by Aggregate expenditure is a macroeconomic concept that refers to the total amount of spending in an economy. It is the sum of all expenditures made by households, businesses, government, and foreign buyers on final goods and services produced within a country during a given period of time, typically a year.
In the aggregate expenditure model, there is a direct relationship between changes in aggregate expenditure and changes in real GDP. This is because an increase in aggregate expenditure will lead to an increase in demand for goods and services, which will encourage businesses to produce more. As businesses produce more, they will hire more workers and pay them more, which will increase household income and consumption spending. This cycle of increased spending and production will continue until the level of real GDP reaches a point where aggregate expenditure is equal to the value of output produced.
The components of aggregate expenditure are:
- Consumption (C): This refers to the spending by households on goods and services. It includes purchases of durable goods, such as cars and appliances, non-durable goods, such as food and clothing, and services, such as healthcare and education.
- Investment (I): This refers to the spending by businesses on capital goods, such as machinery and equipment, and on construction of new buildings. It also includes the change in business inventories.
- Government Spending (G): This refers to the spending by governments on goods and services, such as defense, education, and healthcare.
- Net Exports (NX): This refers to the difference between the value of exports and the value of imports. A positive net exports value indicates that a country is exporting more than it is importing, while a negative value indicates that a country is importing more than it is exporting.
The aggregate expenditure model is based on the assumption that the level of aggregate expenditure determines the level of real gross domestic product (GDP) in an economy. This means that an increase in aggregate expenditure will lead to an increase in real GDP, while a decrease in aggregate expenditure will lead to a decrease in real GDP.
The relationship between aggregate expenditure and real GDP is represented by the aggregate expenditure function, which is an equation that shows how aggregate expenditure varies with changes in income. The aggregate expenditure function is typically represented as:
AE = C + I + G + NX
Where
AE is aggregate expenditure,
C is consumption spending,
I is investment spending,
G is government spending,
NX is net exports.
Methods:
Marginal Propensity to Consume (MPC): The MPC refers to the change in consumption spending resulting from a change in income. It is calculated as the change in consumption spending divided by the change in income. The formula is:
MPC = Change in consumption spending / Change in income
For example, if a $100 increase in income leads to a $80 increase in consumption spending, the MPC would be 0.8 ($80 / $100).
Marginal Propensity to Save (MPS): The MPS refers to the change in saving resulting from a change in income. It is calculated as the change in saving divided by the change in income. The formula is:
MPS = Change in saving / Change in income
For example, if a $100 increase in income leads to a $20 increase in saving, the MPS would be 0.2 ($20 / $100).
Multiplier Effect: The multiplier effect refers to the process by which an initial change in spending leads to a larger change in output and income. The formula for the multiplier is:
Multiplier = 1 / (1 – MPC)
For example, if the MPC is 0.8, the multiplier would be 5 (1 / (1 – 0.8)).
Aggregate Expenditure Equation: The aggregate expenditure equation shows the relationship between aggregate expenditure (AE) and real GDP (Y) in an economy. The formula is:
AE = C + I + G + NX
Where,
C is consumption spending,
I is investment spending,
G is government spending,
NX is net exports.
Aggregate Expenditure Line: The aggregate expenditure line shows the relationship between aggregate expenditure and real GDP graphically. It is a 45-degree line that represents the points where aggregate expenditure is equal to real GDP. The equation for the aggregate expenditure line is:
AE = a + bY
where a is autonomous expenditure, which is the amount of aggregate expenditure that does not depend on income, and b is the marginal propensity to consume, which is the slope of the aggregate expenditure line.
