The Keynesian Aggregate Expenditure Model can be used to show the impact of a change in a component of AE (C / I / G / X / M)

In both panels, the blue line () represents the Aggregate expenditure necessary to reach Full employment. each panel demonstrates either contraction or expansion where the line is either below, or above the line respectively.

Panel A §

Shows the Contraction Phase of the business cycle. The line represents the necessary AE for full employment. In a contraction, it is lower than necessary. The gap between what is necessary for full employment & current AE (green line) is the Deflationary gap.

Archive version of Panel A

The movement of the line down represents the needed aggregate expenditure to reach full employment decreasing. A Deflationary Gap is created as the current level of spending is above what is necessary for full employment.

• Blue Line represents the AE necessary to fully employ all resources (including labour), it has an Equilibrium of
• A Economic Contraction occurs (as happens in the contraction phase)
• The Full resource use line is multiplied down to This is because growth in Real GDP slows from to

Panel B §

Shows the Expansion Phase of the Business Cycle. The Yellow line has a equilibrium of which is higher than the necessary full employment level denoted by , meaning the economy has expanded too much, causing demand to push up prices (inflation) A Inflationary Gap is created as the current AE is higher than that necessary for full employment.

References

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