Moving along the aggregate expenditure (AE) curve, when real GDP increases, aggregate planned expenditures increase
A) by more than real GDP.
B) by the same amount as does real GDP.
C) by less than real GDP.
D) proportionately with real GDP.
E) by the same percentage as does real GDP.
The correct answer and explanation is :
The correct answer is C) by less than real GDP.
Explanation:
In macroeconomics, the aggregate expenditure (AE) curve represents the total planned spending in an economy at different levels of real GDP. This curve is typically upward sloping, reflecting the relationship between income/output (real GDP) and total planned expenditures. When real GDP increases, the aggregate planned expenditures increase, but they do so by less than the increase in real GDP. This is primarily due to the marginal propensity to consume (MPC) and the marginal propensity to save (MPS).
The marginal propensity to consume refers to the fraction of additional income that households are likely to spend on consumption, while the marginal propensity to save is the fraction of additional income that is saved. Typically, the MPC is less than 1, meaning that people do not spend all of their additional income. Instead, some of it is saved. As a result, when real GDP increases, the increase in aggregate expenditures is smaller than the increase in GDP.
This dynamic is often captured through the multiplier effect. The multiplier describes how an initial change in expenditure (such as an increase in government spending or investment) leads to a larger total increase in real GDP. However, even with this effect, the relationship between real GDP and AE is not one-to-one. For instance, an increase in GDP may lead to a corresponding increase in consumption, but due to the marginal propensity to consume being less than 1, the increase in AE will be smaller than the increase in GDP.
Thus, moving along the AE curve, when real GDP increases, the increase in planned expenditures is less than the increase in real GDP, which leads to the correct answer: C) by less than real GDP.