What are the components of aggregate expenditure? In the model developed in this chapter, which components vary with changes in the level of real GDP? What determines the slope of the aggregate expenditure line?
The components of aggregate expenditure are consumption (C), investment (I), government spending (G), and net exports (NX). In the model developed in this chapter, consumption, investment, and net exports vary with changes in the level of real GDP.
Consumption (C) is the largest component of aggregate expenditure and it varies with changes in the level of real GDP. As real GDP increases, individuals and households have more income to spend, which leads to an increase in consumption. Conversely, if real GDP decreases, there is less income available for consumption, leading to a decrease in consumption.
Investment (I) also varies with changes in the level of real GDP. When real GDP is high, businesses are likely to invest more in new capital goods, such as equipment and machinery, to meet the increased demand for their products or services. Conversely, when real GDP is low, businesses may reduce their investment to align with lower demand.
Net exports (NX) also change with changes in the level of real GDP. Net exports represent the difference between exports (goods and services sold to other countries) and imports (goods and services bought from other countries). When real GDP increases, there is usually an increase in the demand for goods and services, both domestically and from other countries, leading to an increase in exports. On the other hand, if real GDP decreases, there may be a decrease in exports due to lower demand.
The slope of the aggregate expenditure line is determined by the marginal propensity to consume (MPC) and the marginal propensity to import (MPM). The MPC represents the change in consumption for every additional unit of income, while the MPM represents the change in imports for every additional unit of income. The slope of the aggregate expenditure line is determined by the difference between the MPC and the MPM. If the MPC is higher than the MPM, the aggregate expenditure line will have a steeper slope. Conversely, if the MPC is lower than the MPM, the aggregate expenditure line will have a flatter slope.