The Aggregate Expenditure Model

Question 1

What is the AE formula

Answer 1

AE=C+I+G+(X-M)

Question 2

What are the components of Aggregate expenditure (AE)

Answer 2

Consumption

Investment

government spending

net exports

Question 3

What are the characteristics of consumption

Answer 3

• 60% of GDP
• Increases at 2-3% per annum
• Relatively stable
• Made up of 60% services 40% goods
• Goods includes durable and non-durable

Question 4

What are the characteristics of investment

Answer 4

• 12-15% of GDP
• % change from year to year – negative 10% to positive 20%
• Volatile
• The purchase or production of capital goods – machinery, equipment , buildings, engineering
• Includes addition to inventories
• Includes dwelling (housing) investment

Question 5

What are the characteristics of government spending?

Answer 5

• Federal, state and local
• G1 current expenditure on goods and service (70%)
o Wages – police, politicians
o Stationary, electricity
• G2 public investment on capital equipment and infrastructure (30%)
o Schools, hospitals, ports, roads
• Relatively stable
• 25% of AE – lower in boom and higher in a trough

Question 6

What are the characteristics of net exports (X-M)

Answer 6

• Range from positive 1% to -2% of GDP negative depending on position in the cycle
• Refer to composition of ecports and imports component
• Relatively volatile.

Question 7

what are the factors affecting consumption

Answer 7

• Consumer confidence
• Consumer indebtness and interest rates
• Distrubution of income
• Inflationary expectations
• Disposable income
• Stock of wealth

Question 8

what are the factors affecting investment

Answer 8

•	Inflationary expectations
•	Change in consumer spending 
•	Interest rates
•	Extent of idle or surplus productive capacity 
•	Technology 
•	Govt policy and taxation 
•	Stocks 
•	Structural change in the economy 
•	Business confidence 
o	Profit expectations 
o	Marker prospects 
•	Exogenous global factors

Question 9

what are the factors affecting government expenditure

Answer 9

• External shocks
• Tax revenue
• Politics
• Policy changes
• G1 spending
• Stage of business cycle

Question 10

What are the factors affecting net exports

Answer 10

• Performance of overseas markets
• Terms of Trade
• International competitiveness
• Tariffs
• Exchange rate

Question 11

What is the consumption function formula

Answer 11

C=a+bY

Question 12

What is the marginal propensity to consume (MPC)

Answer 12

The fraction of the last dollar of income earned that is spent on consumption.

Question 13

What is the marginal propensity to save (MPS)

Answer 13

The fraction of the last dollar of income earned that is saved

Question 14

What’s the savings function formula?

Answer 14

S=-a+sY

Question 15

How can the consumption function be calculated

Answer 15

change in consumption/change in income

Question 16

How can the savings function be calculated

Answer 16

change in savings/change in income

Question 17

what does it mean when the economy is in equilibrium

Answer 17

When there is no tendency for the level of income in the economy to change. The economic system is in balance

Question 18

what are the two conditions for equilibrium

Answer 18

1.	The injection/withdrawal approach 
Injections (J) = Withdrawals (W) 
(I+G+X = S+T+M) 
2.	The flows approach 
Ex = O = Y

Question 19

if the economy is operating below Ye, what will happen to the economy?

Answer 19

The economy will expand

Question 20

when the economy is operating above Ye, what will happen to the economy?

Answer 20

The economy will contract

Question 21

summarise the accelerator process

Answer 21

A rise in consumer/export demand causes higher capacity utilization and higher profits and confidence which in turn create high business investment.

Question 22

Summarise the multiplier process summary

Answer 22

Spending from households creates income for firms which creates for spending for household and so on.