Aggregate Spending and Consumption Function Quiz

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18 Questions

What are the two main components of aggregate spending as mentioned in the text?

Desired private consumption and desired investment spending

Which component is usually the largest in aggregate spending?

Desired private consumption

What does the autonomous consumption 'a' represent?

Consumption when household income is 0

What does the marginal propensity to consume (MPC) show?

How consumption changes with disposable income

What does the average propensity to consume (APC) represent?

Proportion of consumption spending in total disposable income

How does APC change as disposable income rises according to the text?

Falls

What does ∆AE = 0.8∆Y imply in the context of the text?

0.8 of the increase in GDP is spent on domestic output.

What is the relationship between aggregate desired spending and total output at equilibrium GDP?

They are equal.

What determines equilibrium GDP in the given example?

1750

How can aggregate spending rise according to the text?

Due to an upward shift of the AE curve.

What could lead to a shift in the aggregate demand curve?

Permanent increase or decrease in desired consumption by households.

What does a marginal propensity to consume (MPC) of 0.8 imply?

$80 out of every $100 increase in income is consumed.

What is considered the most volatile component of GDP in the basic model?

Investment in business fixed capital

In the context of the given model, what does the marginal propensity to consume represent?

The fraction of any increment to GDP that will be spent on purchasing domestic output

What is the formula for aggregate spending in the hypothetical example provided?

$AE = 350 + 0.8Y$

What does the marginal propensity not to spend represent?

The fraction of any increment to GDP that does not add to desired aggregate spending

What does autonomous consumption refer to in the basic model?

Consumption not influenced by income level

How is average propensity to consume calculated?

$C = a + bYd$

Study Notes

Aggregate Spending

  • Aggregate spending equals the sum of desired private consumption (C) and desired investment spending (I): AE = C + I
  • Desired private consumption (C) is the largest component of aggregate spending

Consumption Function

  • The consumption function relates total desired consumer spending to the variables that affect it
  • In a basic framework, a household's spending is dependent on the amount of income available (disposable income): C = a + bYd
  • Autonomous consumption (a) shows what consumption will be when household income is 0
  • Induced consumption (bYd) is the change in consumption due to a change in disposable income
  • Marginal propensity to consume (MPC) is the change in consumption divided by the change in disposable income: MPC = ∆C / ∆Yd
  • Average propensity to consume (APC) is the proportion of consumption spending in total disposable income: APC = C / Yd

Equilibrium GDP

  • At equilibrium, aggregate desired spending equals the total output: Y = AE
  • In the hypothetical example, the equilibrium GDP is given as: Y = 350 + 0.8Y = 1750
  • Graphically, equilibrium occurs where the aggregate spending curve intersects the 45° line

Changes in GDP

  • Changes in GDP can occur due to:
    • Movement along the AE curve (increase in GDP/income)
    • Upward shift of the AE curve (increased desire to spend at each level of GDP)
  • The aggregate demand curve shifts with:
    • Changes in consumption (households' desire to spend)
    • Changes in investment (firms' confidence in the economy)

Investment Spending

  • Three major forms of investment spending are:
    • Investment in inventories
    • Investment in residential housing construction
    • Investment in business fixed capital
  • In this basic model, investment spending is treated as exogenously determined (fixed)
  • In reality, investment spending depends on variables such as the interest rate and is usually the most volatile component of GDP

Hypothetical Example

  • The economy has a desired investment spending of N250 million, autonomous consumption of N100 million, and a marginal propensity to consume of 0.8
  • The aggregate spending function is given as: AE = 350 + 0.8Y
  • The marginal propensity to spend is the fraction of increment to GDP that will be spent on purchasing domestic output: c = ∆AE / ∆Y
  • The marginal propensity not to spend is the fraction of any increment to GDP that does not add to desired aggregate spending: (1 - c)

Test your knowledge on aggregate spending, desired private consumption, and the consumption function in the framework proposed by John Maynard Keynes. Learn about the relationship between desired consumer spending, disposable income, and more.

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