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What are the Different Expenditure Models?

John Lister
John Lister

Expenditure models are an attempt to use a mathematical equation to map and predict changes in the overall behavior of consumers in an economy. The models are used in macroeconomics, which measures activity across an entire economy, rather than microeconomics, which looks at a specific market, for example in one type of product or service. Despite the name, expenditure models can be used to examine production output in an economy; this is simply because the value of goods produced and sold is inherently the same as the value of total spending.

The most basic of the various expenditure models is aggregate expenditure, which is one way of measuring an economy's output, better known as gross domestic product. This model states that GDP is made up of the totals of consumer spending, investment spending by businesses, government spending, and net exports. In this context, net exports is the total value of goods exported from a country, minus the total value of goods imported.

John Maynard Keynes.
John Maynard Keynes.

Aggregate expenditure is used in contrast to the income approach, which states that GDP is the total of employee wages, business profits, rents and interest. The logic is that all the money people and businesses spend on the goods produced in a country end up as some form of income. There is an argument that this model is less accurate, as it does not include depreciation or indirect business taxes such as sales taxes. This means a GDP figure produced by an income model will usually be lower than one produced via aggregate expenditure.

The figure produced by aggregate expenditure forms the basis of some more advanced expenditure models. One is the aggregate demand-aggregate supply model. This uses the components of aggregate expenditure, along with more specific measures such as overall price levels, to produce two curves on a graph, representing the overall levels of demand and supply in an economy.

Somebody using the aggregate demand-aggregate supply model would move one of the curves in response to a specific change in the economy, such as an overall tax increase, or an overall decrease in exports. The theory of the model is that the movement of one curve changes the intersection point between the two curves; this in turn shows the effect the change would have both on output and price levels. This makes the model particularly popular with a wide range of economists, as it can be used both for Keynesian economics, which emphasizes government activity via spending and taxation, and monetarist economics, which emphasizes control of the money supply via measures such as printing more cash or changing exchange rates.

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    • John Maynard Keynes.
      John Maynard Keynes.