Depict graphically the aggregate expenditures model for a...

Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decline in real GDP in your diagram is greater than the initial decline in aggregate expenditures. What would be the ratio of a decline in real GDP to the initial drop in aggregate expenditures if the slope of your aggregate expenditures schedule was .8?

Key Concepts

Aggregate Expenditures Model

This model represents the total spending in an economy at various levels of real GDP. In a private, closed economy, it typically includes consumption and investment, and is depicted graphically by plotting the aggregate expenditures schedule alongside a 45-degree line, where all points represent situations where aggregate spending equals total output (equilibrium).

Goods Market Equilibrium

Goods market equilibrium occurs when aggregate expenditures equal the actual output (real GDP). This is depicted graphically by the intersection of the aggregate expenditures schedule with the 45-degree line. Any shift in the expenditure schedule changes the equilibrium, leading to a new level of real GDP.

Multiplier Effect

The multiplier effect explains why an initial change in autonomous spending, such as a decrease in aggregate expenditures, leads to a larger overall change in real GDP. This occurs because the initial decline triggers successive rounds of spending. The magnitude of this effect is quantified by the multiplier, which is calculated as 1 divided by (1 minus the marginal propensity to spend). In the given case with a slope of 0.8, the multiplier would be 1/(1-0.8) = 5.

Marginal Propensity to Consume (MPC)/Marginal Propensity to Spend

The marginal propensity to consume or spend is the fraction of an additional unit of income that is spent on consumption rather than saved. It is represented by the slope of the aggregate expenditures schedule. This concept is fundamental in determining the size of the multiplier, as a higher propensity to spend amplifies the effect of changes in autonomous spending on the overall economy.

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