The Aggregate Expenditure Model

Question 1

List the components of Aggregate expenditure

Answer 1

Consumption, Investment, Government expenditure and Net exports

Question 2

Define the term components

Answer 2

A part or element of a larger whole

Question 3

Provide three examples to explain the difference between durable and non-durable consumption

Answer 3

Non-durable goods are consumed shortly after purchase, can be regarded as essential, and spending is fairly stable over time. E.g., food, clothing, and petrol
Durable goods last longer, is usually discretionary spending and are not essential. E.g., furniture, motor vehicles and whitegoods

Question 4

Define investment

Answer 4

Investment is expenditure on new capital goods that will be used to produce final goods and services in the future

Question 5

What is the meaning of expectations? Explain how they may effect the aggregate level of durable consumption, of investment?

Answer 5

Expectations are the positive or negative sentiments concerning economic growth, changes in interest rates, changes in exchange rates and movements in the share and property markets effect household confidence, and therefore, their willingness to purchase goods and services

Question 6

Explain two reasons why interest rates effect aggregate levels of consumption

Answer 6

Interest rates represent the price of money, the cost of borrowing. We would expect low levels to have a positive effect on consumption as if credit has been used to fund consumption, the necessary repayments are smaller in proportion to disposable income. Also if the opportunity cost of consumption falls, savings become less attractive when interest rates are low, because they would receive a lower rate of return.

Question 7

What would cause a movement along the ‘investment demand function’ and what would cause a shift?

Answer 7

If interest rates fall, we would expect a movement up the investment demand curve. A shift rightwards would be caused by a favourable change in one of the non-price factors effecting investment such as improved business confidence

Question 8

Explain why the ‘elasticity of investment demand with respect to interest rates’ may vary over time

Answer 8

The interest rate elasticity of investment is influenced by the current stage of the business cycle and expectations about the future. In a cyclical upswing, producers are likely to invest despite rising interest rates. On the other hand, during a contraction or trough, expectations of lower economic activity and profits are likely to reduce investment spending even though interest rates are low.

Question 9

Distinguish between automatic and discretionary forms of government spending

Answer 9

Discretionary changes in government spending are changes in accordance with government policy objectives such as health
Automatic changes are those influenced by the business cycle

Question 10

What factors influence overseas spending on Australian exports?

Answer 10

Regional and world economic conditions
Exchange rates - an appreciation means overseas residents can buy less of the AUD so Australian exports become less competitive in overseas markets, net exports will fall
Commodity prices - an increase in commodity prices, increase exports of resources
Tariffs - imposed tariffs reduce exports, such as the tariff imposed on Australian wine

Question 11

What are the two most important factors influencing each component of aggregate expenditure?

Answer 11

Consumption - disposable income and expectation
Investment - business expectations and interest rates
Government spending - discretionary and automatic changes
Net exports - exchange rates and economic activity