Aggregate Expenditure Model – Lecture Review

35 question-and-answer flashcards covering key definitions, formulas, determinants, and graphical relationships in the Aggregate Expenditure model, the consumption function, multiplier effects, and macroeconomic equilibrium.

What four components make up Aggregate Expenditure (AE)?

Consumption (C) + Planned Investment (I) + Government Purchases (G) + Net Exports (X – M).

State the basic formula for Aggregate Expenditure.

AE = C + I + G + (X – M).

What are non-durable goods?

Goods consumed immediately or within three years (e.g., food, fuel, cleaning products).

Define durable goods.

Goods that last three or more years and yield services over time (e.g., vehicles, major appliances).

Roughly what share of household consumption is on services in Australia?

About 50 % of total consumption.

How are inventories treated in investment calculations?

Changes in inventories are included in actual investment but not in planned investment.

Write the formula linking planned and actual investment with inventories.

Actual Investment = Planned Investment + Change in Inventories.

Differentiate G1 and G2 in government spending.

G1 = current (day-to-day) purchases; G2 = capital purchases on public infrastructure.

What is meant by net exports?

The value of exports minus the value of imports (X – M).

List four major determinants of household consumption.

Disposable income, interest rates (cost of credit), household wealth, consumer expectations/confidence (others: availability of credit, government policy, external shocks).

Which AE component is largest and what was its approximate 2023-24 value?

Consumption; about A$1 358 billion (≈ 52 % of GDP).

What is the marginal propensity to consume (MPC)?

The fraction of any change in income that is spent on consumption.

Define the marginal propensity to save (MPS) and its link to MPC.

The fraction of any change in income that is saved; MPC + MPS = 1.

Provide the formula for calculating MPC.

MPC = ΔC / ΔY.

Provide the formula for calculating MPS.

MPS = ΔS / ΔY.

Write the linear consumption function.

C = a + bY, where a = autonomous consumption and b = MPC.

What is autonomous consumption?

Planned spending that occurs even when disposable income is zero (the intercept ‘a’).

How does a higher MPC affect the consumption-function slope?

The slope becomes steeper (greater rise in C for each extra dollar of Y).

When MPC rises, what happens to the slope of the saving function?

The saving function becomes flatter because MPS falls.

Describe the relationship shown by the investment demand curve.

A negative relationship between the real interest rate and planned investment expenditure.

Name three key factors that influence business investment.

Interest rates, business expectations/confidence, past profits (also risk, government policy, economic cycle).

What is the typical effect of lower interest rates on investment?

They reduce borrowing costs, encouraging more planned investment.

Give two economic reasons governments undertake expenditure.

To fund essential services (health, education, defence) and to stabilise macroeconomic fluctuations via discretionary fiscal policy.

State four factors that influence the level of net exports.

Domestic/overseas economic activity, exchange rate, terms of trade, trade barriers (tariffs, quotas).

Define macroeconomic equilibrium in the AE model.

The point where planned aggregate expenditure equals real GDP and inventories remain unchanged.

What happens to inventories when AE < GDP?

Unsold goods accumulate; inventories rise.

What happens to inventories when AE > GDP?

Stocks are run down; inventories fall, prompting firms to raise output.

In the Keynesian Cross, what does the 45-degree line represent?

All points where aggregate expenditure equals national income (AE = Y).

What is the multiplier and its basic formula?

A coefficient showing how much equilibrium income changes following a change in autonomous spending; k = 1 / (1 – MPC) or k = 1 / MPS.

If MPC = 0.8, calculate the simple multiplier.

k = 1 / (1 – 0.8) = 5.

Write the complex multiplier formula including all leakages.

k = 1 / (MPS + MPT + MPM).

How do larger leakages (S, T, M) affect the multiplier value?

They make the denominator bigger, so the multiplier falls.

Define a positive output gap and name two likely macroeconomic symptoms.

Equilibrium GDP exceeds potential GDP; unemployment below natural rate and rising inflationary pressure.

Define a negative output gap and state its typical effects.

Equilibrium GDP is below potential GDP; higher unemployment and lower inflation.

What is the Average Propensity to Consume (APC) and how does it change with income?

APC = C / Y; it declines as income rises even though MPC remains constant.