Topic 3 - Aggregate Expenditure and The Multiplier

What is the AE formula?

AE = C + I + G + (X-M)

What is the main assumption of the AE?

Prices are fixed

What is the consumption function a relationship between?

expenditure and income, everything else remaining the same

What is the Formul for the consumption function and what does everything stand for?

C = a + bYd

• C is determined by spending power, Yd

• a is autonomous consumption

• b is the induced component of consumption referred to as the

marginal propensity to consume, MPC.

What is the savings function a relationship between?

savings and income, other things remaining the same

What are the 3 savings function formulas?

S = Y – T - C

S = Yd – a –bYd

S = (1 – b)Yd -a

What is MPC?

Marginal propensity to consume - the increase in consumption from an additional £1 in disposable income

What is the formula for MPC?

mpc = ∆C/ ∆Yd

What is the MPC a slope of?

the consumption function

What is MPS?

Marginal propensity to save - increase in saving from an additional £1 in disposable income

What are the 2 formulas for the MPS?

mps = ∆S/ ∆Yd

mps = 1 – mpc

What is the MPS a slope of?

saving function

What are the 2 components of investments?

• Expenditure on adding new stocks

• Expenditure on new capital goods

What is I

a) independent of?

b) treated as?

c) smaller than?

a) independent of Y

b) autonomous

c) smaller than C but more volatile

What is G? Does it depend on Y?

• G is government spending

• Govt buys goods & services from firms

• Use tax revenue to pay for purchases

• G is autonomous, i.e. does not depend on income Y

What is T? Formula? Does it depend on Y?

T is tax revenue net of transfers

• Transfers are cash transfers from govt such as unemployment benefits

and pensions.

T = tY

• t is the rate of tax & is autonomous

• T is induced, i.e. it depends on Y

What is a balanced budget?

T=G

What is a surplus budget?

T > G, the budget is in surplus. The surplus flows to financial markets

What is