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EQUATION OF EXCHANGE: An equation that specifies the relation between the money supply, the velocity of money, the price level, and real production. The equation is stated as M*V = P*Q, where M is the money supply, V is the velocity, P is the price level, and Q is real production. This equation is a key component of the quantity theory of money, which offers an explanation between the money supply and inflation.

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AGGREGATE EXPENDITURES:

The total expenditures on gross domestic product undertaken in a given time period by the four sectors--household, business, government, and foreign. Expenditures made by each of these sectors are commonly termed consumption expenditures, investment expenditures, government purchases, and net exports. Aggregate expenditures (AE) are a cornerstone in the study of macroeconomics, playing critical roles in Keynesian economics, aggregate market analysis, and to a lesser degree, monetarism. In particular, aggregate expenditures are combined with the price level as aggregate demand.
Aggregate expenditures are the total expenditures on gross domestic product. These expenditures are used by the household, business, government, and foreign sectors to purchase all of the gross domestic product supplied by the domestic economy. These combined expenditures are a key part of the foundation of macroeconomic analysis or unemployment, inflation, business cycles, and other phenomena

Aggregate expenditures are related to, but different from, aggregate demand. The difference between aggregate expenditures and aggregate demand is much like the difference between quantity demanded and market demand. Like quantity demanded, aggregate expenditures are expenditures at a given price level. And like market demand, aggregate demand is the whole range of expenditures at a range of price levels.

The Aggregate Expenditures Equation

The following equation is commonly used to summarize the four components that make up aggregate expenditures:
AE=C+I+G+(X-M)
The notation used here is relatively straight forward. AE is aggregate expenditures; C is consumption expenditures by the household sector; I is investment expenditures on capital goods by the business sector; G is government purchases; and (X - M) is net exports, with X being exports and M being imports.

Business Cycles and Stabilization Policies

Aggregate expenditures play a prominent role in macroeconomic analyses and theories. They achieve this status because they are critical to the performance and stability of the macroeconomy. In particular, most business-cycle instability is directly attributable to changes in aggregate expenditures. Business-cycle contractions are invariably the result of decreases in the four expenditures. And business-cycle expansions can be largely traced to increases in the four expenditures.

Because aggregate expenditures are an important source of macroeconomic instability, they are also seen as a prime target for government stabilization policies designed to correct instability problems. Fiscal and monetary policy, the two most widely use stabilization policies, both act on macroeconomic instability through aggregate expenditures. Fiscal policy works on aggregate expenditures directly through changes in government purchases and indirectly through tax-induced changes in consumption expenditures and investment expenditures. Monetary policy affects aggregate expenditures directly by providing the four sectors with spendable money and indirectly through interest-rate-induced changes in consumption expenditures and investment expenditures.

Four Expenditures

The four categories of aggregate expenditures, corresponding with the four basic macroeconomic sectors are: consumption expenditures (household sector), investment expenditures (business sector), government purchases (government sector), and net exports (foreign sector).
  • Consumption Expenditures: Consumption expenditures are the expenditures by the household sector on final goods and services undertaken in a given time period. Consumption expenditures are a rather large part of aggregate expenditures, about two-thirds, that are used by households to purchase commodities such as food, clothing, and kitchen appliances.

    The three specific categories of consumption expenditures--nondurable goods, durable goods, and services. Nondurable goods include food, clothing, and facial tissue--and other things that seldom have a useful life of more than a year. Durable goods can be found among cars, furniture, and kitchen appliances. These are goods that should be around for more than a year. Services include health care, entertainment, education, legal advice, and other intangible activities that do not involve a physical product.

    Each of these three categories of consumption expenditures plays a different role in the macroeconomy. For example, households tend to cut back expenditures for durable goods more than nondurable goods when the economy is heading into a business-cycle contraction. Additionally, expenditures on services tend to rise with the economy's long run march toward prosperity.

  • Investment Expenditures: The business sector is responsible for investment expenditures for capital goods like factories and equipment. Investment expenditures tend to be volatile, but are usually in the range of 10 to 15 percent of aggregate expenditures.

    Investment expenditures are commonly divided into three categories--structures, equipment, and change in inventories. Structures are assorted buildings, including factories, office buildings, shopping malls, apartment complexes, and even residential houses. Equipment is the vast array of machinery and tools used for production, including delivery vehicles, computers, air compressors, forklifts, electric drills, pencil sharpeners, and a whole bunch of other tools that enter into every facet of production by a myriad of different businesses. Changes in inventories include increases or decreases in raw materials, intermediate goods, semi-processed products, and finished, but unsold goods, all of which are designed to smooth the flow of inputs and outputs to match production with sales orders.

    The decision to undertake investment expenditures can be a tricky business endeavor. The slightest change in the economy can trigger a big boost in investment or an equally large drop. This makes investment the most volatile of the four expenditures. It also makes investment expenditures a prime cause of business-cycle instability.

  • Government Purchases: The government sector, like the household and business sectors, buys a portion of the final goods and services produced by the economy. The purchases by the government sector of this production is aptly termed government purchases. Government purchases also fall in the range of 10 to 15 percent of total expenditures.

    While a great deal of theoretical and policy-maker attention is understandably focused on the federal level in the study of macroeconomics, all three levels of government are important--federal, state, and local. Federal government purchases are only about one-third of the total. State and local governments account for the remaining two-thirds. Government purchases do not include ALL government spending, only those expenditures used to purchase final goods and services, that is, gross domestic product. Government spending on transfer payments, like Social Security and welfare, are not included as government purchases.

  • Net Exports: The foreign sector, which includes everyone who is not a citizen of the domestic economy, also purchases domestic production. Net exports are considered the expenditures by the foreign sector on gross domestic product. Net exports, which are usually under 5 percent of total expenditures, are comprised of two parts--exports and imports. Exports are the purchase of domestic production by the foreign sector. Imports are the purchase of foreign production by the three domestic sectors (household, business, and government). Net exports are then exports minus imports.

    While it might seem as though exports is the correct measure to include as part of aggregate demand, net exports are used because the three expenditures on aggregate demand--consumption expenditures, investment expenditures, and government purchases--include a significant amount of imported goods produced by foreign economies. By subtracting imports from exports, and calculating net exports, it is possible, in one fell swoop, to eliminate this foreign production from aggregate expenditures, and end up only with aggregate expenditures on domestic production.

<= AGGREGATE DEMAND SHIFTSAGGREGATE EXPENDITURES DETERMINANTS =>


Recommended Citation:

AGGREGATE EXPENDITURES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: April 26, 2017].


Check Out These Related Terms...

     | aggregate demand | aggregate demand curve | aggregate demand and market demand | aggregate demand determinants | aggregate supply | aggregate market analysis | AS-AD model |


Or For A Little Background...

     | macroeconomics | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | price level | macroeconomic theories | macroeconomic markets | macroeconomic sectors | demand | real gross domestic product | National Income and Product Accounts |


And For Further Study...

     | change in aggregate expenditures | change in aggregate demand | aggregate demand shifts | slope, aggregate demand curve | business cycles | circular flow | Keynesian economics | monetary economics | personal consumption expenditures | gross private domestic investment | government consumption expenditures and gross investment | net exports of goods and services |


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