In the aggregate expenditure (AE) model, the economy is driven to its equilibrium by changes in
A) government expenditures on goods and services that are the result of changes in real GDP.
B) induced expenditures that are the result of changes in real GDP.
C) investment that are the result of changes in real GDP.
D) autonomous expenditures that are the result of changes in real GDP.
E) net taxes that are the result of changes in real GDP.
The correct answer and explanation is :
The correct answer is:
B) induced expenditures that are the result of changes in real GDP.
Explanation:
In the aggregate expenditure (AE) model, equilibrium occurs when the total spending (aggregate expenditure) in the economy equals the total output or income (real GDP). The model is driven by changes in different types of expenditures, which can be either autonomous (independent of GDP) or induced (dependent on GDP).
Induced expenditures are the type of expenditures that are directly influenced by the level of real GDP. These are typically consumption and investment, which change as income (GDP) changes. When GDP increases, people generally have more income, leading to higher consumption levels. This is because people tend to spend a portion of their additional income, which leads to induced increases in consumption. Similarly, as GDP rises and business confidence improves, firms are more likely to invest in new projects, which also leads to an increase in induced investment spending.
For example, when the economy grows, consumers and businesses spend more, creating a cycle of rising GDP and expenditure. This spending generates further income for others in the economy, which leads to more spending, and so on. This process continues until the economy reaches its equilibrium, where the level of aggregate expenditure equals the level of output (GDP).
On the other hand, autonomous expenditures (such as government spending, investment spending independent of GDP, or exports) are not directly affected by changes in real GDP. While they can influence the economy, they are not driven by changes in GDP itself.
Thus, in the context of the AE model, it is primarily the induced expenditures that adjust in response to changes in real GDP, driving the economy toward equilibrium. When induced expenditures rise or fall with changes in GDP, the economy can either move toward or away from its equilibrium output level.