Expenditure models predict changes in consumer behavior in an economy, with aggregate spending being the most basic model used to measure an economy’s output. The income approach is an alternative model, but it is argued to be less accurate. Aggregate spending is used in advanced models, such as the aggregate demand model of aggregate supply, which can be used for both Keynesian and monetarist economics.
Expenditure models are an attempt to use a mathematical equation to map and predict changes in general consumer behavior in an economy. The models are used in macroeconomics, which measures activity in an entire economy, rather than microeconomics, which analyzes a specific market, for example, in a type of product or service. Despite the name, spending models can be used to examine output in an economy; This is simply because the value of goods produced and sold is inherently equal to the value of total spending.
The most basic of the various spending models is aggregate spending, which is a way of measuring an economy’s output, better known as gross domestic product. This model states that GDP is made up of total consumer spending, business investment spending, government spending, and net exports. In this context, net exports are the total value of goods exported from a country minus the total value of imported goods.
Aggregate spending is used in contrast to the income approach, which states that GDP is the total of employee salaries, business profits, rents, and interest. The logic is that all the money that people and companies spend on the goods produced in a country ends up as a form of income. There is an argument that this model is less accurate, since it does not include depreciation or indirect business taxes, such as sales taxes. This means that a GDP figure produced by a revenue model will generally be less than one produced through aggregate spending.
The figure produced by aggregate spending forms the basis of some more advanced spending models. One is the aggregate demand model of aggregate supply. It uses the components of aggregate spending, along with more specific measures, such as general price levels, to produce two curves on a graph, representing the general levels of demand and supply in an economy.
Someone using the aggregate demand model of aggregate supply would move one of the curves in response to a specific change in the economy, such as a general increase in taxes or a general decrease in exports. The theory of the model is that movement of a curve changes the point of intersection between the two curves; This in turn shows the effect that the change would have on both output and price levels. This makes the model particularly popular with a wide range of economists, as it can be used for both Keynesian economics, which emphasizes government activity through spending and taxation, and monetarist economics, which emphasizes control of the money supply through measures such as printing more cash or changing exchange rates.
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