8) Aggregate Expenditure
Aggregate Expenditure - the total level of spending from all sectors of the economy. It is
calculated by AE = C + I + (G1+G2) + (X-M).
Consumption Expenditure (C) - includes all expenditure on durable goods, non-durable
goods, and service. Durable goods are goods which last for a long period of time and
account for 15% of consumption expenditure. Non-durable goods are goods which are
consumed after a short period of time and account for 35% of consumption expenditure.
Services are non-commodity items and account for 50% of consumption expenditure.
Factors Effecting Consumption Expenditure - includes levels of disposable income, interest
rates which represent the cost of borrowing and the return for saving, consumer
expectations, the availability of credit, and the stock of wealth.
Investment Expenditure (I) - includes business investment, housing investment, and
inventories.
Factors Effecting Investment Expenditure - includes business expectations, government
policy such as tax, interest rates which represent the cost of borrowing and the return for
saving, and the level of past profits.
Government Expenditure (G1+G2) - includes all federal, state, and local government
spending. Current expenditure (G1) provides for the basic functions of government
operation while capital expenditure (G2) provides for future needs and infrastructure.
Factors Effecting Government Expenditure - includes government policy, changes in the
business cycle, stabilisation goals to macroeconomic fluctuations, and economic policy
objectives.
Net Exports (X-M) - the income earned by exports after the consideration of the payments
made for imports on the overseas sector.
Factors Effecting Net Exports - includes domestic economic activity, global economic
activity, the exchange rate, the terms of trade, and barriers to trade such as tariffs and
quotas.
The Simple Keynesian Model
The simple Keynesian model is based on the relationship between the level of household
disposable income and the level of consumer spending.
Disposable Income (Yd) - the income remaining after the deduction of taxes which
households can use to spend or save.
Autonomous Expenditure (a) - the minimum amount which a household can spend on
consumption.
Marginal Propensity To Consume (b) - the fraction of change in disposable income which is
used for consumption.
Marginal Propensity To Save (1-b) - the fraction of change in disposable income which is
saved.
The Consumption Function = a + b . Yd
The Savings Function = (-a) + (1-b) . Yd
Equidistant and Macroeconomic Equilibrium - where disposable income is equal to the
level of consumer spending a 45⁰ line is formed. When the consumption function is above
the 45⁰ line, the savings function is below the x-axis and therefore savings are negative or in
'dis-savings'. When the consumption function is below the 45⁰ line, the savings function is
above the x-axis and therefore savings are positive. When the consumption function equals
the 45⁰ line, the savings function intersects the x-axis meaning savings equals 0. At this
point disposable income will equal consumer spending and there will be no savings. This is
known as the macroeconomic equilibrium.
Average Propensity To Consume =
Average Propensity To Save =
The Expanded Keynesian Model
The Expanded Keynesian Model measures the relationship between aggregate expenditure
in the economy and real GDP.
Real GDP - the total value of all final goods and services produced in the economy adjusted
for inflation.
Macroeconomic Equilibrium - occurs when total planned spending equals production.
Changes in Aggregate Expenditure - investment and government expenditure are constant
so as they increase macroeconomic equilibrium will increase. Net-exports can be a volatile
component as it changes depending of the terms of trade, the exchange rate, and the level
of exports relative to imports. As net-exports increase positively macroeconomic
equilibrium will rise. As net-exports increase negatively macroeconomic equilibrium will
fall.
The Multiplier Effect
The Multiplier Effect [ K = 1 / (1-b) ] - the long term effects of expenditure on the economy.
It is the ratio of change in disposable income caused by a change in spending. It is used to
calculate the power of initial expenditure on the economy. It drives up injections allowing
for increased expenditure which increases macroeconomic equilibrium. For example, if a
mining company decides to spend on a new venture in Western Australia, the initial
investment creates income for other contracted firms and workers such as engineers,
architects, and construction workers. The disposable income of these people will increase
which will increase their level of consumer spending on other goods and services. Thus the
power of the initial expenditure has been multiplied.