To Better Understand Economy - Aggregate Demand And Consumption Expenditure

Macroeconomics deals with the economy as a whole, but macroeconomic analysis helps to understand what factors will influence general economic trends that will also affect the average citizen. To better understand, you need to know some basic concepts. In this article, we will look at Aggregate demand and household consumption expenditure

Aggregate demand

Aggregate demand is a key category in macroeconomics. Aggregate demand or total demand, refers to the sum (amount) that economy entities plan to spend on goods and services at various levels of income (including at given prices) in a given period. Aggregate demand consists of all consumer goods, capital goods (factories and equipment), exports, imports, and government spending.

The total demand consists of:

• household consumption expenditure
• capital expenditures,
• government spending
• net exports.

Formula:

Aggregate Demand=C+I+G+Nx

Thus, in the economy we are dealing with three entities: households, entrepreneurs and the government, which incur expenses marked in the literature with the symbols C - Consumption, I - Investition, G from the word Government. A separate category is net export (NX - Net eXport), which is the difference between expenses incurred by domestic and foreign entities - NX = X - Im.

Changes in the above factors shaping the total demand are affected by changes of a political nature: changes in taxes and money supply, government purchases, and of an economic nature: changes in the prices of goods and services, income of the population, profits of enterprises, consumer expectations and expectations of enterprises.

Economic conditions can impact aggregate demand whether those conditions originated domestically or internationally. The crises had a severe impact on banks and financial institutions. As a result, they reported widespread financial losses leading to a contraction in lending, as shown in the graph on the left below. With less lending in the economy, business spending and investment declined. For example: The financial crisis of 2007-08, sparked by massive amounts of mortgage loan defaults.

Consumption expenditure

Consumption expenditure is household spending on:

• durable goods, such as washing machines, refrigerators, cars, etc.,
• non-durable goods, e.g. food, clothing, cleaning products, etc.,
• services, such as cosmetic services or medical care.

It is important that they do not include expenses for the purchase of real estate by the household.

Consumption expenditure is one of the components of the Gross Domestic Product. Along with capital expenditures and government spending, they are an important part of global demand. It is according to the absolute income hypothesis that the amount of consumption expenditure depends on the level of national income per capita. According to the given hypothesis, total consumer demand increases with the increase in national income. The described correlation between consumption and national income takes place only when the state does not exist (no taxes on the population and no government transfers to households). However, to a large extent, consumption expenditure depends on the size of disposable income of households.

Consumer spending is the largest component of PKP (60-70% of GDP) in highly developed countries. Households, realizing their own utility function, plan to purchase various goods and services. Spending on durable goods is clearly higher than spending on non-durable goods. The largest are those for goods and services. This is mainly due to the fact that along with the increase in household income, there is now a clear decrease in the percentage share of expenditure on food and other basic goods. It is also worth noting that the savings in this case grow relatively quickly.

The consumption curve

In the case of consumer spending, household income plays a very important role, as it has a key impact on the level of economic activity. The relationship between this consumption and the level of disposable income is illustrated by the consumption curve.

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The consumption function is an increasing linear function. This means that an increase in the level of disposable income corresponds to a higher level of consumption expenditure. The slope of the straight line is equal to the marginal propensity to consume. The 45º line on the graph informs whether consumption expenditure is equal to, greater than or less than income. The intersection of the function with the line at an angle of 45º is the "equalization point" where consumption expenditure is exactly equal to disposable income. The net savings in this case are zero. If the function lies below the 45º line, household expenditures are lower than incomes, and above - higher.

Source: Sloman J.(2001). Podstawy ekonomii, investopedia.com