14A The Aggregate Expenditures Model

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The aggregate expenditures model (AE) is a short-run model of economic fluctuations. it holds that prices are completely sticky (inflexible) and that aggregate demand (aggregate expenditures) determines the economy's level of output and income.

The Consumption of Aggregate Expenditures

Consumption

• Disposable income
• MPC - the portion of additional income that is spent on consumption (additional likelihood to spend).

$MPC = \frac{\Delta \: in \: spending}{\Delta \: in \: income}$

• Aggregate Consumption Function

$C = AE_0 + MPC \cdot Y$

where $C$ is consumption, $AE_0$ is autonomous expenditure, and $Y$ is Real GDP (income).

• Investment
• An Economy without Government Spending or Net Exports
• Equilibrium without Government Spending or Net Exports
• Equilibrium with Government Spending or Net Exports

What Are the Implications of the AE model

1. Spending Determines Equilibrium Output and Income in the Economy
2. Equilibrium Can Occur Away from Full Employment
3. The Spending Multiplier

$\begin{aligned} Multiplier &= \frac{1}{1- MPC}\\ initial \: spending \times Multiplier &= total \: spending \end{aligned}$

Example (Income Inequality)
CEO's MPC is $0.5$, and employee's MPC is $0.95$
1. Reward CEO 1 million bonus
2. Reward each of 10000 employees 100 dollars.

2 reasons why people spend money.

1. Autonomous expenditure (Independent of income level)
2. Induced expenditure (dependent on income)

Autonomous Aggregate Expenditure = Sum of all Autonomous

$AE_0 = C_0 + I_0 + G_0 + NX_0$

Equilibrium

Aggregate Expenditure (AE) = Income (Y) (RGDP)

$\begin{aligned} AE_0 &= C_0 + I_0 + G_0 + NX_0\\ AE &= C_0 + MPC \cdot Y + I_0 + G_0 + NX_0\\ AE &= AE_0+ MPC \cdot Y\\ AE &= AE_0 \cdot \frac{1}{1-MPC} \end{aligned}$

Inequilibrium

production > expenditure $\To$ positive inventory
production < expenditure $\To$ negative inventory

Assume $AE = 5000 + 0.5Y$