Aggregate expenditure is an economic measure that is the sum of four components: consumption, investment, net exports and government spending. Models that involve aggregate expenditure are fiscal models, which means they predict the effects that spending has on the economy. Governments use these models to try to understand the consequences their policies have in the economy. They supplement the main summation equation with other equations that show the relationship between the components of aggregate expenditure. They introduce other variables, like the marginal propensity to save and the reserve requirement, to explain the behavior that translates economic conditions into these components.
Consumption refers to all of the money people spend on consumption goods. This includes durable and non-durable goods. The complement to consumption is savings, which is the amount of money people choose to put away in savings accounts. It also includes the money that is spent on personal investment in financial products. The percentage of disposable income that people spend on consumption, expressed as a decimal, is called the marginal propensity to consume, and the percentage that people save is called the marginal propensity to save — these numbers must add up to one.
Many people think of financial investing when they hear the word "investment," but in aggregate expenditure models, investment refers to capital investment. This is the money spent to build factories, buy new equipment and construct new houses. Investment depends on the level of the interest rate because that rate determines how profitable investment is. People can get the interest rate by putting money into savings, including financial products, so the interest rate provides a minimum threshold of profitability. People will only invest in projects if they offer higher returns than the interest rate, so when the interest rate is lower, more projects pass this test and investment is higher.
Net exports are the total exports of a country minus the total imports. This is reported on the current account statement. If the country imports more products than it exports, this number will be negative.
Government spending is the tool that governments use to enact fiscal policy. Using aggregate expenditure models, policymakers study the reverberations of government spending throughout the economy. Models are needed because spending adds a higher amount to aggregate expenditure than the amount of the actual spending: the addition is equal to the amount of spending multiplied by a factor called the money multiplier.
The money multiplier measures how far each government dollar goes. Much of government spending goes toward wages. Increased wages translate into increased consumption and savings. The saved money is often in banks, which are allowed to loan out more money than they take in according to their reserve requirements. The money they loan out goes toward investment and more wages, and at every step aggregate expenditure grows.