The Aggregate Expenditure Model

8.1 LEARNING OBJECTIVE

The Aggregate Expenditure Model

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Aggregate expenditure model A macroeconomic model that focuses on the short-run relationship between total spending and real GDP, assuming that the price level is constant.

In any particular year, the level of GDP is determined mainly by the level of aggregate expenditure.

Aggregate Expenditure

In 1936, the British economist John Maynard Keynes published a book, The General Theory of Employment, Interest, and Money, that systematically analyzed the relationship between changes in aggregate expenditure and changes in GDP.

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Keynes identified four components of aggregate expenditure that together equal GDP:

• Consumption (C). This is spending by households on goods and services.

• Planned investment (Ip). This is the planned spending by firms on capital goods such as factories, office buildings, and machines, and by households on new homes.

• Net exports (NX). This is spending by foreign firms and households on goods and services produced in Canada minus spending by Canadian firms and households on goods and services produced in other countries.

• Government purchases (G). This is spending by local, provincial, and federal governments on goods and services, such as the armed forces, bridges and roads, and the salaries of RCMP officers.

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So, we can write

or

AE = C + Ip + G + NX

Planned aggregate expenditure = Consumption + Planned investment

+ Government purchases + Net exports

Inventories Goods that have been produced but not yet sold.

The Difference between Planned Investment and Actual Investment

Notice that planned investment spending, rather than actual investment spending, is a component of aggregate expenditure.

In this chapter, we will use Ip to represent planned investment.

Actual investment will equal planned investment only when there is no unplanned change in inventories.

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