3.15: Planned Aggregate Expenditure II

Planned aggregate expenditure helps us see how much spending is expected at different levels of output in the economy. It combines what households plan to consume and what firms plan to invest. This relationship is useful for understanding how the economy moves toward balance over time.

Suppose the total output or income in the economy is $400. At this level, households might plan to spend some of it, but not all. Let’s say the spending behavior follows a pattern where people always spend $80 no matter what, and for every dollar they earn, they spend 70 cents more. This shows that part of spending doesn't rely on income, while the rest changes with income levels. This relationship can be written as: C = 80 + 0.7Y, where Y is total output.

Now add planned investment. Imagine businesses are planning to invest $40, and this amount stays fixed regardless of how much the economy produces. When we combine this with consumption, we get the total planned aggregate expenditure: PAE = 80 + 0.7Y + 40 This simplifies to: PAE = 120 + 0.7Y

This formula helps us see what spending looks like at any income level. If income is $400, then: PAE = 120 + 0.7 × 400 = 120 + 280 = 400 Here, planned spending matches output—this is equilibrium. But if income rises to $500, planned spending becomes 120 + 350 = $470. Now output is higher than planned spending, and firms may notice extra inventory piling up, which might cause them to reduce production.

By comparing output and planned spending, we can understand whether the economy is balanced or needs adjustment.

Let’s examine the planned aggregate expenditure schedule in a simplified closed economy with only consumption and planned investment.

In this example, consumption is given by C=100+0.75 with autonomous consumption of 100, a marginal propensity to consume of 0.75, which is the fraction of each extra dollar of income that is spent, and fixed planned investment of twenty-five dollars.

Let’s examine the aggregate expenditure schedule, when aggregate output is zero, spending still begins at one hundred twenty-five dollars—this is called autonomous expenditure. It reflects the minimum level of spending that occurs even without output.

Further, at four hundred dollars of aggregate output, AE is four hundred twenty-five. Planned spending exceeds actual output, causing an unplanned inventory decrease of twenty-five dollars.

At five hundred dollars of aggregate output, equilibrium occurs with no change in the inventory.

At six hundred dollars, AE is five seventy-five. Actual output exceeds planned spending, leading to an inventory buildup of twenty-five dollars.

The schedule shows how spending varies with aggregate output and reveals equilibrium.