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Chapter 5.4

ECON202 Chapter 5.4: Aggregate Planned Expenditure

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Harvey King

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5.4 Aggregate Planned Expenditure
We have a good idea of how consumption works, and some preliminary idea of the size and
variability of the components of aggregate expenditure.
We are now going to develop a basic model of aggregate spending/expenditure (AE) and what
factors affect aggregate spending, and how changes in aggregate spending lead to changes in
the level of production Y.
This is our first building block model, to be able to understand key components of the
We are going to make things a little simpler by assuming initially that there are no changes in
the aggregate price level.
We now wish to find the point of equilibrium expenditure.
Equilibrium expenditure occurs when aggregate planned expenditure equals real GDP.
In other words, when planned spending equals actual production this is an equilibrium
because everyone who wants to buy something can find some goods/services to buy, and
everyone who wants to sell something can find a buyer.
Aggregate planned expenditure is the sum of planned consumption, planned investment,
planned government purchases and planned net exports in our simplified example.
(5.9) AEp = Cp + Ip + Gp + NXp.
We need to see how the economy arrives at an equilibrium, and then use this understanding to
see how the economy adjusts in the face of a shock to the system in Module 6.
Planned consumption expenditure comes from our consumption function:
(5.2) C p = a + bYD.
YD = Y T is disposable income , and T is net taxes .
We will start out by assuming that T = t0 only . This is autonomous taxes (taxes that do NOT
vary with income), no income tax for the moment.
Substituting in these values gives us our simple planned consumption function:
(5.10) Cp = (a bt0) + bY.
This gives us the relationship of Cp to Y .
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