Consumption and Investment Function
Aggregate Demand and its Components
Objective
After going through this lesson, you shall be able to understand the following concepts.
- Aggregate demand and its components
- Concept of Ex-Ante and Ex-Post
Aggregate demand implies the total demand of final goods and services by all the people in an economy. It expresses the total demand in terms of money. In this manner, it can be defined as the actual aggregate expenditure incurred by all the people in an economy on different goods and services.
Components of Aggregate Demand
As in microeconomics, demand implies an individual consumer’s demand, but in macroeconomics, aggregate demand implies sum total of demand by different sectors. These sectors are households, firms, government and foreign sector. So, as per the definition, aggregate demand consists of the following components.
- Demand by Households- Private Consumption Expenditure (C)
- Demand by Firms-Private investment expenditure (I)
- Demand by Government- Government Expenditure (G)
- Demand by Foreign Sector- Net Exports (X – M)
AD = C + I + G + (X – M)
Private Consumption Expenditure (C)
Private consumption expenditure refers to the total expenditure incurred by all the households in an economy on different types of final goods and services in order to satisfy their wants. Consumption depends on the level of the disposable income. It shares a positive relationship with the level of disposable income, that is, lower the level of disposable income lower will be the purchasing power and hence lower will be the consumption expenditure. The functional form that depicts the relationship between consumption expenditure and the level of disposable income is known as consumption function. There are two types of consumption expenditure- Autonomous Consumption Expenditure and Induced Consumption Expenditure. Autonomous Consumption Expenditure is independent of the level of disposable income, whereas, Induced Consumption Expenditure depends on the level of disposable income.
Private Investment Expenditure (I)
Private investment expenditure refers to the planned (ex-ante) total expenditure incurred by all the private investors on creation of capital goods such as, expenditure incurred on new machinery, tools, buildings, raw materials, etc. This expenditure by all the private investors on the capital goods add to the total stock of capital thereby increases the overall productive capacity of the economy. Investment depends on the rate of interest and level of income. Broadly, investment can be categorised in two types- Autonomous Investment Expenditure and Induced Investment Expenditure. The Autonomous Investment Expenditure is independent of the rate of interest and level of income, whereas, the Induced Investment Expenditure depends on the rate of interest and level of income.
Government Expenditure (G)
Government expenditure refers to the total planned expenditure incurred by the government on consumption and investment purposes to enhance the welfare of the society and to achieve higher economic growth rates. The Government Expenditure comprises of both investment expenditure as well as consumption expenditure. The Government Expenditure on investment purposes includes expenditure on different elements that enable the economy to grow faster and also enhance the welfare of the society. For example, expenditure on infrastructure, expenditure on education and health sector, etc. On the other hand, Government Expenditure on consumption purposes includes expenditure on consumption of final goods and services produced by the firms.
Net Exports (X – M)
Net exports refers to the difference between the demand for domestically produced goods and services by the rest of the world (exports) and the demand for goods and services produced abroad by the residents of a country. In other words, it is the difference between the exports and imports. That is,
Net exports = Total Exports – Total Imports
Net exports depend on various factors such as, trade policy, exchange rate system, balance of payment position, etc.
Concept of Ex-Ante and Ex-Post
The various terms and variables used in the concept of aggregate demand and national income accounting can be used in a dual sense i.e. in terms of their actual values and in terms of their planned values.
When the actual values of the variable are taken into account, then it is called the Ex-Post measure of these items.
As against this, when the planned or the desired values of the variables are taken into account, then it is called the Ex-Ante measure of these items. For example, if a student at the beginning of the academic year of Class-XII aims at scoring 90 marks in economics, but if he/she scores 95 in the final exam, then 90 is regarded as ex-ante measure and 95 is regarded as ex-post measure.
Economic Example of Ex-Ante and Ex-Post
Private consumption may be expressed in terms of what people actually consume during a given period (ex-post consumption expenditure) or it can also be expressed in terms of what they had planned to consume in the same period (ex-ante consumption expenditure).
Similarly, private investment can be expressed in terms of what the private investors actually added to the stock of capital in a given period (ex-post investment) or in terms of what they had planned to add to the stock of capital in the same period (ex-ante investment).
Note: In the theoretical model of the economy (i.e. for theoretical purposes), the ex-ante measures of the variables are used.Objective
After going through this lesson, you shall be able to understand the following concepts.
- Aggregate demand and its components
- Concept of Ex-Ante and Ex-Post
Aggregate demand implies the total demand of final goods and services by all the people in an economy. It expresses the total demand in terms of money. In this manner, it can be defined as the actual aggregate expenditure incurred by all the people in an economy on different goods and services.
Components of Aggregate Demand
As in microeconomics, demand implies an individual consumer’s demand, but in macroeconomics, aggregate demand implies sum total of demand by different sectors. These sectors are households, firms, government and foreign sector. So, as per the definition, aggregate demand consists of the following components.
- Demand by Households- Private Consumption Expenditure (C)
- Demand by Firms-Private investment expenditure (I)
- Demand by Government- Government Expenditure (G)
- Demand by Foreign Sector- Net Exports (X – M)
AD = C + I + G + (X – M)
Private Consumption Expenditure (C)
Private consumption expenditure refers to the total expenditure incurred by all the households in an economy on different types of final goods and services in order to satisfy their wants. Consumption depends on the level of the disposable income. It shares a positive relationship with the level of disposable income, that is, lower the level of disposable income lower will be the purchasing power and hence lower will be the consumption expenditure. The functional form that depicts the relationship between consumption expenditure and the level of disposable income is known as consumption function. There are two types of consumption expenditure- Autonomous Consumption Expenditure and Induced Consumption Expenditure. Autonomous Consumption Expenditure is independent of the level of disposable income, whereas, Induced Consumption Expenditure depends on the level of disposable income.
Private Investment Expenditure (I)
Private investment expenditure refers to the planned (ex-ante) total expenditure incurred by all the private investors on creation of capital goods such as, expenditure incurred on new machinery, tools, buildings, raw materials, etc. This expenditure by all the private investors on the capital goods add to the total stock of capital thereby increases the overall productive capacity of the economy. Investment depends on the rate of interest and level of income. Broadly, investment can be categorised in two types- Autonomous Investment Expenditure and Induced Investment Expenditure. The Autonomous Investment Expenditure is independent of the rate of interest and level of income, whereas, the Induced Investment Expenditure depends on the rate of interest and level of income.
Government Expenditure (G)
Government expenditure refers to the total planned expenditure incurred by the government on consumption and investment purposes to enhance the welfare of the society and to achieve higher economic growth rates. The Government Expenditure comprises of both investment expenditure as well as consumption expenditure. The Government Expenditure on investment purposes includes expenditure on different elements that enable the economy to grow faster and also enhance the welfare of the society. For example, expenditure on infrastructure, expenditure on education and health sector, etc. On the other hand, Government Expenditure on consumption purposes includes expenditure on consumption of final goods and services produced by the firms.
Net Exports (X – M)
Net exports refers to the difference between the demand for domestically produced goods and services by the rest of the world (exports) and the demand for goods and services produced abroad by the residents of a country. In other words…
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