Aggregate expenditure

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Intros
Lessons
  1. Aggregate Expenditure
    • AE=C+I+G+X−MAE=C+I+G+X-M
    • Induced vs Autonomous Expenditure
    • Actual aggregate expenditure
    • Planned aggregate expenditure
    • Real GDP
  2. Equilibrium Expenditure
    • Aggregate Planned Expenditure = Real GDP
    • 45 degree line & AE Curve Intersect
    • Unplanned Inventory Changes
  3. Converging to the Equilibrium
    • Below the Equilibrium
    • Planned > Actual Aggregate Expenditure
    • Above the Equilibrium
    • Planned < Actual Aggregate Expenditure
Topic Notes
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Aggregate Supply Definitions

Aggregate Planned Expenditure is the sum of planned consumption expenditure, investment, government expenditure, and exports minus imports. In other words,

AE=C+I+G+(X−M)AE=C+I+G+(X-M)

In the table below, we organize our data of the expenditures with real GDP

Aggregate Expenditure

There are two forms of expenditures in this table:

  1. Induced Expenditure: is consumption expenditure minus imports, which varies with real GDP.

  2. Autonomous Expenditure: is the sum of investment, government expenditure, and exports, which does not vary with real GDP.

Using the data from the table, we can graph autonomous expenditures.

Aggregate Expenditure

Note: Autonomous expenditures are horizontal lines because it does not vary with real GDP.

We can also graph the AE Curve.

Aggregate Expenditure


Note: It is an upward sloping curve because it has induced expenditures (consumption and imports) which varies with real GDP.

Differences of Actual Aggregate Expenditure, Aggregate Planned Expenditure, & Real GDP

Notice that actual aggregate expenditure, aggregate planned expenditure, and real GDP relate to each other, but they are not the same:

  1. Real GDP is always equal to Actual Aggregate Expenditure
  2. Actual Aggregate Expenditure is not always equal to Aggregate Planned Expenditure
  3. Real GDP is not always equal to Aggregate Planned Expenditure

What causes them to differ? It depends on whether a firm’s inventory is smaller or larger than they have planned.

Case 1: Aggregate planned expenditure < Actual Aggregate expenditure

In this case, firms sell less than what they planned to sell, causing an unplanned high amount of inventory.

Case 2: Aggregate planned expenditure > Actual Aggregate expenditure

In this case, firms sell more than what they planned to sell, causing an unplanned low amount of inventory.

Equilibrium Expenditure

The Equilibrium Expenditure happens when aggregate planned expenditure is equal to real GDP.

Aggregate Expenditure

Note that:
  1. The AE curve intersects the 45° line.
  2. Equilibrium expenditure determines real GDP.
  3. When AE curve is above the 45° line, then planned expenditure exceeds real GDP.
  4. When AE curve is below the 45° line, then planned expenditure is lower than real GDP.

The unplanned inventory can be calculated by subtracting real GDP with aggregate planned expenditure. In other words,

Y−AEY-AE

In the table, we can calculate and graph the unplanned inventory

Aggregate Expenditure

  1. When the unplanned inventory is < 0, then inventory is low. Firms increase production and labor to increase real GDP.

  2. When the unplanned inventory is > 0, then inventory is high. Firms decrease production and labor to decrease real GDP.


Converging to the Equilibrium

Suppose that within the AEAE curve, we are not at the equilibrium expenditure. Then we are either above the equilibrium expenditure, or below it.

Case 1: We are below the equilibrium expenditure.

Aggregate Expenditure

In this case, we see that aggregate planned expenditure > actual aggregate expenditure.

We know that firms sell more than what they planned for, resulting the inventory to be low. So, firms increase production and labor to increase their inventory, which increases real GDP.

Firm’s increases their production and labor until equilibrium expenditure has been reached.

Case 2: We are above the equilibrium expenditure.

Aggregate Expenditure

In this case, we see that aggregate planned expenditure < actual aggregate expenditure.

We know that firms sell less than what they planned for, resulting the inventory to be high. So, firms decrease production and labor to decrease their inventory, which decreases real GDP.

Firm’s decreases their production and labor until equilibrium expenditure has been reached.