Question

1. What is the space of analysis of the multiplier model? What is the significance of the 45 degree line in the Aggregate Production curve? Draw an aggregate production curve.

2. What are Aggregate Expenditures (AE)? Be sure to distinguish both autonomous and induced expenditures.

3. What is the slope of the Aggregate Expenditure function? What is its significance?

4. Show equilibrium in the Keynesian multiplier model. Identity the stability of equilibrium using the notion of unintended inventory changes.

5. Write the formula for the multiplier and identify the algebraic condition of the change in aggregate expenditure with respect to the change in real income.

Answer 1

Answer for Question No: 2

Aggregate Demand and Aggregate Supply together determine the level of income, output and employment.

Aggregate Demand is the total demand for final goods and services in the economy, that all sectors of the economy are planning to buy at a given level of income, during a period of time. Aggregate Demand, in fact, represents the total planned expenditures on goods and services in an economy.

Aggregate demand or Aggregate Expenditure is the expenditure incured on Consumption, Investment, Govrnment Spending and the Net Export Expenditure. It is the sum of all the expenditures undertaken in the economy during a specified period of time.

The components of Aggregate Expenditures are:

1. Consumption Expenditure

2. Investment Expenditure

3. Government Spending

4. Net Export Expenditure

Aggregate Expenditure = C+I+G+X-M

Consumption Expenditure:

Consumption Expenditure is the household consumption expenditure and it is the most important component of Aggegate Expenditure. It refers to the total amount of expenditure incurred by the households on purchase of goods and services to satisfy their wants.

Investment Expenditure:

Investment Expenditure refers to the expenditure incurred by the private firms on the purchase of capital goods such as plant and equipment, construction works, etc

Investment expenditure can be further divided into two parts, planned investment and unplanned investment.

Government Expenditure:

Government Expenditure refers to the expenditure incurred by the government on purchase of goods and services. The level of government expenditure is determined by the government's policy.

Net Exports:

Net Exports refers to the difference between exports and imports. (X-M). It shows the effect of domestic spending on foreign goods and services (Imports) and foreign spending on domestic goods and services. (Exports)

House hold consumption expenditure is the largest component

Difference between Autonomous and Induced Expenditure:

Autonomous Expenditure	Induced Expenditure
1. Consumption expenditure which is not affected by change in income is Autonomous Consumption. It means, even if the income of the consumer is zero, there will be some consumption.	1.  Induced consumption expenditure refers to the level of consumption dependent on the level of income. Here, when the income of the consumer increases, his consumption also increases as a result of change in income.
2. The consumer can manage with his previous income. This type of expenditure that are not impacted by the real income.	2. It is the expenditure which results from changes in the level of real income of the economy. In the Macro level, Induced Expenditure are the expenditure by the house hold sector, business sector, government sector and foreign sector.
3. Autonomous expenditure do not vary with the level of real GDP	3.Induced expenditure vary with the level of real GDP