1. Aggregate Expenditure Chapter 14

2. AE (Aggregate Expenditure) • Concept • total expenditure in the economy which is equal to the sum of C, I, G and NX. • Autonomous vs. induced expenditure • Autonomous: spending not influenced by the level of real GDP (e.g., I, G, X) • Induced: spending affected by the level of real GDP (e.g., C) • Planned vs. unplanned • Actual expenditure = planned plus unplanned expenditure = real GDP

3. AE (Aggregate Expenditure)Continued • Distinction between AE and AD • AE : relationship between planned aggregate expenditure and real GDP • AD: relationship between real GDP demanded and the price level

4. Consumption Expenditure • Induced expenditure • Consumption function: relationship between consumption expenditure and disposable income (consumption depends on disposable income) • MPC (marginal propensity to consume): the fraction of the change in disposable income that is spent on consumption • MPC = Δ C / Δ Disposable Income • MPC for the US economy is .87 • Other variables that affect (shift) consumption • Real interest rate, purchasing power of money, expected future disposable income

5. Other Expenditures • Imports • Induced expenditure (imports depend on the level of real GDP) • Marginal propensity to import = Δ imports / Δ real GDP • Exports • Autonomous expenditure • Investment • Autonomous expenditure • Government purchase • Autonomous expenditure

6. Equilibrium Expenditure • The level of aggregate expenditure that occurs when planned aggregate expenditure equals real GDP • If AE > real GDP  Unplanned decrease in inventories  production increase  back to equilibrium level • If AE < real GDP  Unplanned increase in inventories production decrease  back to equilibrium level

7. Expenditure Multiplier • You thought it is over with the multiplier with the 2nd test, but not yet. • What is it? • The magnitude by which real GDP (= equilibrium expenditure) changes from a change in autonomous expenditure • Δ real GDP / Δ autonomous expenditure • Formula • Expenditure multiplier = 1/ (1-MPC)

8. Expenditure MultiplierContinued • How to obtain the formula • Assuming no government and no foreign sector, Δ Y = Δ C + Δ I • Δ C can be expressed as MPC * Δ Y. • So, Δ Y = MPC * Δ Y + Δ I • By rearranging, Δ Y – MPC * Δ Y = Δ I or (1-MPC) Δ Y = Δ I • Therefore, Δ Y / Δ I = 1 / (1-MPC) • Actual multiplier is smaller than theoretically predicted because of imports and income taxes.