Aggregate Expenditures, Aggregate Supply
and Aggregate Demand Models
An inverse relationship exists between aggregate expenditures and unemployment. The more people spend, the fewer
people are unemployed; the less people spend, the more people are unemployed. In our economy, people tend to spend
more than they save. This generalization is what helps our economy grow. When people spend money, they create jobs;
when people “hold” money, the economy contracts. Although we may be able to generalize and say that people spend
more money than they save, we need to analyze just how much people spend and save relative to their incomes.
The percentage of total income that consumers spend is called average propensity to consume (APC). The percentage
of total income that consumers save is called average propensity to save (APS). The formulas for determining APC
and APS are as follows:
APC Income
Consumption
= APS Income
Saving
=When individuals earn more money, this change in income typically leads to a change in consumption and savings.
The ratio or percentage of any change in income consumed is called the marginal propensity to consume (MPC). The
ratio or change in income saved is called the marginal propensity to save (MPS). The formulas for determining MPC
and MPS are as follows:
MPC Change in income
Change in consumption
= MPS Change in income
Change in savings
=Since Gross Domestic Product (GDP) is an overall measurement of an economy’s performance, we must now look at
what forces create GDP. Aggregate supply and aggregate demand determine GDP; in this chapter we examine how GDP
is determined in both a closed economy (without imports and exports) and an open economy (with imports and exports).
In a private(or closed) economy, equilibrium GDP changes in response to adjustments in either the investment sched-
ule or the consumption schedule:
■ Investment schedule:A curve or schedule that illustrates how much firms plan on investing at various values of
real GDP.
■ Consumption schedule:A curve or schedule that illustrates how much households plan on investing at various
values of real GDP.With an open economy GDP is slightly changed with the involvement of international trade. The example of a closed
economy is used to simplify the concepts—closed economies allow us to see GDP working with the incomes and
expenditures of domestic consumers and firms.
Consumers, suppliers, and the government are the main pieces in the aggregate puzzle (the whole economy). This chap-
ter reviews how decisions to spend, save, or invest affect the real GDP of our economy. These decisions are the forces
behind aggregate supply and aggregate demand, which in turn create equilibrium GDP.
Graphical Analysis of a Consumption Schedule
Figure 4-1 shows a graph that illustrates consumption and savings. The 45-degree line represents equality between the
vertical axis and the horizontal axis. The value of what is being measured on the horizontal axis (GDP) is equal to
whatever is being measured on the vertical axis (aggregate expenditures).