Aggregate Spending and Consumption Function Quiz

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.