Chapter 9 Review
9.1 – The aggregate expenditures model: consumption and saving
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.
o This model assumes that the price is fixed.
o Keynes made this assumption to reflect the reality of the Great
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 (degree) line.
o 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).
o At any below-equilibrium GDP, aggregate expenditures will exceed
real output resulting in unintended declines in inventories and
eventual increases in GDP.
At equilibrium GDP, the amount households save (leakages) and the amount
businesses plan to invest (injections) are equal.
o Any excess of saving over planned investment will cause a shortage of
total spending, forcing GDP to fall.
o Any excess of planned investment over saving will cause an excess of
total spending, inducing GDP to rise.
o The change in GDP will in both cases correct the discrepancy between
saving and planned investment.
At equilibrium GDP, no unplanned changes in inventories occur. o When aggregate expenditures diverge from GDP, an unplanned
change in inventories occurs.
o Unplanned increases in inventories are followed by a cutback in
production and a decline of real GDP.
o Unplanned decreases in inventories result in an increase in
production and a rise of GDP.
o Actual investment consists of planned investment plus unplanned
changes in inventories and is always equal to saving.
9.2 – Changes in equilibrium GDP and the multiplier
The simple multiplier is equal to the reciprocal of the marginal propensity to
o The greater the marginal propensity to save, the smaller the
o Also, the greater marginal propensity to consume, the larger the
A shift in the investment schedule (caused by changes in expected rates of