The purpose of the aggregate expenditures line is to graphically illustrate the basic expenditures-income relation for the economy, which is the foundation of the aggregate expenditures line used in Keynesian economics. The intersection of the aggregate expenditures line and the 45-degree line indicates the equilibrium level of income and production.

The aggregate expenditures line comes in different varieties, depending on the specific Keynesian model under study, the number of sectors included in the analysis, and which expenditures are assumed autonomous and which are induced by income. The three most common aggregate expenditures lines are for a two-sector analysis (household and business), three-sector analysis (adding government), and four-sector analysis (adding the foreign sector).

The two basic types of expenditures--autonomous and induced--are indicated by the aggregate expenditures line.

• Autonomous expenditures are the vertical intercept, or Y-intercept, of the aggregate expenditures line. This is the sum of autonomous consumption, autonomous investment, autonomous government purchases, and autonomous net exports.


• Induced expenditures are the slope of the aggregate expenditures line. The marginal propensity to consume (MPC), which is the slope of the consumption line, forms the foundation of the slope of the aggregate expenditures line. This slope, however, is augmented by the marginal propensity to invest (MPI), marginal propensity for government purchases (MPG), and marginal propensity to import (MPM).

An Overview

Aggregate Expenditures Line

The two primary characteristics of the aggregate expenditures line are slope and intercept:

• Slope: The slope of the aggregate expenditures line presented here is positive, but less than one. In fact, the slope of the aggregate expenditures line is numerically equal to the marginal propensities for all expenditures included in the construction of this line. In this case the slope is equal to 0.8. The positive slope reflects induced expenditures--more income and production means more expenditures. This also reflects the basic Keynesian principle of effective demand. Click the [Slope] button to illustrate.


• Intercept: The aggregate expenditures line intersects the vertical axis at a value of $5 trillion. Theoretically, this is a minimum "baseline" level of aggregate expenditures, the amount of expenditures undertaken by the four sectors even if income and production fall to zero. More to the point, this intersection indicates autonomous expenditures--aggregate expenditures unrelated to income. Click the [Intercept] button to illustrate.

Four Expenditures

Consumption Line
Investment Line
Government Purchases Line
Net Exports Line

The exhibit to the right presents the linear relations for each of the four aggregate expenditures.

• Consumption Expenditures: The largest of the four expenditures on gross domestic product is consumption expenditures by the household sector. These expenditures are used to purchase everything from apple juice to cubic zirconium, essentially all of the goods and services that people purchase to satisfy wants and needs. The consumption line is the relation between these consumption expenditures and aggregate income or production. A representative consumption line, labeled C, is presented in the top panel of the exhibit to the right. This red line is positively sloped due to the Keynesian psychological law and the slope is measured by the marginal propensity to consume (MPC). The intercept is autonomous consumption.


• Investment Expenditures: The least stable of the four expenditures on gross domestic product is investment expenditures by the business sector. These are expenditures on capital goods, ranging from million-dollar factories to fifty-cent screw drivers. Investment expenditures are for fixed structures, equipment, and inventories (working capital). The relation between investment expenditures and aggregate income or production is illustrated by an investment line. Two alternative investment lines are presented in the second panel of the exhibit to the right. The horizontal gray line, labeled I, indicates autonomous investment, investment that is unaffected by income or production. The positively-sloped red line, labeled I', is induced investment, investment that is affected by income or production, and is measured by the marginal propensity to invest (MPI).


• Government Purchases: A key fiscal policy tool used to stabilize business cycles is government purchases on gross domestic product by the government sector. These are expenditures on goods and services used for a wide range of government activities, ranging from military aircraft to paper clips, and includes expenditures by federal, state, and local governments. It includes both capital goods as well as consumption goods. The relation between government purchases and aggregate income or production is illustrated by a government purchases line. Two alternative government purchases lines are presented in the third panel of the exhibit to the right. The horizontal gray line, labeled G, indicates autonomous government purchases, government purchases that are unaffected by income or production. The positively-sloped red line, labeled G', is induced government purchases, government purchases that are affected by income or production, and is measured by the marginal propensity for government purchases (MPG).


• Net Exports: The smallest of the four expenditures on gross domestic product are net exports by the foreign sector. Net exports are the difference between exports, domestic production purchased by the foreign sector, and imports, foreign production purchased by the three domestic sectors (household, business, and government). The relation between net exports and aggregate income or production is illustrated by the net exports line. A typical net exports lines is show in the bottom panel of the exhibit to the right. This negatively-sloped red line, labeled X-M, is the combination of autonomous exports and induced imports. Because imports are subtracted from exports, the negative slope of the net exports line is the negative of the marginal propensity to import (MPM).

Three Lines

• Two Sectors: The simplest aggregate expenditures line is based on expenditures by the two "private" sectors--household and business. This two-sector aggregate expenditures line is the combination of consumption expenditures and investment expenditures. More often than not, this line is based on autonomous investment. This two-sector line captures the essential elements of Keynesian economics and thus is often used as an introductory presentation. One important element captured in this line is, first and foremost, induced consumption and the psychological law. Another element is the equilibrium equality between production and expenditures and the potential instability created by changes in autonomous investment.


• Three Sectors: A second expenditures line is obtained by adding the "public" or government sector to the two-sector line. This three-sector aggregate expenditures line is the combination of consumption expenditures, investment expenditures, and government purchases. In addition, an adjustment of consumption expenditures for taxes is also commonly incorporated in this line. This expanded line is not only more realistic, it also enables the analysis of the impact of government fiscal policies on the economy, which is a key consideration of Keynesian economics. The three-sector aggregate expenditures may or may not include induced investment, induced government purchases, or induced taxes.


• Four Sectors: The complete expenditures line is constructed by adding net exports to the three-sector line. This four-sector aggregate expenditures line is the combination of consumption expenditures, investment expenditures, government purchases, and net exports. While the assorted expenditures can be assumed autonomous, as the "complete" aggregate expenditures line, anything that is realistically induced by income and production is generally assumed to be induced in the construction of this line.

Shocking The Line

Determinants

These determinants cause changes in autonomous expenditures and the vertical intercept of the aggregate expenditures and in so doing shift it up or down. The exhibit to the right can be used to illustrate the up and down shifts of the aggregate expenditures line.

• Shifting Up: An increase in aggregate expenditures is illustrated by a vertical upward shift of the aggregate expenditures line. This can be demonstrated by clicking the [Up] button in the exhibit. Note that the vertical intercept, or autonomous expenditures, is greater. This increase can be caused by lower interest rates, expansionary fiscal policy, or optimistic expectations.


• Shifting Down: A decrease in aggregate expenditures is illustrated by a vertical downward shift of the aggregate expenditures line. This can be demonstrated by clicking the [Down] button in the exhibit. Note that the vertical intercept, or autonomous expenditures, is now less. This decrease can be caused by higher interest rates, contractionary fiscal policy, or pessimistic expectations.