Aggregate Expenditure

Chapter 14

AE (Aggregate Expenditure)

• Concept – total expenditure in the economy which is equal to the sum of C, I, G and NX.

– Autonomous vs. induced expenditure • Autonomous: spending not influenced by the level of real GDP (e.g., I, G, X) • Induced: spending affected by the level of real GDP (e.g., C) – Planned vs. unplanned • Actual expenditure = planned plus unplanned expenditure = real GDP

AE (Aggregate Expenditure) Continued

• Distinction between AE and AD – AE : relationship between planned aggregate expenditure and real GDP – AD: relationship between real GDP demanded and the price level

Consumption Expenditure

• Induced expenditure • Consumption function: relationship between consumption expenditure and disposable income (consumption depends on disposable income) • MPC (marginal propensity to consume): the fraction of the change in disposable income that is spent on consumption – MPC = Δ C / Δ Disposable Income – MPC for the US economy is .87

• Other variables that affect (shift) consumption – Real interest rate, purchasing power of money, expected future disposable income

Other Expenditures

• Imports – Induced expenditure (imports depend on the level of real GDP) • Marginal propensity to import = Δ imports / Δ real GDP • Exports – Autonomous expenditure • Investment – Autonomous expenditure • Government purchase – Autonomous expenditure

Equilibrium Expenditure

• The level of aggregate expenditure that occurs when planned aggregate expenditure equals real GDP • If AE > real GDP  in inventories  Unplanned decrease production increase  back to equilibrium level • If AE < real GDP  Unplanned increase in inventories  production decrease  back to equilibrium level

Expenditure Multiplier

• You thought it is over with the multiplier with the 2 nd test, but not yet.

• What is it?

– The magnitude by which real GDP (= equilibrium expenditure) changes from a change in autonomous expenditure • Δ real GDP / Δ autonomous expenditure – Formula • Expenditure multiplier = 1/ (1-MPC)

Expenditure Multiplier Continued

– How to obtain the formula • Assuming no government and no foreign sector, Δ Y = Δ C + Δ I • Δ C can be expressed as MPC * Δ Y.

• So, Δ Y = MPC * Δ Y + Δ I • By rearranging, Δ Y – MPC * Δ Y = Δ I or (1-MPC) Δ Y = Δ I • Therefore, Δ Y / Δ I = 1 / (1-MPC) – Actual multiplier is smaller than theoretically predicted because of imports and income taxes.