# Aggregate Expenditure Model & Formula

## Aggregate Expenditure Model

**Aggregate expenditure** is defined as the value of all finished goods and services at a given time within an economy. This model is one that economists might use to determine the gross domestic product, or GDP, of an economy. GDP is the total output within an economy over a given time period; it is usually calculated within the context of a year. Since aggregate expenditure can be used to calculate GDP, it allows countries to measure the size of their economies and the growth over time.

**Planned expenditure** is the value of the total amount of finished goods and services within an economy that are intended to be sold. **Actual expenditure** is the value of finished goods and services that actually sell, and the amount of inventory investment is the difference between the two. If planned expenditure was always met, every product produced would always be sold. Since this is not the case, the leftover goods are considered an investment in inventory.

## Aggregate Expenditure

Most people track how much money they spend over the course of a year so that they can accurately budget their income. The economy of a country can be tracked in the same way. Much to the delight of economists, there are a number of different ways that a country can measure its economy. One of the most popular methods is to determine the aggregate expenditure of the country. The **aggregate expenditure** is defined as the value of all of the completed goods and services that currently exist in a country.

## Aggregate Expenditure Formula

The calculation of aggregate expenditure is found by summing consumption (C), investment (I), government expenditure (G), and net exports (X-M), as shown below. Each of these components will be discussed in further detail.

AE = C + I + G + (X - M)

### Consumption

Consumption is total household consumption over a given period of time. This includes all households within a country, and all expenditures by each of those households.

### Investment

Investment is the amount of money spent on capital good investments, such as factories, properties, and equipment. This is almost always done by businesses.

### Government Expenditure

Government expenditure is the total amount of spending done by local, states, and federal governments within a given period of time. Anything the government decides to spend money on falls in this category.

### Net Exports

Net exports is found by subtracting the total imports (M) from the total exports (X). This shows the total amount of goods brought into the economy less the total amount of goods taken out of the country.

## Aggregate Expenditure Graph

Aggregate expenditure and aggregate supply constantly work with each other to try to reach a state of equilibrium, where aggregate expenditure is equal to aggregate supply. When aggregate supply is larger than aggregate expenditure, prices will decrease or the quantity produced will decrease to meet aggregate expenditure, resulting in an overall decrease to GDP. When aggregate expenditure is greater than aggregate supply, prices and/or output will increase to meet aggregate expenditure, resulting in a higher GDP. Though these two are tied, they are not often graphed together. Rather, the aggregate expenditures curve is graphed against a 45 degree line which shows all combinations where real GDP is equal to aggregate expenditures, which is where the point of equilibrium is achieved.

Remember, equilibrium is where there is no shortage or surplus of finished goods and services; rather, every good and service produced is purchased at the point of equilibrium. As you can see in the accompanying graph, equilibrium is reached where real GDP and aggregate expenditures equal approximately 3.5. If aggregate expenditures fall to the left of this point, there is an unplanned decrease in inventories; if to the right, there is an unplanned increase.

## How to Calculate Aggregate Expenditure

Using the aggregate expenditure formula, the following example can be used to find aggregate expenditure.

Say country A has household consumption levels of $1000, investment levels of $1,500, government expenditure levels of $2000, exports equal to $5000 and imports equal to $3000. To find aggregate expenditure for country A, the following formula can be used:

AE = C + I + G + (X - M)

AE = $1000 + $1,500 + $2,000 + ($5,000 - $3,000)

AE = $6,500

In country A, aggregate expenditure is $6,500. This means that real GDP is also equal to $6,500.

## Aggregate Expenditure Shifts

A key feature of the aggregate expenditure model is that a fixed price level is assumed. A change in price will cause consumption (C), investment (I), and net exports (X - M) to change. A decrease in price would increase the purchasing power a consumer has, and they will most likely consume more goods and services. On the other hand, an increase in price would decrease purchasing power and, as a result, decrease consumption. This relationship between change in price levels and change in consumption and "real wealth" is defined as the *wealth effect.* Changes in prices will shift the curve as a result.

Another factor that shifts the aggregate expenditure curve is the *interest rate effect.* Since price levels affect the real quantity of money within an economy, changes in prices also affect the interest rate. A lower price level will result in a higher level of money in the economy and result in a lower interest rate since there is plenty of money to go around. This lower interest rate will increase the level of investments and shift the aggregate expenditure curve. It also works in the reverse: a higher price level results in a lower level of money, resulting in a higher interest rate, equating to a lower level of investment and ultimately a lower aggregate expenditure.

A change in the price level domestically will impact net exports, known as the *international trade effect.* When the domestic price level is higher, exports will decrease and imports of cheaper goods will increase, resulting in a lower level of net exports and a lower aggregate expenditure. When the domestic price level is lower, exports will increase, imports will decrease, net exports increase and aggregate expenditure will increase.

## Aggregate Expenditure Theories

### Classical Economics

Classical economics takes a different approach than that of which we just covered. Instead of including government expenditures and net exports, classical economics follows Say's law and only includes consumption and investment in its calculation of aggregate expenditure. The theory behind doing so is that, according to Say's law, supply creates its own demand. The thought is that wage and rent payments made during the production of goods and services generate enough income to create the demand for the products produced, and so on.

### Keynesian Economics

Keynesian economics follows the aggregate expenditure model that was just discussed at length in this lesson. It considers government expenditure and net exports in addition to consumption and investment.

## Lesson Summary

**Aggregate expenditure** is the total value of all finished goods and services within an economy. **Planned expenditure** is the value of the goods and services created for sale, while **actual expenditure** is the amount of goods and services that were actually demanded.

Aggregate expenditure is calculated by adding consumption (C), investment (I), government expenditure (G), and net exports (X - M). Consumption is all household consumption within an economy. Investment is all capital investment made within an economy. Government expenditure is any spending done by the government. Net exports are calculated by subtracting imports from exports. Shifts to the aggregate expenditure curve can be caused by the wealth effect, the interest rate effect, and the international trade effect.

## Four Different Components

You're probably thinking that the aggregate expenditure must be an awful lot of stuff. You're definitely correct in thinking that. We'll make that number a bit easier to comprehend by looking at the different components that make up the total. Aggregate expenditure is made up of four components:

- Household consumption: This is the total amount of money that individuals spend on goods and services over the course of a year, including things like the purchases of couches, toilet paper, and ballpoint pens.
- Investment: This is the amount of money that people and businesses invest on capital expenditures. These are things like new manufacturing machines, improvements to real estate, and purchases of buildings.
- Government spending: This is the total amount of money that's spent by the government.
- Net exports: This is determined by subtracting the total imports of a country from the total exports. This is the only component that can be a negative number. It will be a negative number if imports are greater than exports.

## Aggregate Expenditure Calculation

Once you have determined the value for each of the components, you are ready to calculate the total amount by using the formula for aggregate expenditure. First, we will establish some abbreviations so the formula will be easier to follow:

- AE = Aggregate expenditure
- C = Household consumption
- I = Investment
- G = Government spending
- X = Net exports

The formula is then a basic addition problem:

AE = C + I + G + X

Here are some of the component totals for the fictitious country of New Oldenstan:

- Household consumption = $100,000
- Investment = $250,000
- Government spending = $500,000
- Exports = $300,000
- Imports = $150,000

Now we can plug this data into the formula. Remember that net exports are just exports minus imports, or X = exports - imports.

AE = C + I + G + X

Plugging in, we get:

AE = $100,000 + $250,000 + $500,000 + ($300,000 - $150,000)

So we get:

AE = $100,000 + $250,000 + $500,000 + $150,000

So, finally, we have AE = $1,000,000. The total aggregate expenditure for New Oldenstan is $1,000,000.

Now lets see what happens when there is a negative net export. We'll solve for some new data from New Oldenstan:

- Household consumption = $150,000
- Investment = $200,000
- Government spending = $600,000
- Exports = $300,000
- Imports = $400,000

So we have:

AE = C + I + G + X

Plugging in our values, we get:

AE = $150,000 + $200,000 + $600,000 + ($300,000 - $400,000)

This simplifies to:

AE = $150,000 + $200,000 + $600,000 - $100,000

So we have AE = $850,000. The only real difference here is that net exports are subtracted rather than added. Why is that? Because net exports are negative if imports are greater than exports.

## Examples

Imagine that you're on a diet and you're trying to lose 20 pounds. You get on the scale one day and it reads 150 pounds. Are you on target for your weight loss? How much have you lost so far? Looking at your weight on a single day means nothing because it doesn't answer either of those two questions. You can only track your progress by looking at your historical weight measurements and comparing them with your current weight measurement. The data for aggregate expenditure is similar in terms of analysis.

The totals for aggregate expenditures in industrialized countries are typically in the billions of dollars and sometimes even in the trillions of dollars. Those are some really big numbers! So what can you infer from one of those huge numbers? The answer is, unfortunately, not much. The importance of the numbers comes when you compare them to numbers from previous dates. You can then see if the economy of the country grew or shrank. You can also see if the economy grew (or shrank) more or less than was predicted, and you can compare many years of data to see trends in a country's economy.

## Lesson Summary

All right, let's now take a moment or two to review. **Aggregate expenditure** is defined as the value of all of the completed goods and services that currently exist in a country. It's determined by calculating the sum of household consumption, investment, government spending, and net exports. In order to determine net exports, you subtract total imports from total exports. This is the only component that can be a negative number. Once you've determined the aggregate expenditure for a particular country you can then analyze the country's economy by comparing the current data to historical aggregate expenditures.

To unlock this lesson you must be a Study.com Member.

Create your account

## Aggregate Expenditure

Most people track how much money they spend over the course of a year so that they can accurately budget their income. The economy of a country can be tracked in the same way. Much to the delight of economists, there are a number of different ways that a country can measure its economy. One of the most popular methods is to determine the aggregate expenditure of the country. The **aggregate expenditure** is defined as the value of all of the completed goods and services that currently exist in a country.

## Four Different Components

You're probably thinking that the aggregate expenditure must be an awful lot of stuff. You're definitely correct in thinking that. We'll make that number a bit easier to comprehend by looking at the different components that make up the total. Aggregate expenditure is made up of four components:

- Household consumption: This is the total amount of money that individuals spend on goods and services over the course of a year, including things like the purchases of couches, toilet paper, and ballpoint pens.
- Investment: This is the amount of money that people and businesses invest on capital expenditures. These are things like new manufacturing machines, improvements to real estate, and purchases of buildings.
- Government spending: This is the total amount of money that's spent by the government.
- Net exports: This is determined by subtracting the total imports of a country from the total exports. This is the only component that can be a negative number. It will be a negative number if imports are greater than exports.

## Aggregate Expenditure Calculation

Once you have determined the value for each of the components, you are ready to calculate the total amount by using the formula for aggregate expenditure. First, we will establish some abbreviations so the formula will be easier to follow:

- AE = Aggregate expenditure
- C = Household consumption
- I = Investment
- G = Government spending
- X = Net exports

The formula is then a basic addition problem:

AE = C + I + G + X

Here are some of the component totals for the fictitious country of New Oldenstan:

- Household consumption = $100,000
- Investment = $250,000
- Government spending = $500,000
- Exports = $300,000
- Imports = $150,000

Now we can plug this data into the formula. Remember that net exports are just exports minus imports, or X = exports - imports.

AE = C + I + G + X

Plugging in, we get:

AE = $100,000 + $250,000 + $500,000 + ($300,000 - $150,000)

So we get:

AE = $100,000 + $250,000 + $500,000 + $150,000

So, finally, we have AE = $1,000,000. The total aggregate expenditure for New Oldenstan is $1,000,000.

Now lets see what happens when there is a negative net export. We'll solve for some new data from New Oldenstan:

- Household consumption = $150,000
- Investment = $200,000
- Government spending = $600,000
- Exports = $300,000
- Imports = $400,000

So we have:

AE = C + I + G + X

Plugging in our values, we get:

AE = $150,000 + $200,000 + $600,000 + ($300,000 - $400,000)

This simplifies to:

AE = $150,000 + $200,000 + $600,000 - $100,000

So we have AE = $850,000. The only real difference here is that net exports are subtracted rather than added. Why is that? Because net exports are negative if imports are greater than exports.

## Examples

Imagine that you're on a diet and you're trying to lose 20 pounds. You get on the scale one day and it reads 150 pounds. Are you on target for your weight loss? How much have you lost so far? Looking at your weight on a single day means nothing because it doesn't answer either of those two questions. You can only track your progress by looking at your historical weight measurements and comparing them with your current weight measurement. The data for aggregate expenditure is similar in terms of analysis.

The totals for aggregate expenditures in industrialized countries are typically in the billions of dollars and sometimes even in the trillions of dollars. Those are some really big numbers! So what can you infer from one of those huge numbers? The answer is, unfortunately, not much. The importance of the numbers comes when you compare them to numbers from previous dates. You can then see if the economy of the country grew or shrank. You can also see if the economy grew (or shrank) more or less than was predicted, and you can compare many years of data to see trends in a country's economy.

## Lesson Summary

All right, let's now take a moment or two to review. **Aggregate expenditure** is defined as the value of all of the completed goods and services that currently exist in a country. It's determined by calculating the sum of household consumption, investment, government spending, and net exports. In order to determine net exports, you subtract total imports from total exports. This is the only component that can be a negative number. Once you've determined the aggregate expenditure for a particular country you can then analyze the country's economy by comparing the current data to historical aggregate expenditures.

To unlock this lesson you must be a Study.com Member.

Create your account

#### How do you calculate the aggregate expenditure model?

Aggregate expenditure is calculated by adding household consumption (C), investment (I), government expenditure (G), and net exports together.

AE = C + I + G + (X - M)

Net exports is equal to total exports minus total imports.

#### What are the four components of aggregate expenditures?

The four components of aggregate expenditure are total household consumption within an economy (C), total capital investment within an economy (I), total government spending (G), and net exports, which is equal to total exports minus total imports. X is total exports and M is total imports.

AE = C + I + G + (X - M)

#### What causes aggregate expenditure shift?

Price level changes are the main factor that causes aggregate expenditure to shift. Price impacts purchasing power, the interest rate, and the level of net exports, all of which play into the calculation of aggregate expenditure.

#### What is the aggregate expenditure model?

The aggregate expenditure model is a graphical representation of aggregate expenditure, or the total value of all finished goods and services within an economy. It is graphed against a 45 degree line which shows all combinations of equilibrium within the economy. The point where the aggregate expenditure curve crosses the 45 degree line is the point of equilibrium where aggregate expenditures equal real GDP.

### Register to view this lesson

### Unlock Your Education

#### See for yourself why 30 million people use Study.com

##### Become a Study.com member and start learning now.

Become a MemberAlready a member? Log In

Back### Resources created by teachers for teachers

I would definitely recommend Study.com to my colleagues. Itâ€™s like

**a teacher waved a magic wand and did the work for me.** I feel like itâ€™s a lifeline.