Aggregate expenditure Flashcards
What is aggregate expenditure?
The sum of all spending on goods and services produced in the economy. It consists of consumption, investment, government spending and net exports.
What is the equation for AE?
AE = C + I + G + (X-M)
What was Australia’s GDP in 2013-14?
Australia’s Gross Domestic Product in 2013-14 was $1.6 trillion dollars
Consumption expenditure
Accounts for 55.7% of AE Consists of: - Expenditure on non-durable goods - Expenditure of durable goods - Expenditure on services
Non-durable goods
- Consumed shortly after purchase
- Eg. Food, drink and packaged products, clothing and footwear
- Regarded as essential
- 35% of consumption expenditure
Durable goods
- Last longer
- Include white goods, brown goods, toys, sporting equipment and motor vehicles
- Usually discretionary, so it can be postponed or brought forward
- 15% of consumption expenditure
Services
- Intangible and usually provide transitory satisfaction of wants
- Include items such as education, transport, health and recreation
- Largest component and accounts for 50% of consumption expenditure
What is private investment?
Spending on new capital goods and additions to inventories
22.5% of AE
What does a capital good refer to?
Any item of machinery that is used to assist labour in the productive process
What does private investment consist of?
- Business investment – privately funded expenditure on capital goods such as equipment, machinery and buildings used in production
- Housing investment – private expenditure on new housing
- Inventories – unsold goods or stock (inventories rise when all current production is not sold). Inventories are excluded from investment spending in the aggregate expenditure equation
What is planned investment?
The planned spending by firms on business investment and residential investment by households
What does actual investment comprise of?
Planned investment plus inventories
Investment spending
- Most volatile component of AE
- Private investment has accounted for between 16% and 26% of GDP
- Fluctuations in private investment spending are through to be a key factor in explaining changes in economic activity over the course of the business cycle
Government expenditure
22.3% of AE and is divided into current spending (G1) and capital spending (G2)
Current spending
- Expenditure on the day-to-day business of government in its core functions like health, education, social welfare and defence.
- This includes wages and salaries, and the purchase of goods and services
Capital spending
- Spending on productive machinery and essential public infrastructure
- Such as power and water supply, roads, railways and communications networks
Net exports
Exports - imports
Make up -0.4% of GDP
What are the main factors affecting consumption?
- Level of disposable income
- Cost of credit (interest rates)
- Current stock of wealth
- Consumer expectations
- Government economic policy
- Other influences
The level of disposable income (affecting consumption)
- Most important factor
- It is the level of income households receive after taxation
- Consumption function model
o There is a positive relationship between the amount households spend on consumption and their disposable income
o Although, the proportion of income spent on consumption declines as income rises
Interest rates (affecting consumption)
- Interest rates represent the price of money – the cost of borrowing
- Low interest rates have a positive effect on household spending
o Interest rates represent a smaller slice of disposable income when interest rates are low
o The opportunity cost of consumption also falls as households are faced with two choices, to spend or save their income.
o Saving is less attractive when interest rates are low because they won’t get as much of a return on their saved funds - When interest rates rise, the opportunity cost of consumption increases and repayments take up a larger proportion of disposable income, therefore giving households a greater incentive to save
Current stock of wealth (affecting consumption)
- Households that hold real assets such as property or shares tend to feel wealthier when prices in those markets are high
- Even though the values are only on paper, a decline in the stock of wealth may cause significant changes in saving and spending patterns in the economy because it changes people perceptions of their wealth
Consumer expectations (affecting consumption)
- They are the positive or negative sentiments that people hold about the state of the economy
- Consumer sentiment has a greater impact on households’ intentions to purchase discretionary items such as holidays, computers, televisions and motor vehicles
Government economic policy (affecting consumption)
- The Reserve Bank of Australia administers monetary policy, for example increasing interest rates will discourage spending in the economy resulting in a contraction effect
- The Commonwealth Government is responsible for fiscal policy and uses the government’s spending and taxing powers to influence household spending decisions
Other influences affecting consumption
- Exchange rates
- Distribution of income and wealth
- Demographic factors
What is investment?
Expenditure on producer or capital goods that will be used to produce final goods and services in the future.
Investment rises and falls according to the perceived level of risk which the future entails
What are the main factors that influence investment expenditure?
- Rate of interest
- The elasticity of investment
- Profitability in the business sector
- Business expectations
- Government policies
- Stability of the macroeconomic environment
Rate of interest (investment expenditure)
- Interest rates and the level of investment expenditure are negatively related
- Interest rates represent the price of borrowed money, so when rates rise, so do the periodic payments for capital items purchased with borrowed money
- Firms have a choice of using retained profit for new investment or some alternative purpose
- The opportunity cost of investment increases when interest rates are high
Elasticity of investment with respect to interest rates (investment expenditure)
- Influenced by the current stage of the business cycle and producer expectation
- During an upswing
o Producers are likely to be upbeat about future prospects and continue to invest despite rising interest rates - During a contraction phase
o Expectations of lower levels of economic activity and profits are likely to reduce investment spending even though interest rates may be relatively low