1. How are consumption and saving related?
Households do three things with their income: spend it, save it, and pay taxes on it. Since households have no choice about paying taxes, economists usually look at after-tax, or disposable, income. Consumption and saving are the two components of disposable income. So if we know that disposable income is $1,000 and saving is $200, then we know that consumption must be $800.
2. What are the determinants of consumption?
The determinants of consumption are disposable income, wealth, expectations, demographics, and taxation. Consumption is a positive function of income, wealth, positive expectations about the economy, and population. If any of these determinants increase, consumption increases. Consumption is negatively related to negative expectations about the economy and taxes. If either of these factors increases, consumption decreases.
3. What are the determinants of investment?
The determinants of investment are the interest date, profit expectations, technological change, the cost of capital goods, and the rate at which capacity is utilized. Investment is a positive function of expected profit, technological change that reduces costs, and the rate at which capacity is utilized. If any of these factors increase, investment will increase. Investment is a negative function of interest rates and the cost of capital goods. If either of these determinants increase, investment will decrease. Because these determinants of investment are so variable over the business cycle, investment is the most volatile component of aggregate spending.
4. What are the determinants of government spending?
Government spending is assumed to be autonomous of income. The government authorities set government spending according to political and other considerations at whatever level they choose.
5. What are the determinants of net exports?
Net exports are exports minus imports. The determinants of net exports are foreign and domestic income, tastes, trade restrictions, and exchange rates. Net exports are a positive function of foreign income, tastes that favor exports, favorable changes in government restrictions on trade, and depreciation of the domestic currency. Net exports are negatively related to domestic income, tastes that favor imports, unfavorable changes in government restrictions on trade, and appreciation of the domestic currency.
6. What is the aggregate expenditures function?
The aggregate expenditures function is the sum of the spending components in the economy: consumption plus investment plus government spending plus net exports:
AE = C + I + G + X
