What is the Aggregate Expenditure Model in Economics?

What is the aggregate expenditure model?

The aggregate expenditure model shows the total expenditure is incurred by an economy to buy goods and services produced. In other words, the aggregate expenditure model is a macroeconomic tool to determine the value of final goods and services based on the total spending of an economy. The amount of goods and services that can be produced within an economy shows the full employment level. So, we can use the aggregate expenditure model to determine the gross domestic product (GDP) or national income level of a country within a specific period.

Gross Domestic Product ( NGDP) means the monetary value of the currently produced (produced within the current period, not in the previous periods), final goods and services (not including the intermediate goods and services) in a specific geographical area (usually within a country or a region).

Since aggregate expenditure can be used to calculate GDP, it allows countries to measure the size of their economies and the growth over time.

What is Keynesian model of aggregate expenditure?

The aggregate expenditure model is also called as the Keynesian cross model, because aggregate expenditure model is based on the findings of the well-known British economist John Maynard Keynes.

Keynes contended that prolonged periods of high unemployment could result from a lack of overall demand. Consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries) are the aggregate of four factors that determine an economy’s output of goods and services. One of these four factors must be the source of any growth in demand.

However, as expenditure decreases during a recession, powerful forces frequently depress demand. For instance, during economic downturns uncertainty frequently undermines consumer confidence, leading people to cut spending, particularly on luxuries like a home or a car. Businesses may spend less on investments as a result of customers spending less because there is less of a need for their products.

You may be interested in to read more,

Keynesian Economics : Concept, history, and examples.

What are the Four Components of Aggregate Expenditure?

There are four main components of the aggregate expenditure. They are,

1. Household consumption spending (C)

2. Investment spending (I)

3. Government spending (G)

4. Net exports (NX)

Let’s discuss about them separately.

Household consumption spending (C): This component measures the aggregate level of private consumption occurred by the households. There are two types of consumption spending. They are autonomous consumption expenditure (not depending on the income level) and induced consumption expenditure (depending on the income level).

Investment spending (I): Investment spending includes the total amount of money spent on capital goods by the investors.

Government spending (G): Expenditures are occurred by the federal, state, and local level governments.

Net exports (NX): Net exports are the difference between a country’s total exports and total imports.

Aggregate Expenditure Model Formula / Aggregate Expenditure Function

Aggregate expenditure model formula determines the equilibrium level GDP based on the the total spending of a country. There are four components for the aggregate expenditure. They are Household consumption spending (C), Investment spending (I), Government spending (G), Net exports (NX).

Aggregate expenditure model formula is as follows

Aggregate Expenditure (AE) = Household consumption spending (C) + Investment spending (I) + Government spending (G) + Net exports (NX).

Aggregate Expenditure Calculator

Other than the aggregate expenditure model formula, we can calculate the aggregate expenditure using an aggregate expenditure calculator. It is very easy. You have to type the values of components of the aggregate expenditure and then the aggregate expenditure calculator calculates the aggregate expenditure value.

Aggregate Expenditure Curve / Aggregate Expenditure Graph

The aggregate expenditure of a nation can be graphed as follows. This is also called the Keynesian cross diagram.

In above graph, AE line represents the aggregate expenditure of an economy while 45-degree line represents the set of output levels of real GDP level equals to aggregate expenditure of an economy (Y = E).  

When the macroeconomy is in equilibrium, it must be true that the aggregate expenditures in the economy are equal to the real GDP—because by definition. So, according to the aggregate expenditure model, the equilibrium of the economy occurs when the AE line intercepts the 45-degree line. So, in the above graph, Yf output level shows the equilibrium output level of an economy.