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**preview**shows half of the first page. to view the full**3 pages of the document.**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

macroeconomy.

• 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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