Aggregate expenditure
Encyclopedia
In economics, Aggregate Expenditure is a measure of national income. Aggregate Expenditure is defined as the current value of all the finished goods and services in the economy. The aggregate expenditure is thus the sum total of all the expenditures undertaken in the economy by the factors during a given time period. It refers to the expenditure incurred on consumer goods, planned investment (or savings) and in the Keynesian model also includes the expenditure made by the government in the economy. In an open economy scenario, the aggregate expenditure also includes the difference between the exports and the imports.
Aggregate Expenditures is defined as
Here,
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 model
also known as the Keynesian cross
.AE is also used in the Aggregate Demand
-Aggregate Supply
Model which advances the Aggregate Expenditures Model with the inclusion of Price changes.
Components of Aggregate Expenditure (AE) - defined as the total amount that firms and households plan to spend on goods and services at each level of income. Also, it can be seen that the aggregate expenditure is the sum of expenditures on consumption, investment, government expenses and net exports. It is normally derived from all the components of the Aggregate 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 refers to the household consumption over a given period of time. The total household consumption can be divided into two parts, they are: Autonomous Consumption and Induced consumption. 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.
C = Ca + MPC (Y)
Investment is the amount of expenditure towards the capital goods. Investment refers to the expenditure towards goods that are expected to yield a return or increase their own value over time. The investment expenditure can be further divided into two parts, planned investment and unplanned investment. Over the long run the sum of differences in the unplanned investment would equal to zero as economy approaches equilibrium.
The Keynesian model propagates an active state to control and regulate the economy. The government can make expenditure in terms of infrastructure or through transfers and thus increase the total expenditure in the economy as advocated by Keynes.
In an open economy, the total expenditure of the economy also includes the components of the net exports which is the total exports minus the total imports.
which states that supply creates its own demand, which stemmed from the belief that wages,prices and interest rates are all flexible. This comes from the classical thought that the factor payments which are made to the various factors of production
during the production process, would create enough income in the economy to create a demand for the products produced.
This supports the classical thought which revolves around Adam Smith's invisible hand
which states that the markets would achieve equilibrium via the market forces that impact economic activity and thus there is no need for government intervention.Moreover, the classical economists believed that the economy was operating at a full employment
Hence the classical Aggregate expenditure model is:
Aggregate Expenditure = Aggregate Consumption + Planned Investment
Therefore,
Where,
Classical economics has been criticized for its assumptions that the economy works on a full-employment equilibrium which is a false assumption as in reality, the economy operates at an under-employment equilibrium which provides the foundation for the Keynesian model of Aggregate Expenditure.
believes, contrary to the classical thought that the Wages, Prices and interest rates are not flexible and hence violating Say's Law, which provided the foundation for the maxim that "supply creates its own demand". Keynes believed that the economy was subject to Sticky Prices and thus the economy was not in a state of perpetual equilibrium and also operated at an under-employment equilibrium. Keynesian economics calls for a government intervention and is called demand side economics as it believes that aggregate demand and not the aggregate supply determines the GDP because of the difference between the Aggregate Supply and Planned expenditure in an economy.Hence Keynes believed that the government played an important role in the determination on the Aggregate Expenditure in an economy and was thus included Government Expenditure in the Aggregate Expenditure Function.
Hence,
Where,
Keynesian economics preaches that in times of a recession, the government must undertake the expenditure to compensate for the lack in the components of Household expenditure (C) and private investment (I) so as to ensure that the demand is maintained in the markets. This also leads to the Keynesian Multiplier
which suggests that every dollar spent by the government creates a multiplier effect and leads to an increased expenditure of more than one dollar.
Aggregate Expenditures is defined as
Here,
- C = Household Consumption
- Ip = Planned Investment
- Iu = Unplanned Investment
- G = Government spending
- Xn = Net exports (Exports-Imports)
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 model
Keynesian cross
In the Keynesian cross diagram , a desired total spending curve is drawn as a rising line since consumers will have a larger demand with a rise in disposable income, which increases with total national output...
also known as the Keynesian cross
Keynesian cross
In the Keynesian cross diagram , a desired total spending curve is drawn as a rising line since consumers will have a larger demand with a rise in disposable income, which increases with total national output...
.AE is also used in the Aggregate Demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
-Aggregate Supply
Aggregate supply
In economics, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period...
Model which advances the Aggregate Expenditures Model with the inclusion of Price changes.
Components of Aggregate Expenditure (AE) - defined as the total amount that firms and households plan to spend on goods and services at each level of income. Also, it can be seen that the aggregate expenditure is the sum of expenditures on consumption, investment, government expenses and net exports. It is normally derived from all the components of the Aggregate Demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
. 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.
Components of AE
Various school of thoughts use various components to come up with the Aggregate Expenditure. The major school of economic thoughts which are the classical and Keynesian economists use the following components:- Consumption expenditure (C)
Consumption refers to the household consumption over a given period of time. The total household consumption can be divided into two parts, they are: Autonomous Consumption and Induced consumption. Autonomous Consumption
Autonomous consumption
Autonomous consumption is a term used to describe consumption expenditure that occurs when income levels are zero. Such consumption is considered autonomous of income only when expenditure on these consumables does not vary with changes in income...
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
Induced consumption
Induced consumption is a term used to describe consumption expenditure by households on goods and services which varies with income. Such consumption is considered induced by income when expenditure on these consumables varies as income changes....
refers to the level of consumption dependent on the level of income.
C = Ca + MPC (Y)
- Ca = Autonomous Consumption
- MPC = Marginal Propensity to Consume
- Y = Income
- Investment (I)
Investment is the amount of expenditure towards the capital goods. Investment refers to the expenditure towards goods that are expected to yield a return or increase their own value over time. The investment expenditure can be further divided into two parts, planned investment and unplanned investment. Over the long run the sum of differences in the unplanned investment would equal to zero as economy approaches equilibrium.
- Government Expenditure:(G)
The Keynesian model propagates an active state to control and regulate the economy. The government can make expenditure in terms of infrastructure or through transfers and thus increase the total expenditure in the economy as advocated by Keynes.
- Net Exports:(NX)
In an open economy, the total expenditure of the economy also includes the components of the net exports which is the total exports minus the total imports.
Classical Economics
Classical economists relied on the Say's lawSay's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...
which states that supply creates its own demand, which stemmed from the belief that wages,prices and interest rates are all flexible. This comes from the classical thought that the factor payments which are made to the various factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
during the production process, would create enough income in the economy to create a demand for the products produced.
This supports the classical thought which revolves around Adam Smith's invisible hand
Invisible hand
In economics, invisible hand or invisible hand of the market is the term economists use to describe the self-regulating nature of the marketplace. This is a metaphor first coined by the economist Adam Smith...
which states that the markets would achieve equilibrium via the market forces that impact economic activity and thus there is no need for government intervention.Moreover, the classical economists believed that the economy was operating at a full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
Hence the classical Aggregate expenditure model is:
Aggregate Expenditure = Aggregate Consumption + Planned Investment
Therefore,
Where,
- C= Consumption Expenditure
- I = Aggregate investment ( Savings = Investment)
Classical economics has been criticized for its assumptions that the economy works on a full-employment equilibrium which is a false assumption as in reality, the economy operates at an under-employment equilibrium which provides the foundation for the Keynesian model of Aggregate Expenditure.
Keynesian Economics
Keynesian EconomicsKeynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
believes, contrary to the classical thought that the Wages, Prices and interest rates are not flexible and hence violating Say's Law, which provided the foundation for the maxim that "supply creates its own demand". Keynes believed that the economy was subject to Sticky Prices and thus the economy was not in a state of perpetual equilibrium and also operated at an under-employment equilibrium. Keynesian economics calls for a government intervention and is called demand side economics as it believes that aggregate demand and not the aggregate supply determines the GDP because of the difference between the Aggregate Supply and Planned expenditure in an economy.Hence Keynes believed that the government played an important role in the determination on the Aggregate Expenditure in an economy and was thus included Government Expenditure in the Aggregate Expenditure Function.
Hence,
Where,
- C = Household Consumption Expenditure
- I = Investment (Planned)
- G = Government Expenditure
- NX= Net Exports ( Exports - Imports )
Keynesian economics preaches that in times of a recession, the government must undertake the expenditure to compensate for the lack in the components of Household expenditure (C) and private investment (I) so as to ensure that the demand is maintained in the markets. This also leads to the Keynesian Multiplier
Multiplier (economics)
In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...
which suggests that every dollar spent by the government creates a multiplier effect and leads to an increased expenditure of more than one dollar.