Question

What does the slope of the aggregate expenditure line equal? How is the slope of the aggregate expenditure line related to the slope of the consumption function?

Short answer

The slope of the aggregate expenditure line equals the marginal propensity to consume (MPC). It is the same as the slope of the consumption function because the change in income has the same effect on consumption in both cases.

Step-by-step solution

Define the Slope of the Aggregate Expenditure Line

The aggregate expenditure line plots aggregate expenditure for each level of national income or real GDP. The slope of the aggregate expenditure line equals the marginal propensity to consume (MPC), which is the amount of additional consumption that occurs with each additional unit of income.

Define the Slope of the Consumption Function

The consumption function plots total consumption at each level of disposable income. The slope of the consumption function also equals the marginal propensity to consume (MPC).

Connect the Slopes of the Aggregate Expenditure Line and Consumption Function

The slope of the aggregate expenditure line and consumption function are the same because they both equal the marginal propensity to consume (MPC). This commonality arises because a change in income has the same effect on consumption in both cases.

Key concepts

Marginal Propensity to Consume (MPC)

The Marginal Propensity to Consume, often abbreviated as MPC, is a fundamental concept in macroeconomics that reflects how much additional consumption will result from an increase in income. When an individual receives an extra dollar of income, MPC tells us how much of that dollar will be spent on consumption rather than saved. This concept is crucial in understanding consumer behavior and its effects on the overall economy.
Mathematically, MPC is represented as the change in consumption (\( \Delta C \)) divided by the change in income (\( \Delta Y \)): \[ MPC = \frac{\Delta C}{\Delta Y} \]

• A high MPC indicates that consumers are likely to spend most of their additional income.
• A low MPC suggests that consumers will save more of the extra income they earn.

Understanding MPC is critical as it ties directly into how economic changes affect aggregate demand and total economic output. When the MPC is high, increases in national income lead to significant boosts in consumption, which can drive economic growth.

Consumption Function

The consumption function is an economic formula that represents the relationship between total consumption and total disposable income in an economy. This function suggests that consumption increases as income increases, but not necessarily at the same rate.
Typically, the consumption function can be expressed in the form of an equation: \[ C = a + bY_d \] where:

• \( C \) represents the total consumption.
• \( a \) is the autonomous consumption, or the consumption that occurs even when income is zero.
• \( b \) is the marginal propensity to consume (MPC), representing the slope of the consumption function.
• \( Y_d \) is disposable income.

The slope of the consumption function, as defined by the MPC, indicates how much additional consumption occurs with an additional unit of disposable income. This relationship helps economists predict consumer spending behavior and its impact on economic variables.

National Income or Real GDP

National Income and Real GDP are key indicators of an economy's health. They are used to assess the economic performance of a country.
National income is the total amount of money earned within a country, while Real GDP measures the total economic output of a country, adjusted for inflation, thus providing a more accurate reflection of an economy's size and how it's growing over time.

• "National Income" includes wages, rent, interest, profits, and other compensation paid to factors of production.
• Real GDP helps to measure the value of economic output using constant prices, eliminating the effects of price level changes.
Understanding these concepts helps economists make better decisions about fiscal and monetary policies. By monitoring Real GDP and National Income, it becomes easier to determine whether an economy is expanding or contracting, which can then influence government policies aimed at achieving sustainable economic growth.