The aggregate expenditure model. The Aggregate Expenditures Model 2022-10-25
The aggregate expenditure model Rating:
The aggregate expenditure model is a key concept in macroeconomics that explains the relationship between total spending in an economy and the level of output or Gross Domestic Product (GDP). It helps economists understand how changes in spending can affect economic growth and stability.
The model is based on the idea that total spending in an economy consists of four main components: consumption, investment, government spending, and net exports. Consumption refers to the amount of goods and services that households purchase for personal use. Investment includes spending on capital goods such as machinery and equipment, as well as spending on new housing and other construction projects. Government spending includes the purchase of goods and services by federal, state, and local governments. Net exports refer to the difference between exports and imports, with exports being goods and services produced in a country and sold to other countries, and imports being goods and services produced in other countries and sold in the domestic market.
According to the aggregate expenditure model, the level of output or GDP in an economy is determined by the level of total spending. When total spending is high, firms will produce more goods and services to meet the demand, which leads to higher levels of output and economic growth. Conversely, when total spending is low, firms will produce less and the economy will contract.
The aggregate expenditure model also introduces the concept of the equilibrium level of output, which is the level of output at which total spending is equal to the level of output. At this point, firms are producing enough goods and services to meet the demand and there is no excess supply or demand in the economy.
However, the aggregate expenditure model is not a perfect representation of the economy. It assumes that the economy is in a state of full employment, with all available resources being used to their maximum potential. In reality, economies often experience periods of recession or unemployment when there are not enough jobs or resources being used. Additionally, the model does not take into account factors such as technological changes or changes in the money supply, which can also affect economic activity.
Overall, the aggregate expenditure model is a useful tool for understanding the relationship between total spending and output in an economy, and how changes in spending can affect economic growth and stability. It helps economists and policymakers identify potential problems and develop policies to address them.
13.2 The Aggregate Expenditures Model
It can be found by determining the intersection of AE 1 and the 45-degree line. Then autonomous aggregate expenditures rise by the same amount, Δ I P. We assume that firms' planned investment does not depend on the level of real output real GDP. Government Spending Government expenditure will include all expenditure by each level of government. The largest part of consumption expenditure by households is induced expenditure, closely linked to current income.
The multiplier is smaller, of course, because the slope of the aggregate expenditures curve is flatter. So how does this relate to the national economy? The slope is given by the marginal propensity to import MPI , which is the percentage change in spending on imports when national income changes. The Real Interest Rate For the same rationale as we saw with consumption, the real interest rate will dictate the cost of investment spending. Investment Graphically We assume that planned investment will determined ahead of time and will therefore not change based on current real GDP. The axes of the Keynesian cross diagram presented in Figure 9. The slope of the AE curve in Panel b is flatter than the slope of the AE curve in Panel a.
This difference occurs because, in the more realistic view of the economy, households have only a fraction of real GDP available as disposable personal income. Putting It Together: The Aggregate Expenditure Function The final step in deriving the aggregate expenditure function, which shows the total expenditures in the economy for each level of real GDP, i s to sum the parts, which is shown in Table 3. If so, they enter the aggregate expenditures function in the same way that investment did. Note that by doing so, we are unable to determine the full impact of certain types of macroeconomic change. Some plans may not work out. Aggregate Expenditures Components: Government Purchases and Net Exports Let's not forget about the government sector. Thus, the equilibrium must be the point where the amount produced and the amount spent are in balance, at the intersection of the aggregate expenditure function and the 45-degree line.
Therefore, if the value of assets increases or the value of debt decreases, the household is wealthier. As the real interest rate increases, the cost of borrowing will increase. A steeper slope would mean that the additional rounds of spending would have been larger. Much to the delight of economists, there are a number of different ways that a country can measure its economy. The opposite is also true. The marginal propensity to consume MPC is the fraction of any change in income that is consumed and the marginal propensity to save MPS is the fraction of any change in income that is saved. It follows that a shift in the curve will change equilibrium real GDP.
Chapter 13: Consumptions and the Aggregate Expenditures Model
In either case, current disposable income will have a greater impact on aggregate expenditure than future income. This latter type we call autonomous or fixed consumption expenditure, where autonomous means independent of income. It can be found by determining the intersection of AE 1 and the 45-degree line. Compared to the simplified aggregate expenditures model, the aggregate expenditures curve shifts up by the amount of government purchases and net exports 1. If aggregate expenditures equal real GDP, then firms will leave their output unchanged; we have achieved equilibrium in the aggregate expenditures model.
In a simplified economy, the slope of the AE curve is the marginal propensity to consume MPC. Aggregate expenditures equal the sum of consumption C and planned investment I P. A second reason for introducing the model is that we can use it to derive the aggregate demand curve for the model of aggregate demand and aggregate supply. So both have to do with real GDP, and we can actually find the corresponding points if we stack the two graphs together. Though these two are tied, they are not often graphed together.
In the aftermath of the Great Depression, the US government implemented many public works projects as part of the New Deal. Taxes and the Aggregate Expenditure Function Suppose that the only difference between real GDP and disposable personal income is personal income taxes. If aggregate expenditures equal real GDP, then firms will leave their output unchanged; we have achieved equilibrium in the aggregate expenditures model. In this section, we incorporate other components of aggregate demand: investment, government purchases, and net exports. If this is occurring throughout an entire economy then we will see GDP will begin to increase as companies work to increase their production.
That is, we know that changes in disposable income lead to subsequent changes in consumption spending. The equations for the simplified economy are easier to work with, and we can readily apply the conclusions reached from analyzing a simplified economy to draw conclusions about a more realistic one. Household's expenditures on imports are at least partly induced expenditures that change as income and consumption expenditure changes. If aggregate expenditures exceed real GDP, then firms will increase their output and real GDP will rise. This model is one that economists might use to determine the gross domestic product, or GDP, of an economy.