Description                                  
In this presentation, the narrator examines the expenditure model, another method of calculating GDP. The narrator also looks at the relationship between consumption and income in terms of the consumption function. Investment, as another component of GDP calculation, is also discussed.

Narrator: 
The gross domestic product of a country can be measured by adding up the value of all final goods and services it produces. This is the basis of the expenditure model. 

Narrator: 
GDP equals aggregate expenditure... the sum of consumption, investment, government purchases and net exports. Household consumption is a key component of the gross domestic product. To simply illustrate how consumption is related to income, we can assume for now that there are no taxes, or imports, or exports. The only choices that households can make with their income is to consume it or save it. The relationship between consumption and income is called the consumption function. 

Narrator: 
The consumption function passes through the vertical axis at point 'a'. The value of 'a' is referred to as autonomous consumption. It represents aggregate household spending at a zero level of income. It is called autonomous consumption because it is independent of changes in income. 

Narrator: 
The consumption function shows that an increase in income results in an increase in aggregate consumer spending. The change in consumption divided by the change in income is known as the marginal propensity to consume. It is represented by B, the slope of the consumption function. In other words, the marginal propensity to consume indicates the proportion of a change in income that is consumed. By definition, this value must be between zero and one. The consumption function can be described by a simple linear equation where aggregate consumption = autonomous consumption + the marginal propensity to consume X income. 

Narrator: 
In this example, a $1 trillion-dollar increase in income results in a $750 billion-dollar increase in consumption. The marginal propensity to consume is therefore 0.75. Note that a steeper curve represents a higher marginal propensity to consume while a flatter curve represents a lower marginal propensity to consume. A 45° line represents the points where consumption equals income. When the consumption curve is below the 45° line then consumption is lower than income and households have positive aggregate savings. When the consumption curve is above the 45° line, consumption is greater than income and households have negative aggregate savings. In other words, they are dissaving. 

Narrator: 
And at the point where the consumption function crosses the 45° line, consumption equals income and savings is zero, we call the assumption that households can only consume or save their income. This leads to the notion of the marginal propensity to save, which is the fraction of a change in income that is saved. In other words, the fraction not consumed. With no outlet for income other than saving and consuming, the marginal propensity to consume and the marginal propensity to save must add up to one. By plotting the savings function directly beneath the consumption function, we see how consumption and savings are related. If the marginal propensity to consume is 0.75, the marginal propensity to save must be 0.25. 

Narrator: 
Investment is another component of gross domestic product calculation. In macroeconomics, investment refers to spending by firms on new plant equipment and net inventory changes. Firms can plan to invest in new physical capital and expand their inventories but this planning does not guarantee that it will actually happen. So, there is a distinction between planned and actual investment. 

Narrator: 
At this time, we consider only planned investment and assume that it is fixed. Although real world investment depends on a number of factors such as interest rate and income, it is assumed here for simplicity, to be autonomous. G refers to government purchase of goods and services such as defense, highways, education, prisons and law enforcement. Government purchasing decisions are typically motivated by politics rather than economics. For the purposes of this model, government purchases are assumed to be autonomous... in other words, independent of aggregate income. 

Narrator: 
National economies have become increasingly interdependent. International trade has grown dramatically in recent years. Imports are linked to income levels and both exports and imports are dependent on factors like exchange rates; however, for the sake of simplicity, assume for now that net exports are autonomous. For the U.S., net exports have been negative almost every year in the last thirty years. 

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