EC212 · LESSON 04 / 08

4. Aggregate spending and the multiplier

Firms produce 500, but buyers plan to buy 450. Inventories rise unexpectedly. How will firms adjust production?

Understand

What is this lesson explaining?

AE is planned expenditure. In a closed economy AE = C + I + G, where I is planned investment. If AE is below Y, inventories accumulate unexpectedly and firms have an incentive to cut output.

If AE exceeds Y, inventories fall unexpectedly and firms expand output. Equilibrium is AE = Y, with no unintended inventory change. This need not be full-employment income.

KEY MODEL

AE = a − cT + I + G + cY

Y = AE

AEPlanned aggregate expenditure per perioda, c, TAutonomous consumption, MPC, and net taxesI, G, YPlanned investment, government purchases, and output

See it on a graph

The graph is right here

Read the axes and original point first. Then change one value at a time and watch the curve or point move.

KEY MODEL

AE = 100 + 0.8Y

k = 1/(1−0.8) = 5

E₀=E₁ : Y=500, AE=500

45°AE₀AE₁

Change autonomous spending: 0 autonomous spending units from baseline

Autonomous spending changes by 0 → AE shifts in parallel → Y changes by 0. Fixed prices, spare capacity, no proportional taxes or imports; not a long-run prediction.

Blue dashed: original · Solid: new state · E₀/A: original point · E₁/B: new point. Coincident points share a label; use the explanation to read each result.

A curve shifts when one of its non-axis conditions changes. An adjusting point on a fixed curve is movement along that curve, not a shift of it.

Quick check

NO TYPING

AE = 120 + 0.6Y. At Y = 400, what are firms encouraged to do?

Takeaway

Remember these two ideas

✓

Let C = 30 + 0.8Y, I = 50, G = 20, and T = 0. Then AE = 100 + 0.8Y.

Common mix-upGDP always equals actual expenditure in accounting because actual investment includes unintended inventories. GDP need not equal planned expenditure.

Assumptions and sources

Fixed prices, closed economy, fixed T and I, and spare resources permitting output expansion.

EC212 tutoring outline: chapters 1–8 (local course outline)
Mankiw, Macroeconomics, 8th edition, chapter 11, pp. 306–307