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Chapter 9

Chapter 9 Review.docx

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ECN 204
Thomas Barbiero

Chapter 9 Review Summary: 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 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 (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 save: o The greater the marginal propensity to save, the smaller the multiplier. o Also, the greater marginal propensity to consume, the larger the multiplier  A shift in the investment schedule (caused by changes in expected rates of
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