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What Is the Relationship between Aggregate Expenditure and Aggregate Demand?

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  • Written By: Geisha A. Legazpi
  • Edited By: Shereen Skola
  • Last Modified Date: 02 September 2016
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Aggregate expenditure and aggregate demand are macroeconomic concepts that estimate two variants of the same value: national income. In the sub-specialty deemed national income accounting, the market value of all products and services is summed to estimate gross national income, the aggregate wealth produced by the country. Both aggregate expenditure and aggregate demand take consumption, investment, government outlays, and net factor income from abroad as the basic components of economic demand. When the economy is in equilibrium, spending levels on consumption, investment, government outlays, and net factor income from abroad equate to total effective demand and, therefore, the value of all goods and services supplied by the economy.

Imperfect quantitative models though they are, aggregate expenditure and aggregate demand are vital for government policymakers and business planners. Decision-makers need to act not so much on the estimated worth of the economy, but on the direction it is taking. Four years after the recession that commenced in mid-2007, for instance, policymakers on both sides of the Atlantic were worried about GDP that seemed to be weakening in the spring and summer of 2011. It appeared that the economies of the leading industrialized nations were about to slide into another recession before their populations had even experienced a return to robust economic growth.

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The aggregate demand function is, with the exception of government spending, responsive to the general price level or inflation. Government outlays are the exception to the rule because fiscal budgets usually rise irrespective of what goods and services cost. Budgets are typically quite heavily influenced by political and social goals. On the other hand, consumers, investors, and those engaged in foreign trade are able to buy less when inflation rises. Hence, the aggregate demand model is the classic demand-price downward sloping curve.

Other things equal, the demand line moves downward in response to unit price. When the general price level rises, in addition, the aggregate demand curve moves leftward. Inflation reduces the volume of goods and services transacted. Much the same thing happens to aggregate expenditure because its components are nearly similar. The key difference is that the aggregate expenditure side of national income accounting breaks out planned and unplanned investment.

Where aggregate demand is price-sensitive, aggregate expenditure responds to present and expected incomes. Aggregate expenditure and aggregate demand therefore differ in that aggregate expenditure conforms to the classic, upward-sloping income-expenditures model. Somewhere on the trend line, aggregate expenditure intersects with real GDP at the equilibrium point among rising consumer expectations, stabilized net export income, and manufacturer inventories adjusted to purchasing rates. Knowing where incomes are trending, the aggregate expenditure model can therefore be employed to predict the direction GDP is moving in the coming quarter or year.

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