This document presents the Keynesian aggregate expenditure model. It explains that aggregate expenditure (AE) is made up of consumption (C), planned investment (I), government spending (G), and net exports (X-M). It describes the factors that influence each component of AE and how equilibrium occurs when AE equals real output/income (Y). It shows that disequilibrium can result if AE is greater or less than Y, causing inflationary or deflationary gaps, and how the economy adjusts back towards equilibrium through changes in output and income.

1. Keynesian Aggregate Expenditure Model
(c) Andrew Tibbitt 2017 1
WACE Economics – Unit 4
Video 10.1

2. Planned Aggregate Expenditure
Consumption (c)
Planned investment (Ip)
Government spending (G1 + G2)
Net exports (X-M)
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3. Factors affecting consumption spending
Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
Planned investment (Ip)
Government spending (G1 + G2)
Net exports (X-M)
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4. Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
Planned investment (Ip)
Real interest rates
Income (profits) (accelerator)
Technological change
Expectations / confidence
Government spending (G1 + G2)
Net exports (X-M)
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Factors affecting planned investment

5. Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
Planned investment (Ip)
Real interest rates
Income (profits) (accelerator)
Technological change
Expectations / confidence
Government spending (G1 + G2)
Structural spending (allocation,
regulation, transfers)
Automatic stabilisation
Budget deficit to counter
economic cycle
Net exports (X-M)
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Factors affecting government spending

6. Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
Planned investment (Ip)
Real interest rates
Income (profits) (accelerator)
Technological change
Expectations / confidence
Government spending (G1 + G2)
Structural spending (allocation,
regulation, transfers)
Automatic stabilisation
Budget deficit to counter
economic cycle
Net exports (X-M)
Structural factors (competitiveness,
productivity, exchange rate)
Cyclical factors (domestic growth,
overseas growth)
Shocks (drought)
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Factors affecting net exports

7. Income affects each component of income
Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
Planned investment (Ip)
Real interest rates
Income (profits) (accelerator)
Technological change
Expectations / confidence
Government spending (G1 + G2)
Structural spending (allocation,
regulation, transfers)
Automatic stabilisation
Budget deficit to counter
economic cycle
Net exports (X-M)
Structural factors (competitiveness,
productivity, exchange rate)
Cyclical factors (domestic growth,
overseas growth)
Shocks (drought)
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8. Consumption (C) +
Consumption (c)
Real disposable income
Real interest rates
Wealth (debt)
Expectations / confidence
C
Consumption
Real disposable
income
Autonomous Consumption
Induced Consumption
Consumption (c)
C = a + bY
a = autonomous (survival)
consumption
b = marginal propensity to
consume
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9. Ip
Real disposable
income
Autonomous Planned
investment
Induced planned
investment
As incomes rise business gets
greater rewards from planned
investment.
Interest rates may rise as
incomes rise.
Planned investment (Ip)
Real interest rates
Income (profits) (accelerator)
Technological change
Expectations/confidence
Planned
Investment
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Planned investment (Ip) +

10. G
Real disposable
income
Counter-cyclical spending may
give the G function a negative
slope.
But growth means more tax and
tempts the governments to
spend more (expansionary bias).
Government
expenditure
Government spending (G1 + G2)
Structural spending (allocation,
regulation, transfers)
Automatic stabilisation
Budget balance changes to
counter economic cycle
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Government spending (G1+G2) +

11. X-M
Real disposable
income
As incomes grow more money is
spent on imports (impact
depends on marginal propensity
to import (MPM))
Net exports
Net exports (X-M)
Structural factors (competitiveness,
productivity, exchange rate)
Cyclical factors (domestic growth
affects import purchases)
Shocks (drought)
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Net exports (X – M)

12. Planned expenditure
Consumption (C)
Planned investment (Ip)
Government spending (G1+G2)
Net exports (NX)
Ex
Expenditur
e
Income, Output
C
G
NX
Ip
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AEX = C + Ip + G + X - M

13. Mathematic tool or aid
showing all points where
expenditure equals
income.
Known as Y = Ex line or
45o line or actual
expenditure line.
It is not an aggregate
supply line.
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1
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Y = Ex or 45o line

14. Equilibrium income (Y1)
is where planned
expenditure (Ex) = income
(Y)
At Y1 there is just enough
income and output to
satisfy aggregate planned
expenditure.
There is no need for
people to change
behaviour.
Ex
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1
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Equilibrium (Ex = Y)

15. At Y2 planned expenditure is
less than income and output.
Some output is unexpectedly
left unsold.
Stocks or inventories
unexpectedly increase,
causing an unplanned rise in
investment.
Actual expenditure = income
and output (because of the
unplanned rise in stocks) but
planned expenditure ≠
income and output.
Ex
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1 Y2
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Disequilibrium (Ex ≠ Y)

16. Firms will not want to
build up stock levels so
they cut back on output
(and hence incomes).
Output and income move
back towards Y1, and keep
going until they reach Y1.
Ex
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1 Y2
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Disequilibrium (Ex ≠ Y)

17. At Y3 planned expenditure is
more than income and output.
The shortage is met by running
down stocks (or importing).
This causes an unplanned cut
in investment (or a fall in NX)
Actual investment does not
equal planned investment.
Actual expenditure = income
and output (because of
unplanned fall in investment)
but planned expenditure ≠
income and output.
Ex
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1Y3
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Disequilibrium (Ex ≠ Y)

18. Firms will not want to run
out of stock and lose
profits from people buying
imports, so they increase
output (and hence
incomes).
Output and incomes move
back towards Y1, and keep
going until they reaches
Y1.
Ex
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1Y3
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Disequilibrium (Ex ≠ Y)

19. Positive shock
If one or more of the
components of planned
expenditure increase, the
Ex line moves upwards.
Ex 1
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1 Y2
Ex2
At output level Y1 there is now
a shortage. Unless the firms
increase output, stocks will fall
and profit will be lost
Ex2
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Impact of a rise in planned expenditure
Income rises from Y1 to Y2 (by
more than rise in Ex due to the
multiplier process)

20. Negative shock
If one or more of the
components of planned
expenditure decrease the
Ex line moves downwards.
Income falls from Y1 to Y3.
Ex1
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1Y3
Ex3
At output level Y1 there is now a
surplus on the market. Unless the
firms decrease output stocks will
rise and profit will be reduced.
Ex2
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Impact of a fall in planned expenditure

21. Negative shock
If one or more of the
components of planned
expenditure decrease the
Ex line moves downwards.
Ex 1
Expenditur
e
Income, Output
45o
Y = Ex
Ex1
Y1Y3
Ex3
NOTE: The final change in income
is bigger than the change in
planned expenditure that brought
it about. This is the result of the
MULTIPLIER EFFECT
Ex2
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Impact of a fall in planned expenditure

22.  Ignores the effect of changes output on the price level
(inflation).
 Inflation may well affect components of planned
expenditure.
 Do firms change their stocks or inventories in this way?
 Good for showing effect of multiplier process
 Good for basic demonstration of deflationary gaps (Ex
too low for full employment) and inflationary gaps (Ex
too high and above capacity)
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Evaluation of the model

23. End of slide show
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