The aggregate expenditure function is obtained by summing up each of the planned expenditure functions described above. Aggregate expenditures (AE) are composed of consumption (C), investment,(I), government expenditure (G) and net export (NX).  

One of the basic indicators used in assessing the performance of an economy and the general economic conditions in a country is the country’s total production, more correctly the rate of change of this quantity according to the previous period. Total production is the total of all goods and services produced in an economy for a given period of time. The rise in the capacity of economy to produce goods and services is called as economic growth.

If all production phases of a product from manufacturing to finished product are included into national income accounts, the final total of GDP will be higher than the actual one. Therefore, it is required to find and sum up the net value added to GDP as a result of production of each businesses. This value is called the value added and calculated by subtracting the value of intermediate goods from the value of production of related business.

The negative difference between the actual GDP and the potential GDP in an economy is the negative GDP gap or deflationary gap, which is the loss of production due to underemployment in that country.

The second assumption is the flexibility of wages, interest rates, and prices.

When the planned expenditure is greater than the value of current production, production will increase to meet the demand for goods and services. The fact that aggregate expenditures are greater than GDP means that more than the amount of goods and services currently produced in the economy is planned to purchase. To meet this demand, firms sell goods and services that they have produced in the past and are waiting in stock. In other words, if the planned expenditures are greater than GDP, firms’ stocks decrease. The change in stocks compensates the planned expenditure exceeding the GDP. Thus, actual expenditures, including unplanned changes in stocks, are equalized to GDP. Decreasing stocks will cause firms to increase their production.

Total expenditure amount for final goods and services are usually divided into four groups. First of them is consumption expenditures and consist of expenditures paid for goods and services which may directly meet the daily needs. Second type of expenditures is investment expenditures and consists of expenditures of businesses and government for new equipment, tools and buildings, increase in stocks and expenditures of individuals for building new houses. Government expenditures are the total spending of government to buy goods and services. Net export is the difference between export income and import expenditure.

The main factor determining the consumption expenditures to be made in a given period is the income level. Along with the increase in income, the desire and purchasing power of households to make consumption expenditures also increases.

An increase in taxes decreases the total spending and, therefore, shifts aggregate expenditure (AE) function downward. While other things are being equal, the downward shift in AE function lowers the income (Y).

The consumption function is the most important component of the modern macroeconomic theory. Consumption function is widely used by economists to predict an economy’s progress and the behavior of economic agents.

Transfer expenditures: Transfer expenditures are the unreturned (outright) expenditures and have no direct effect on the national income. They only cause purchasing power to shift among private individual or social stratums. These shifts are performed unreturned, and there are no changes on the flow of goods and services within national economy. In other words, the transfer expenditures made by public sector do not refer to consumption of real sources. These expenditures transfer purchasing power from public sector to other sectors. Increases in the total expenditure volume in economy are not caused by transfer expenditures made by the state, but the expenditures made by social stratums benefiting from these state expenditures. It simply means that if public expenditures do not create the flow of goods and services in economy, they are called as transfer expenditures.

Average propensity to save is the ratio of savings to income.

The main factor determining the consumption expenditures to be made in a given period is the income level.

An increase in the expenditures in an economy causes the income level to rise.

While calculating GDP, we obtain a total of 277 kuruş for production value by summing up the values of wheat, flour and dough to produce the bread and the value of the bread itself.

Net export is the difference between the export and import of the home country.

If the government budget balance is achieved, then G = T. On the other hand, if the trade balance is achieved, then IM = EX. If you remember the equilibrium condition stating that leakages must equal injections as:

S + T + IM = I + G + EX

Considering G=T and IM=EX, the above equilibrium condition reduces to

S = I.

Supply side economists are in doubt about the government’s efficiency on softening business cycle fluctuations via monetary and fiscal policies. According to these economists, government should concentrate on policies which increase production and accelerate economic growth.

Since savings and imports are the leakages from income-expenditure flow the total of these marginal propensities represent the total leakage. Therefore, the rest of this total shows the consumption expenditures made for domestically produced goods and services if we subtract it from 1 (recall that MPC + MPS =1).

In order to achieve equilibrium in the economy, the leakages from income – expenditure flow must be balanced by additions (i.e., injections) to this flow. There are three types of injections for income-expenditure model developed so far: investments, government expenditures, and exports for an open economy.