Question

Thoroughly and in detail, explain the AE approach to calculating GDP.

Explain how this relates to both the Business Cycle concept and the Production Possibilities Curve

Answer 1

In economics, aggregate expenditure (AE) is a measure of national income. Aggregate expenditure is defined as the current value of all the finished goods and services in the economy. The aggregate expenditure is thus the sum total of all the expenditures undertaken in the economy by the factors during a given time period. It refers to the expenditure incurred on consumer goods, planned investment and the expenditure made by the government in the economy. In an open economy scenario, the aggregate expenditure also includes the difference between the exports and the imports.

It is the sum of all the expenditures undertaken in the economy by the factors during a specific time period.
The equation for aggregate expenditure is:
AE = C + I + G + NX.

Written out the equation is: aggregate expenditure equals the sum of the household consumption (C), investments (I), government spending (G), and net exports (NX).

Consumption expenditure (C)

Consumption refers to the household consumption over a given period of time. The total household consumption can be divided into two parts, they are: Autonomous Consumption and Induced consumption. Autonomous Consumption refers to the amount of consumption regardless of the amount of income, hence, even if the income is zero, the autonomous consumption would be the total consumption. Induced consumption refers to the level of consumption dependent on the level of income.

Y = Income
Investment (I)

Investment is the amount of expenditure towards the capital goods. Investment refers to the expenditure towards goods that are expected to yield a return or increase their own value over time. The investment expenditure can be further divided into two parts, planned investment and unplanned investment. Over the long run the sum of differences in the unplanned investment would equal to zero as economy approaches equilibrium.

Government Expenditure:(G)

The Keynesian model propagates an active state to control and regulate the economy. The government can make expenditure in terms of infrastructure, thus increase the total expenditure in the economy as advocated by Keynes. Transfer payments (such as pensions and unemployment benefits) are NOT included in G as that would mean a double count.

Net Exports:(NX)

In an open economy, the total expenditure of the economy also includes the components of the net exports which is the total exports minus the total imports.

A business cycle occurs due to the fluctuations that an economy experiences over time resulting from changes in economic growth. Understanding business cycles is the essence of a course in macroeconomics. Economists try to discern where the economy is located and more importantly where it is heading in order to deal with possibly adverse future economic events. When the economy is at or is heading in an undesirable direction, economists may apply fiscal or monetary policy tools to change the course of the economy.

n general, a business cycle describes changes in the demand-side of the economy as measured by GDP, where:

GDP = C + I + G + NX

Over time, GDP does not remain constant and will change for many reasons, economic and non-economic. Economic reasons include changes in government policies such as taxes and interest rates. The non-economic reasons are too many to even consider listing, but include factors such as war, drought, natural and man-made disasters.