Aggregate Expenditure

Rosete, Herrika Red G.

Balgoa, Jastine

Aggregate Expenditure
Aggregate

Expenditureis ameasure of
national income. It is defined as the
current value of all the finished goods and
services in the economy.
It is the sum total of all the expenditures
undertaken in the economy by the factors
during a given time period.
Aggregate Expenditures is defined as:
AE = C+Ip+G+Xn,here,

C
Ip
G
Xn

= Household Consumption
= Planned Investment
= Government spending
= Net exports (Exports-Imports)

Aggregate Expenditure
Aggregate

Expenditure is one of the methods

to calculate the sum total of all economic
activities in an economy, which is referred to as
the Gross Domestic Product of an economy.
The gross domestic product which is an
important measure of the growth of the
economy is calculated through the Aggregate
Expenditure Modelalso known as the
Keynesian cross.
AE is also used in theAD-AS Model which
advances the Aggregate Expenditures Model
with the inclusion of Price changes.

Aggregate Expenditure
Components

ofAggregate
Expenditure(AE) - defined as the total
amount that firms and households plan to
spend on goods and services at each level
of income.
It is normally derived from all the
components of theAggregate Demand.
Aggregate demand (AD) refers to the
sum total of goods that are demanded in an
economy over a period and thus AD is
defined by the planned total expenditure in
an economy for a given price level.

Consumption
The

largest component of aggregate

expenditures is consumption (C).
Consumption refers to the household
consumption over a given period of time.
Consumption goods
non-durables like food items and
beverages
durables like household appliances
Services such as body spa and body workouts. House and apartment rents as well as
the rental value of owner occupied housing
are included under this category.

The

total household
consumption can be
divided into two parts,
they are:
Autonomous
consumption refers to
the amount of
consumption regardless
of the amount of income,
hence, even if the income
is zero, the autonomous
consumption would be
the total consumption.
Induced

consumption
refers to the level of
consumption dependent
on the level of income.

Keynes

believed that peoples

current income primarily determines
their consumption spending.
According to Keynes, disposable
incomeones income after taxes
is by far the most important
determinant of current consumption.
If disposable income increases,
consumers will increase their
planned expenditures.

This

positive relationship between

disposable income and consumption spending
is called consumption function. C= a + bY
At low levels of aggregate income, the
consumption expenditures of households will
exceed their disposable income.
When income is low, households dissave
they either borrow money or draw from their
past savings to purchase consumption goods.
As income increases, consumption will also
increase, but not as rapidly as income. This
indicates that the marginal propensity to
consume is less than one; some fraction of
additional income is allocated to saving.

At $9 trillion, current consumption and income are equal.

As income expands beyond $9 trillion, household income
will exceed consumption and saving will be positive. Note
that the consumption function is flatter than the 45-degree
line. This indicates that as income expands, households
increase their consumption by less than their increase in
income.

Non-income determinants of C
Net

wealth

Value of all assets minus liabilities

Decrease

in net wealth

Spend less
C decreases
C function shifts down

Save more (increase S)

Non-income determinants of C
Changes

in price level

Changes in real value of cash and

bank accounts
Increase in price level
Decreased purchasing power
Decrease C
Downward shift of C function

Increase S

Non-income determinants of C
Interest

rate

Reward for savers

Cost for borrowers
Higher interest rates
Save more
Borrow less
Spend less
Decrease C

Non-income determinants of C
Consumer

expectations

Future income increase

Increase C now

Future price level increase

Increase C now

Future interest rate increase

Increase C now

Shifts of the Consumption Function

Real consumption

C
C
C

Real disposable income

A downward shift of the consumption function, such as from C to C, can be caused by
a decrease in net wealth, an increase in the price level, an unfavorable change in
consumer expectations, or an increase in the interest rate. An upward shift, such as
from C to C, can be caused by an increase in net wealth, a decrease in the price
level, a favorable change in expectations, or a decrease in the interest rate.

Ex.
Given a change in your disposable
income (DY) equal to PHP 100,000
and you decide to save PHP 20,000
of that extra income, how much will
the multiplier be?
Sol. DY=C+S compute the value of C
C=DY-S
C= 100,000-20,000
C= 80,000

Lead to compute MPC

MPC =

change in C
change in DY
MPC=80,000/100,000 =
0.8
m=

1
1 MPC
1 / 1 - 0.8
1 / 0.2
m=5

=
MPS

Let us further illustrate the effect of the

multiplier on the equilibrium level of
income. We will use the consumption
function C=a + bY and the equilibrium
condition AE=C in a simple economy
without investment and government
spending.

C= total consumption ;
Y= income;
a= initial consumption
b= MPC or the marginal
propensity to consume

Consumption Function

C = 80,000+0.8Y
Since the equilibrium level of Y is AE,
we can express the equilibrium
condition as Y=C. Substituting the
value of C in the equilibrium
condition, we get:
C=a + bY
Y =80,000+0.8Y
Y-0.8Y =80,000
0.2Y = 80,000
Y =400,000
0.2
0.2

Investment (I) = 20,000

Y=C + I
Y = a+bY+I
Y = 80,000+0.8Y+20,000
Y-0.8Y = 80,000+20,000
0.2Y = 100,000
0.2
0.2
Y = 500,000

a=80,000

b=0.8 MPC I=20,000

G= 25,000

Y=C+I+G
Y = a+bY+I+G
Y=
80,000+0.8Y+20,000+25,000
Y-0.8Y =
80,000+20,000+25,000
0.2Y = 125,000
0.2
0.2
Y = 625,000