflation, caused by highly imprudent expansions of the money supply, may undermine the
monetary system and cause severe declines in real output.
CHAPTER EIGHT: BASIC MACROECONOMIC RELATIONSHIPS
Other things equal, a direct (positive) relationship exists between income and consumption and income and
saving. The consumption and saving schedules show the various amounts that households intend to consume
and save at the various income and output levels, assuming a fixed price level.
The average propensities to consume and save show the fractions of any total income that are consumed and
saved: APC + APS = 1. The marginal propensities to consume and save show the fractions of any change in
total income that is consumed and saved: MPC + MPS = 1.
The locations of the consumption and saving schedules (as they relate to real GDP) are determined by (a) the
amount of wealth owned by households; (b) expectations of future income, future prices, and product
availability; (c) the relative size of household debt; and (d) taxation. The consumption and saving schedules
are relatively stable.
The immediate determinants of investment are (a) the expected rate of return and (b) the real interest rate.
The economy's investment demand curve is found by cumulating investment projects, arraying them in
descending order according to their expected rates of return, graphing the result, and applying the rule that
investment will be profitable up to the point at which the real interest rate, i, equals the expected rate of
return, r. The investment demand curve reveals an inverse relationship between the interest rate and the level
of aggregated investment.
Shifts in the investment demand curve can occur as the result of changes in (a) the acquisition, maintenance,
and operating costs of capital goods; (b) business taxes; (c) technology; (d) the stocks of capital goods on
hand; and (e) expectations.
Either changes in interest rates or shifts in the investment demand curve can shift the investment schedule.
The durability of capital goods, the variability of expectations, and the irregular occurrence of major
innovations all contribute to the high fluctuations in investment spending.
Through the multiplier effect, an increase in investment spending (or consumption spending, government
purchases, or net export) ripples through the economy, ultimately creating a magnified increase in real GDP. The multiplier is the ultimate change in GDP divided by the initiating change in investment or some other
component of spending.
The multiplier is equal to the reciprocal of the marginal propensity to save: the greater the marginal
propensity to save, the smaller the multiplier. Also, the greater the marginal propensity to consume, the larger
Economists disagree on the size of the actual multiplier in Canada, with estimates ranging all the way from
2.5 to 0. But all estimates or real-world multipliers are less than the multiplier in our simple text illustrations.
Consumption and Disposable Income, 1985–2011
Each dot in this figure shows consumption and disposable income in a specific year. The line C, which generalizes the
relationship between consumption and disposable income, indicates a direct relationship and shows that households
consume most of their income. Consumption and Saving Schedules
The two parts of this figure show the income–consumption and income–saving relationships in Table 8-1 graphically.
The saving schedule in part (b) is found by subtracting the consumption schedule in part (a) vertically from the 45°
line. Consumption equals disposable income (and saving thus equals zero) at $390 billion for these hypothetical data. The Marginal Propensity to Consume and the Marginal Propensity to Save
The MPC is the slope (ΔC/ΔDI) of the consumption schedule, and MPS is the slope (ΔS/ΔDI) of the saving schedule.
The Greek letter delta (Δ) means ―the change in.‖ Shifts in the Consumption and Saving Schedules
Normally, if households consume more at each level of real GDP, they are necessarily saving less. Graphically this
means that an upward shift of the consumption schedule (C0 to C1) entails a downward shift of the saving schedule
(S0 to S1). If households consume less at each level of real GDP, they are saving more. A downward shift of the
consumption schedule (C0 to C2) is reflected in an upward shift of the saving schedule (S0 to S2). (This pattern
breaks down, however, when taxes change; then the consumption and saving schedules shift in the same direction—
opposite to the direction of the tax change.) The Investment Demand Curve
The investment demand curve is constructed by arraying all potential investment projects in descending order of their
expected rates of return. The curve is downward-sloping, reflecting an inverse relationship between the real interest
rate (the financial ―price‖ of each dollar of investing) and the quantity of investment demanded. Shifts in the
Increases in investment
demand are shown as
rightward shifts in the
curve; decreases in
investment demand are
shown as leftward
shifts in the investment
The Multiplier Process (MPC = 0.75)
An initial change in investment
spending of $5 billion creates an equal
$5 billion of new income in round 1.
Households spend $3.75 billion ( =
0.75 × $5 billion) of this new income,
creating $3.75 billion of added income
in round 2. Of this $3.75 billion of new
income, households spend $2.81
billion ( = 0.75 × $3.75 billion), and
income rises by that amount in round
3. The cumulation of such income
increments over the entire process
eventually results in a total change of
income and GDP of $20 billion. The
multiplier therefore is 4 ( = $20 billion
÷ $5 billion). CHAPTER NINE: THE AGGREGATE EXPENDITURE MODEL
The aggregate expenditures model views the total amount of spending in the economy as the primary factor
determining the level of real GDP that the economy will produce. The model assumes that the price is fixed.
Keynes made this assumption to reflect the reality of the Great Depression, in which declines in output and
employment rather than declines in prices were the dominant adjustments made by firms when they faced
huge declines in their sales.
For a private closed economy, the equilibrium level of GDP occurs when aggregate expenditures and real
output are equal—or, graphically, where the C + Ig line intersects the 45° line. At any GDP greater than
equilibrium GDP, real output will exceed aggregate spending, resulting in unintended investment in
inventories and eventual declines in output and income (GDP). At any below-equilibrium GDP, aggregate
expenditures will exceed real output, resulting in unintended declines in inventories and eventual increases in
At equilibrium GDP, the amount households save (leakages) and the amount businesses plan to invest
(injections) are equal. Any excess of saving over planned investment will cause a shortage of total spending,
forcing GDP to fall. Any excess of planned investment over saving will cause an excess of total spending,
inducing GDP to rise. The change in GDP will in both cases correct the discrepancy between saving and
At equilibrium GDP, no unplanned changes in inventories occur. When aggregate expenditures diverge from
GDP, an unplanned change in inventories occurs. Unplanned increases in inventories are followed by a
cutback in production and a decline of real GDP. Unplanned decreases in inventories result in an increase in
production and a rise of GDP.
Actual investment consists of planned investment plus unplanned changes in inventories and is always equal
The simple multiplier is equal to the reciprocal of the marginal propensity to save: the greater the marginal
propensity to save, the smaller the multiplier. Also, the greater the marginal propensity to consume, the larger
A shift in the investment schedule (caused by changes in expected rates of return or changes in interest rates)
shifts the aggregate expenditures curve and causes a new equilibrium level of real GDP. Real GDP changes
by more than the amount of the initial change in investment. This multiplier effect (ΔGDP/ΔIg) accompanies
both increases and decreases in aggregate expenditures and also applies to changes in net exports (Xn) and
government purchases (G).
The net export schedule relates net exports (exports minus imports) to levels of real GDP. For simplicity, we
assume the level of exports is the same at all levels of real GDP.
Positive net exports increase aggregate expenditures to a higher level than they would be if the economy were
―closed‖ to international trade. They raise equilibrium real GDP by a multiple of the net exports. Negative net
exports decrease aggregate expenditures relative to those in a closed economy, decreasing equilibrium real
GDP by a multiple of their amount. Increases in exports or decreases in imports have an expansionary effect
on real GDP, but decreases in exports or increases in imports have a contractionary effect.
Government purchases shift the aggregate expenditures schedule upward and raise GDP.
Taxation reduces disposable income, lowers consumption spending and saving, shifts the aggregate
expenditures curve downward, and reduces equilibrium GDP.
In the complete aggregate expenditures model, equilibrium GDP occurs where Ca + Ig + Xn + G = GDP. At
the equilibrium GDP, leakages of after-tax saving (Sa), imports (M), and taxes (T) equal injections of
investment (Ig), exports (X), and government purchases (G). Also, there are no unplanned changes in
The equilibrium GDP and the full-employment GDP may differ. The recessionary expenditure gap is the
amount by which aggregate expenditures fall short of those required to achieve full-employment GDP. This
gap produces a negative GDP gap (actual GDP minus potential GDP). The inflationary expenditure gap is the
amount by which aggregate expenditures exceed those needed to achieve full-employment GDP. This gap
causes demand–pull inflation.
Keynes suggested that the solution to the large negative GDP gap that occurred during the Great Depression
was for government to increase aggregate expenditures. It could do this by increasing its own expenditures
(G) or by lowering taxes (T) to increase after-tax consumption expenditures (Ca) by households. Because the economy had millions of unemployed workers and massive amounts of unused production capacity,
government could boost aggregate expenditures without worrying about creating inflation.
The stuck-price assumption of the aggregate expenditures model is not credible when the economy
approaches or attains its full-employment output. With unemployment low and excess production capacity
small or nonexistent, an increase in aggregate expenditures will cause inflation along with any increase in real
The Investment Demand Curve and the Investment Schedule
(a) The level of investment spending (here, $20 billion) is determined by the real interest rate (here, 8 percent)
together with the investment demand curve ID. (b) The investment schedule Ig relates the amount of investment ($20
billion) determined in part (a) to the various levels of GDP.
Equilibrium GDP in a Private
The aggregate expenditures
schedule, C + Ig, is determined by
adding the investment schedule Ig
to the upward-sloping
consumption schedule C. Since
investment is assumed to be the
same at each level of GDP, the
vertical distances between C and
C + Ig do not change. Equilibrium
GDP is determined where the
aggregate expenditures schedule
intersects the 45° line, in this case
at $470 billion. Changes in the Aggregate Expenditure Schedule and the Multiplier Effect.
An upward shift of the aggregate expenditures schedule from (C + Ig)0 to (C + Ig)1 will increase the equilibrium
GDP. A downward shift from (C + Ig)0 to (C + Ig)2 will lower the equilibrium GDP. Net Exports and the Equilibrium GDP
An increase in net exports raises the aggregate expenditures from (C + Ig + Xn)0 to (C + Ig + Xn)2 and increases the
equilibrium GDP. Conversely, a decrease in net exports shifts the aggregate expenditures schedule downward from (C
+ Ig + Xn)0 to (C + Ig + Xn)1 and lowers the equilibrium GDP. Government Spending and the Equilibrium GDP
The addition of government purchases, G, raises the aggregate expenditures (C + Ig + Xn + G) schedule and increases
the equilibrium level of GDP, as would an increase in C, Ig, or Xn.
If the MPC is 0.75, the $40 billion of taxes will lower the domestic consumption schedule by $20 billion and cause a
decline in the equilibrium GDP. In the open economy with government, with Ca representing after-tax income,
equilibrium GDP occurs where Ca + Ig + Xn + G = GDP. Recessionary and Inflationary Expenditure Gaps
The equilibrium and full-employment GDPs may not coincide. (a) A recessionary expenditure gap is the amount by
which aggregate expenditures fall short of those required to achieve full-employment GDP. Here, the recessionary
expenditure gap is $20 billion, caused by a $10 billion shortfall of aggregate expenditures. (b) An inflationary
expenditure gap is the amount by which aggregate expenditures exceed those needed to achieve full-employment
GDP. Here, the inflationary expenditure gap is $20 billion; this overspending brings about demand–pull inflation.
The Aggregate Expenditures Curve
CHAPTER TEN: AGGREGATE DEMAND AND AGGREGATE SUPPLY
The aggregate demand–aggregate supply model (AD–AS model) is a variable-price model that enables
analysis of simultaneous changes of real GDP and the price level.
The aggregate demand curve shows the level of real output that the economy will purchase at each price
The aggregate demand curve is downward-sloping because of the real-balances effect, the i