Aggregate Expenditure

Question 1

AE definition

Answer 1

• Aggregate expenditure is the total level of spending in the economy from all sectors (C+I+G+X-M)

Question 2

Consumption

Answer 2

• Spending by households
• > 3 types:
• > non-durable: food, is essential spending
• > durable: discretionary, can be postponed or put forward
• > services: can be essential or discretionary

Question 3

Investment

Answer 3

• Economists define investment as spending on new capital goods and additions to inventories
• 3 categories:
• > business investment
• -> privately funded equipment, capital
• > household investment
• -> private expenditure on new housing
• > inventories
• -> unsold goods

Question 4

Consumption Expenditure determinants

Answer 4

• > Level of disposable income
• > Cost and availability of credit
• > stock of wealth
• > consumer expectations
• > government economic policy (fiscal policy) ( monetary policy)

Question 5

Investment Expenditure Determinants

Answer 5

• > interest rates
• > business expectations
• > level of past profits
• > technological advancement
• > government policies

Question 6

45 degree line

Answer 6

-Significance of this is that it shows all points where planned expenditure equals total production
-Whenever the consumption function intersects the 45 degree line, the economy is in equilibrium

Question 7

o MPC

Answer 7

• can be defined as the fraction of the change in income that is spent on consumption
• MPC = change in consumption/change in income

Question 8

o MPS

Answer 8

• can be defined as the fraction of a change in income that is saved
•  MPS = change in savings/change in income

Question 9

 APC

Answer 9

average propensity to consume

• proportion of total income which is spent on consumption

Question 10

 APS

Answer 10

average propensity to save

• the proportion of total income which is saved

Question 11

financial sector

Answer 11

• role of the financial sector is to act as an intermediary to channel the savings of households to firms who can draw on these funds to finance investment
• o If the level of income is either above or below the equilibrium level, then planned spending will not equal output and firms inventories will change signalling them to either increase or decrease production

 If level of income is higher than planned spending (aggregate expenditure), the C + I function is below the 45 degree line
• This means firms will have unsold output which will be added to inventories and firms will then decrease output in the next time period resulting in a fall in both production and income

 If level of income is lower than planned spending (aggregate expenditure), the C + I function is above the 45 degree line
• This means firms will have sold all current output and will have to sell out the excess/remainder out of their inventories
• This means inventories will fall and firms will react by increasing production in the next time period
• This will increase the level of income

Question 12

multiplier

Answer 12

• the ratio of the change in income caused by the initial change in spending
• The multiplier is the amount by which real income or GDP changes after an initial change in expenditure
• K= 1/(1-MPC)
• > where K is the multiplier