Aggregate Expenditure

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

Equilibrium Expenditure The level of aggregate expenditure that occurs when planned aggregate expenditure equals real GDP If AE > real GDP  Unplanned decrease in inventories  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 2nd 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.