7 The Aggregate Expenditure Model
9.1 The Aggregate expenditure model
From: https://courses.lumenlearning.com/boundless-economics/chapter/introducing-aggregate-expenditure/
Defining Aggregate Expenditure: Components and Comparison to GDP
Aggregate expenditure is the current value of all the finished goods and services in the economy.
In economics, aggregate expenditure is the current value of all the finished goods and services in the economy. It is the sum of all the expenditures undertaken in the economy by the factors during a specific time period. The equation for aggregate expenditure is: AE = C + I + G + NX.
Written out the equation is: aggregate expenditure equals the sum of the household consumption (C), investments (I), government spending (G), and net exports (NX).
- Consumption (C): The household consumption over a period of time.
- Planned investment (I): Planned spending on capital goods.
- Government expenditure (G): The amount of spending by federal, state, and local governments. Government expenditure can include infrastructure or transfers which increase the total expenditure in the economy.
- Net exports (NX): Total exports minus the total imports.
The aggregate expenditure determines the total amount that firms and households plan to spend on goods and services at each level of income.
The aggregate expenditure is one of the methods that is used to calculate the total sum of all the economic activities in an economy, also known as the gross domestic product (GDP). The gross domestic product is important because it measures the growth of the economy. The GDP is calculated using the Aggregate Expenditures Model.
Investment versus Planned Investment
Recall from chapter 4 that the investment component of GDP includes business fixed expenditures (such as a business purchasing new machinery, new vehicles, building a new factory, etc.), new residential construction, and changes in inventory. A change in inventory occurs either when a company produces a product but does not sell it (causing an increase in inventory) or when a company sells a previously unsold good (causing a decrease in inventory.) When a company decides on how much to spend on investment, we assume they are making a decision about business fixed expenditures. Therefore, we assume that the amount that companies plan to spend on things like machinery and other physical capital will be equal to what they actually spend. The difference between actual investment and planned investment will be caused by an unexpected change in inventories.
For example, suppose that Toyota produces 125,000 Tundra pick-up trucks. If they sell all of them, then there will be no change in inventory. But, if they only sell 100,000 Tundra pick-up trucks, then those 25,000 trucks are added to inventory and result in an unexpected increase in investment. Therefore, changes in inventories depend on actual sales which can not always be accurately predicted.
If we consider the entire economy, actual i