Aggregate Expenditure

Question 1

What are the components of Aggregate Expenditure?

Answer 1

Consisting of:
Consumption - household expenditure on final goods/services.
Investment - firms spending on capital equipment.
Government - gov. spending.
Net Exports - (X-M).

AE = C + I + G + NX (measured by GDP)

Question 2

What are the factors that impact this in AE (C)?

Answer 2

1) Disposable income: Increased disposable income = increase in consumption
2) Consumer sentiment: Higher consumer confidence = increase in consumption
3) Stock of wealth: This refers to stock of assets (shares/houses). Large stock of wealth = greater consumption
4) Interest rates: Interest rates influence consumption in 2 ways.
Higher interest rates reduce consumption because they make it more expensive to borrow, plus they make it more attractive to save.
5) Availability of credit: The more available credit is = more consumption

Question 3

What are the factors that impact this in AE (G)?

Answer 3

1) Business Cycle: typically during a recession, GS will increase (increased welfare payments, less tax), and during a boom, GS will decline.
2) Stabilising business Cycle: Governments can choose to alter discretionary spending to stabilise business cycle. Typically during a recession, GS will increase (increased welfare payments, less tax), and during a boom, GS will decline.
3) Policy decisions: political choices on spending e.g. spending on health etc.

Question 4

What are the factors that impact this in AE (I)?

Answer 4

1) Business expectations: Greater confidence = greater investment
2) Level of past profits: Greater past profits = greater investment
3) Interest rates: Higher interest rates = reduced investment. This is because it raises the required rate of return on new investment, making it harder to justify.
4) Government policy: Favourable policies (e.g. less tax) = greater investment

Question 5

What are the factors that impact this in AE (X-M)?

Answer 5

1) Domestic economic growth: greater domestic growth increases import spending, decreasing net exports
2) Overseas economic growth: greater overseas growth increases export spending, increasing net exports
3) Exchange rates: Depreciation lowers cost of exports for overseas buyers, therefore, increases exports/decreases imports, increasing net exports
4) Terms of Trade: Increases in TOT mean greater export prices/lower import prices, therefore an increase in TOT increases net exports

Question 6

Define Aggregate Expenditure.

Answer 6

The sum of all expenditure on finished goods/services undertaken in the economy during a specific period of time - measured via. GDP.

Question 7

What is the concept of macroeconomic equilibrium?

Answer 7

When planned expenditure matches income.
Y=O=E - 45° line - equilibrium occurs when AE/ C intersects with the line.

When AE exceeds Y, inventories fall, output increases, and incomes rise to a new equilibrium
When AE is below Y, inventories rise, output falls, and incomes decline to a new equilibrium

Question 8

Outline the multiplier process in AE.

Answer 8

The multiplier effect refers to the concept that changes in aggregate expenditure will flow/multiply through the economy and lead to an impact beyond what the initial change was.

The multiplier value is represented by ‘k’ and can be calculated through the following:

k = change in income / change in AE component (e.g. I, C)
k = 1 / MPS
k = 1 / (1-MPC)

• the larger the MPC is in an economy, the greater the multiplier value
  (this is because higher consumption rates mean new AE gets re-injected at a greater level

Question 9

Outline the impact of change in AE on the equilibrium level of output.

Answer 9

A rise in AE (due to a rise in any of the components of AE) shifts the AE curve upwards.
This leads to a new equilibrium level being formed at a greater GDP size, higher levels of Y overall, and greater output.

Question 10

Outline the consumption function.

Answer 10

The consumption function is that compares consumption spending and income levels.

Formula: C = a + bY

C = consumption					(y variable)
a = autonomous spending (spending on necessities) 	(y-intercept)
b = Marginal propensity to consume		(gradient)
Y = disposable income 				(x variable)

Question 11

Outline the marginal propensity to consume.

Answer 11

The fraction of any change in income that is spent on consumption. e.g. If income rises $100 and $60 is spent on consumption, then the MPC = 0.6

MPC = 1 - MPS 	or MPC + MPS = 1
MPC =   change in consumption / change in income 

The larger the MPC = the steeper the consumption function

Question 12

Outline the marginal propensity to save.

Answer 12

The fraction of any change in income that is saved.

MPS= 1 - MPC 	or MPC + MPS = 1
MPS =   change in saving/change in income

Question 13

What is the average MPS/MPC?

Answer 13

APC + APS = 1
APC = consumption amount / income amount (at different income levels)
APS = savings amount / income amount

As income rises, MPC stays the same yet APC decreases

Question 14

How is the multiplier adjusted for taxes and imports?

Answer 14

The multiplier assumes money is either consumed (MPC) or saved (MPS), however in real-life part of our money also goes to taxes (MPT) or imports (MPM). So MPC + MPS + MPT + MPM = 1

Therefore another version of the multiplier is:
k = 1 / (MPS + MPT + MPM)