Output expenditure model definition. What Is the Income Expenditure Model? (Includes Examples) 2022-10-24
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The output expenditure model is a macroeconomic model that explains the relationship between the production of goods and services (output) and the expenditure used to produce them. It is a key concept in the study of national income and gross domestic product (GDP).
The output expenditure model is based on the idea that firms produce goods and services in order to sell them to households, firms, and the government. The demand for these goods and services is determined by the level of expenditure on them, which in turn is influenced by factors such as income, interest rates, and consumer confidence.
The output expenditure model can be expressed using the equation: GDP = C + I + G + NX, where GDP is the total output of the economy, C is consumer expenditure, I is investment expenditure, G is government expenditure, and NX is net exports (exports minus imports).
This equation represents the different components of expenditure that contribute to GDP. Consumer expenditure (C) is the money spent by households on goods and services, such as food, clothing, and housing. Investment expenditure (I) is the money spent by firms on capital goods, such as machines and buildings, in order to increase their productive capacity. Government expenditure (G) is the money spent by the government on goods and services, such as education and defense. Net exports (NX) is the difference between the value of exports and imports.
The output expenditure model helps to understand the factors that drive economic growth and the role of government policy in shaping the economy. For example, if the government increases its expenditure on infrastructure, it will stimulate demand for goods and services and increase output. Conversely, if households reduce their expenditure due to a decrease in income or a rise in interest rates, it will lead to a decline in output.
In conclusion, the output expenditure model is a useful tool for understanding the relationship between production and expenditure in the economy and the factors that influence them. It helps economists and policymakers to analyze and make decisions about economic policy, such as the use of fiscal and monetary policy to stimulate growth or reduce inflation.
The multiplier effect describes how an initial change in aggregate demand generated several times as much as cumulative GDP. The Multiplier Effect The Keynesian policy prescription has one final twist. However, the increase in equilibrium output, shown on the horizontal axis, is clearly larger. Since the multiplier is lower for professional sports than for other local entertainment options, the arrival of professional sports to a city would reallocate entertainment spending in a way that causes the local economy to shrink, rather than to grow. In this example, exports are set at 840.
The equilibrium in the diagram will occur where the aggregate expenditure line crosses the 45-degree line, which represents the set of points where aggregate expenditure in the economy is equal to output or national income. Similarly, if you look back at The multiplier does not just affect government spending, but applies to any change in the economy. If these general assumptions hold true, then money spent on professional sports will have less local economic impact than money spent on other forms of entertainment. Output on the horizontal axis is conceptually the same as national income, since the value of all final output that is produced and sold must be income to someone, somewhere in the economy. However, all the other factors that vary investment—new technological opportunities, expectations about near-term economic growth, interest rates, the price of key inputs, and tax incentives for investment—can cause the horizontal investment function to shift up or down. This relationship between income and consumption, illustrated in consumption function. In this way, even though changes in the price level do not appear explicitly in the Keynesian cross equation, the notion of inflation is implicit in the concept of the inflationary gap.
Consumption as a Function of National Income How do consumption expenditures increase as national income rises? Remember that GDP can be thought of in several equivalent ways: it measures both the value of spending on final goods and also the value of the production of final goods. When this shift occurs, the new equilibrium E 1 now occurs at potential GDP as shown in Conversely, 0 intersects the 45-degree line above potential GDP. Conversely, if the leakages are relatively large, then any initial change in demand will diminish more quickly in the second, third, and later rounds, and the multiplier will be small. The process continues, thus multiplying the impact of the reduction in aggregate expenditures resulting from the reduction in planned investment. This is called the multiplier effect: An initial increase in spending, cycles repeatedly through the economy and has a larger impact than the initial dollar amount spent. The second conceptual line on the Keynesian cross diagram is the 45-degree line, which starts at the origin and reaches up and to the right. In the expenditure-output model, how does consumption increase with the level of national income? The consumption function shows the upward-sloping relationship between national income and consumption.
Notice first that the intercept of the AE curve in Panel b is higher than that of the AE curve in Panel a. The income expenditure model is an economic concept created by John Maynard Keynes to explain market fluctuations. If so, they enter the aggregate expenditures function in the same way that investment did. Say that business confidence declines and investment falls off, or that the economy of a leading trading partner slows down so that export sales decline. Calculating the Multiplier Fortunately for everyone who is not carrying around a computer with a spreadsheet program to project the impact of an original increase in expenditures over 20, 50, or 100 rounds of spending, there is a formula for calculating the multiplier.
Government Spending and Taxes as a Function of National Income In the Keynesian cross diagram, government spending appears as a horizontal line, as in Figure 11. The level of investment firms intend to make in a period is called I P and unplanned investment I U. Embassy New Delhi — It was the first time expansionary fiscal policy had ever been proposed. Companies may also adapt this formula when estimating their gross market value. The marginal propensity to save MPS is the amount saved out of an additional dollar of income. Thus, the equilibrium calculated with a Keynesian cross diagram will always end up where aggregate expenditure and output are equal—which will only occur along the 45-degree line.
Review Questions What other changes in the economy can be evaluated by using the multiplier? Assume that the full employment level of output is 6,000. Imagine an economy with the following characteristics. Say's Law argued that "supply creates its own demand", meaning that everything produced would be consumed. Now, consider the impact of money spent at local entertainment venues other than professional sports. For example, income taxes are based on the level of income earned and sales taxes are based on the amount of sales made, and both income and sales tend to be higher when the economy is growing and lower when the economy is in a recession. These factors were summarized in the earlier discussion of consumption, and listed in Investment as a Function of National Income Investment decisions are forward-looking, based on expected rates of return. All sales of the final goods and services that make up GDP will eventually end up as income for workers, for managers, and for investors and owners of firms.
Finally, because more of them live locally, they will spend a higher proportion of their income on local goods—say, 65%. Indeed, the question of how much to increase government spending so that equilibrium output will rise from 5,454 to 6,000 can be answered without working through the algebra, just by using the multiplier formula. The investment sector, often known as the business sector, is responsible for the spending of the The government allocates its revenue to a wide variety of priorities, such as national defense, social security, interest payments on the national debt, health care, and the construction of highways. How can the multiplier be used to analyze the economic impact of professional sports? A wise economist will shape the model to fit the specific question under investigation. The investment function is drawn as a flat line because investment is based on interest rates and expectations about the future, and so it does not change with the level of current national income. She uses the income expenditure formula to gauge the market's overall health before they plan production. If AE 0 shifts down to AE 1, so that the new equilibrium is at E 1, then the economy will be at potential GDP without pressures for inflationary price increases.
What might cause a recessionary gap? Thus, for this example, we assume that disposable personal income and real GDP are identical. One can think of spending outside a local economy, in this example, as the equivalent of imported goods for the national economy. While the owners of these other businesses may be comfortably middle-income, few of them are in the economic stratosphere of professional athletes. In our example, the marginal propensity to consume is 0. The aggregate expenditure-output model shows aggregate expenditures on the vertical axis and real GDP on the horizontal axis. Government spending is drawn as a horizontal line in the Keynesian cross diagram, because its level is determined by political considerations, not by the current level of income in the economy.
What Is the Income Expenditure Model? (Includes Examples)
That, in turn, would reduce incomes for households that would have received the spending by the first group of households. The pattern of consumption shown in Table 11. Thus, in thinking about the components of the aggregate expenditure line—consumption, investment, government spending, exports and imports—the key question is how expenditures in each category will adjust as national income rises. INVESTMENT AS A FUNCTION OF NATIONAL INCOME Investment decisions are forward-looking, based on expected rates of return. In this way, the original change in aggregate expenditures is actually spent more than once.
Then, the MPC is 0. The marginal propensity to consume shows the part of income households consume rather than save. It is basically aggregate expenditure equal to real GDP: While the real GDP might be relatively easy to measure and check whether it is equal to aggregate expenditure, it is hard to calculate aggregate expenditure. At AE 1, the aggregate expenditure function is moved up to reach potential GDP. The aggregate expenditures curve shifts up by the same amount—Δ A is the same in both panels. The Export and Import Functions.