DEMAND INCREASE AND SUPPLY DECREASE: A simultaneous increase in the willingness and ability of buyers to purchase a good at the existing price, illustrated by a rightward shift of the demand curve, and a decrease in the willingness and ability of sellers to sell a good at the existing price, illustrated by a leftward shift of the supply curve. When combined, both shifts result in an indeterminant change in equilibrium quantity and an increase in equilibrium price.
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DERIVATION, AGGREGATE EXPENDITURES LINE:
An aggregate expenditures line, a graphical depiction of the relation between aggregate expenditures and the level of aggregate income or production, can be derived by sequentially adding expenditures by the four macroeconomic sectors (household, business, government, and foreign). This derivation process begins with the consumption line, then adds investment, government purchases, and finally net exports. The process actually generates three alternative aggregate expenditures lines based on the number of sectors included (two sector, three sector, and four sector). An aggregate expenditures line can be derived by graphically adding or stacking the expenditures by each of the four macroeconomic sectors. The foundation of an aggregate expenditures line is the consumption line, which represents the relation between consumption expenditures and household sector income. The addition of investment expenditures by the business sector produces the two-sector aggregate expenditures line, often termed private sector expenditures. The subsequent addition of government purchases then generates the three-sector aggregate expenditures line. The complete four-sector aggregate expenditures line arises with the addition of net exports.
The Aggregate Expenditures LineThe aggregate expenditures line, which embodies the key Keynesian principle of effective demand, shows the relation between aggregate expenditures and the level of aggregate income or production in the domestic economy. The income and production measures commonly used are national income and gross domestic product.
The purpose of the aggregate expenditures line is to graphically illustrate the basic expenditures-income relation for the economy. 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).
Building The Stack
The place to begin in the derivation of an aggregate expenditures line is with the consumption line. Such a is presented in the exhibit to the right. This red line, labeled C in the exhibit, is positively sloped, indicating that greater levels of income and production generate greater consumption expenditures by the household sector. This positive relation reflects the Keynesian economics psychological law--more income means more consumption.
- Adding Investment: The first addition to the consumption line is investment expenditures. Investment expenditures are undertaken by the business sector to purchase capital goods. They are often assumed to be autonomous with respective to income, for most introductory analysis of Keynesian economics, but they are realistically induced. The addition of investment expenditures to the exhibit at the right can be accomplished by clicking the [Investment] button.
The line revealed by this click is labeled C+I, consumption plus investment. This line is technically termed the two-sector aggregate expenditures line, with the two sectors being household and business. It is also informally called the private sector aggregate expenditures line, because the private sector is comprised of the household and business sectors.
The two lines contained in the exhibit are parallel, meaning they have identical slopes. The slopes of both lines is the marginal propensity to consume. This result is achieved because autonomous investment is added to the consumption line. Because investment is autonomous, it is constant for all levels of income, hence the difference between C and C+I is constant. The inclusion of induced investment creates a more steeply sloped C+I line, one with a slope equal to the marginal propensity to consume plus the marginal propensity to invest.
- Adding Government Purchases: The next addition to the stack is government purchases. Government purchases are undertaken by the government sector to obtain the goods needed to provide government services. They are also usually assumed to be autonomous with respective to income, for most introductory analysis of Keynesian economics, but they are also realistically induced. The addition of government purchases to the exhibit can be accomplished by clicking the [Government Purchases] button.
The line revealed by this click is labeled C+I+G, consumption plus investment plus government purchases. This line is technically termed the three-sector aggregate expenditures line, with the three sectors being household, business, and government.
Now all three lines in the exhibit are parallel, with identical slopes. The slopes of these lines are once again the marginal propensity to consume. The addition of autonomous government purchases to the C+I line keeps the difference between C+I and C+I+G constant. The inclusion of induced government purchases creates a more steeply sloped C+I+G line, one with a slope equal to the marginal propensity to consume plus the marginal propensity for government purchases (and the marginal propensity to invest if induced investment is included).
- Adding Net Exports: The last addition to the stack is net exports. Net exports are the difference between exports of domestic production to the foreign sector and imports of foreign production to the domestic economy. This expenditure is attributable to the foreign sector. For simplicity, net exports are also assumed to be autonomous with respective to income. But they are also realistically induced. The addition of net exports to the exhibit can be accomplished by clicking the [Net Exports] button.
The new line at the top of the stack revealed by this click is labeled C+I+G+(X-M), consumption plus investment plus government purchases plus net exports. Continuing the naming trend, this line is termed the four-sector aggregate expenditures line, with the four sectors being household, business, government, and foreign.
Because net exports are assumed to be autonomous, all four lines in the exhibit are parallel, and have identical slopes equal to the marginal propensity to consume. The inclusion of induced net exports creates a slightly flatter C+I+G+(X-M) line, one with a slope equal to the marginal propensity to consume less the marginal propensity to import (and the marginal propensity to invest and the marginal propensity for government purchases if both induced investment and government purchases are included).
DERIVATION, AGGREGATE EXPENDITURES LINE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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