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• Aggregate Expenditure (AE)

• The total spending on goods and services produced in
the country.
• This spending consists of four elements and these are:
• Consumer spending by households (C)
• Investment expenditure by firms (I)
• Spending by the government (G)
• Exports to overseas countries (X)

AE = C + I + G + ( X- M ) 2
• Aggregate output
• The total quantity of goods and services produced (or
supplied) in an economy in a given period.
• Aggregate income
• The total income received by all factors of production in a
given period.
• Aggregate output (income) (Y)
• A combined term used to remind you of the exact equality
between aggregate output and aggregate income.

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• Two ways to determine the equilibrium
level of national income:
• Aggregate expenditure = aggregate output
Y = C + I + G + (X – M)
• injection = leakages
I + G + X = S +T + M
Circular Flow of National Income Model

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 Y=C+S
 A household can do two, and only two, things with its
income (Y):
◦ It can buy goods and services → consume (C)
◦ It can save → saving (S)
 Consumption
◦ Household purchases of final goods and services.
 Saving
◦ The part of its income that a household does not
consume in a given period.
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• All income is either spent on consumption or saved in an
economy in which there are no taxes.

• Consumption is the dependent variable because depends

on the disposable income.

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• Some determinants of aggregate consumption include:
• Household income
• Household wealth
• Interest rate
• Households’ expectations about the future

• Consumption function:
• The relationship between consumption and income, others
thing constant.

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 For an individual household,
the consumption function
shows the level of
consumption at each level of
household income.
 The household consumption
increased with household
income, assuming other
determinants remain constant.
 The higher your income is, the
higher your consumption is
likely to be.

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 C = a + bY
Marginal Propensity to Consume
(MPC)

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• Definition:
• The fraction of a change in income that is consumed.
• The change in consumption divided by the change in income
caused it.
• Formula:
C
marginal propensity to consume  slope of consumptio n function 
Y

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• Definition:
• The part of its income that a household does not consume in a
given period.

• Once we know how much consumption will result from a

given level of income, we know how much saving there will
be.
• Formula: Saving ≡ income − consumption
S≡Y−C

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• Definition:
• The relationship between saving and income while other things
constant.

• Figure:

Slope = ΔS /ΔY

ΔS

ΔY
Marginal Propensity to Save
(MPS)

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• Definition:
• The fraction of a change in income that is saved.
• The change in saving divided by the change in income that caused
it.

• Formula:
S
MPS =
Y

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• The marginal propensity to consume plus the marginal
propensity to save must sum to 1.
• Because disposable income is either spent or saved.

• Formula:
MPC +MPS  1
• Question:
• If Malaysia income increases from RM18.0 trillion to RM18.5
trillion, consumption increases by RM0.4 trillion and saving by
RM0.1 trillion. What is the MPC and MPS?

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C = 100+ .75Y

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 C = 100+ .75Y
• When Y = RM0, consumption is RM100 (a).
• For every RM100 increase in income (Y), consumption
rises by RM75 billion (C).
• So, saving function????

S Y−C

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Investment
Refers to purchases by firms of new buildings and
equipment and additions to inventories, all of which add to
firms’ capital stock.
 Inventory change is partly determined by how much households decide to buy, which is
not under the complete control of firms.

change in inventory = production – sales

Desired or planned investment

The additions to capital stock and inventory that are
planned by firms.
Actual investment
The actual amount of investment that takes place; it
includes items such as unplanned changes in inventories.
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• Government expenditure (G)
• Spending for goods and services by all levels of
government.
• Net taxes (T)
• Taxes paid by firms and households to the government
minus transfer payments made to households by the
government.

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• Disposable income (Yd)
• The income households have available to spend or to save after
paying taxes and receiving transfer payment.
• Formula:
disposable income ≡ total income − net taxes
Yd ≡ Y − T
• Budget
• The difference between what a government spends and what it
collects in taxes in a given period.
• Formula:
budget ≡ G − T

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• Before taxes:

C = a + bY
• After taxes:

C = a + bYd
or
C = a + b(Y − T)

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 EQUILIBRIUM OUTPUT:
AE APPROACH
 Equilibrium in the goods market as that point at which
aggregate expenditure equals to aggregate output.

 Equilibrium:
 EQUILIBRIUM OUTPUT:
AE APPROACH
• 2 sectors economy:

Closed Economy
• 3 sectors economy:

• 4 sectors economy:

Open Economy
 Aggregate
Expenditure (AE) Y

C+I

AE0

Aggregate
Output (Y)
Y0
 CALCULATING EQUILIBRIUM
OUTPUT:
AE APPROACH
Example:
Consider the following model of an economy:
C = 100 + 0.75Y
I = 150
Calculate the equilibrium output.
 EQUILIBRIUM OUTPUT:
AE APPROACH
Solution:
 EQUILIBRIUM OUTPUT:
AE APPROACH
Aggregate
Expenditure (AE)

Aggregate
Output (Y)
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 CALCULATING EQUILIBRIUM
OUTPUT:
AE APPROACH
Self-Practice:
Consider the following model of an economy:
C = 100+0.5Yd
I = 200
G = 300
T = 30
Calculate the equilibrium output.
 EQUILIBRIUM OUTPUT:
AE APPROACH
Solution:
 EQUILIBRIUM OUTPUT:
AE APPROACH
Aggregate
Expenditure (AE)

Aggregate
Output (Y)
 CALCULATING EQUILIBRIUM
OUTPUT:
LEAKAGES/ INJECTIONS APPROACH
Self-Practice:
Consider the following model of an economy:
C = 100+0.5Yd
I = 200
G = 300
T = 30
Calculate the equilibrium output by using injection/leakage
approach.
 EQUILIBRIUM OUTPUT:
LEAKAGES/ INJECTIONS APPROACH
Solution:
 EQUILIBRIUM OUTPUT:
LEAKAGES/ INJECTIONS APPROACH
Solution:
Definition
◦ The ratio of the change in the equilibrium level of output
to a change in some autonomous variable .
 Autonomous variable → a variable that is assumed not to depend on the
state of the economy—that is, it does not change when the economy changes.
 For example: investment, government expenditure and net export.
 The multiplier of autonomous investment describes the impact of an initial
increase in planned investment on production, income, consumption spending,
and equilibrium income.

 The size of the multiplier depends on the slope of the

planned aggregate expenditure line.
• Multiplier effect
• The equilibrium expenditure increases by more than
the increase in autonomous expenditure.
• It is always greater than one.

Multiplier
Effect to
Autonomous Aggregate
variable Expenditure /
(I, G, T) Output / Income
(direct or indirect impact)
• Spending multiplier, k:

or
MULTIPLIER
Self-Practice
Consider the following model of an economy:
C = 100 + 0.75Y
I = 150
• Assume that the investment increase to 175. Calculate new
equilibrium level of output by using multiplier approach.
Solution:
 MULTIPLIER
Consider the following model of an economy:
C = 100 + 0.75Y
I = 150
• Assume that the investment increase to 175. Calculate new
equilibrium level of output by using multiplier approach.
Solution:
MULTIPLIER

Aggregate
Expenditure (AE)

Aggregate
Output (Y)