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Aggregate Expenditure

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Presentation on theme: "Aggregate Expenditure"— Presentation transcript:

1 Aggregate Expenditure
Chapter 14

2 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

3 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

4 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

5 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

6 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

7 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)

8 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.

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