Effect of Autonomous Change in Aggregate Demand on Income and Output

The components of an economy’s aggregate spending that are unaffected by the actual amount of income in that same economy are referred to as autonomous expenditures. This type of expenditure, whether done by the government or by people, is considered automatic and mandatory. A change in autonomous expenditures creates a change in national income and gross domestic product via the multiplier. Autonomous changes are depicted by movements in the aggregate expenditures line in Keynesian economics and the Keynesian cross diagram. Changes in income and production are the result of autonomous changes, which then ‘induce’ changes in aggregate expenditures, notably consumption expenditures, which are the result of induced changes. Understanding business cycle swings requires a two-step process in which autonomous changes produce induced changes.

Consumption that is unaffected by money is referred to as autonomous consumption. In other words, spending on such consumption is made regardless of one’s economic level. It comprises food, clothes, and housing consumption, among other things. It is impossible for such a cost to be zero. C is used to represent this portion of consumer spending. Continuing consumer spending is shown by the bar above C. It does not change regardless of the degree of money.

The amount of income at which the economy is in equilibrium is determined by aggregate demand. As a result, if aggregate demand changes, so do the equilibrium level of income. This can happen in any of the following scenarios, or a combination of them:

Change in Consumption

Household income is the most significant determinant of consumption demand and the consumption function describes the relationship between income and consumption. Of course, even if one’s income is nothing, one can still consume. Autonomous consumption refers to a degree of consumption that is unaffected by income. This function’s description is as follows:

C = C + cY

The consumption function is represented by the equation above. Household consumption expenditure is symbolized by C. There are two types of consumption: autonomous and induced consumption (cY).

Autonomous consumption (abbreviated as C) refers to consumption that is independent by money, because of autonomous consumption, consumption occurs even when income is nil. The induced component of consumption, cY represents the dependency of consumption on income. When income increases by Re 1, induced consumption increases by MPC, which stands for marginal propensity to consume. It may be described as a change in consumption rate when income varies.

MPC = ∆C/∆Y= c

Let’s have a look at the potential of MPC. Changes in consumption (∆C) can never surpass changes in income (∆Y) when income changes. The highest possible value for c is 1. Consumers, on the other hand, may opt not to adjust their spending habits even though their income has changed. MPC = 0 in this example. MPC is a number that ranges from 0 to 1 in most cases (inclusive of both values). This indicates that as income rises, customers either do not raise consumption at all (MPC = 0), spend the full increase in income (MPC = 1), or utilize a portion of the gain in money to shift consumption (0< MPC<1).

Consider the country of Imaginea, which has a consumption function of C=100+0.8Y.

This means that even when Imaginea’s residents have no income, they still spend Rs. 100 worth of products. The autonomous consumption of Imaginea is 100. Its MPC is 0.8. This suggests that if income in Imaginea rises by Rs. 100, consumption will rise by Rs. 80.

Change in Investment

We’ve assumed that investment is autonomous. It simply implies that it is independent of income. Other than money, there are a variety of factors that might influence investing. Credit availability is a key factor: simple credit availability drives investment. Another element is interest rate: the interest rate is the cost of investible capital, and corporations prefer to reduce investment when interest rates are higher. With the aid of the following example, let us focus on investment transformation.

Let C= 40+0.8Y and I = 10 be the values. In this scenario, the equilibrium income (as determined by the equation Y to AD) is 250.

Let’s take it to 20 now. The new equilibrium is 300, as can be seen. This growth in revenue is attributable to increased investment, which is a component of autonomous spending in this case.

Note that production and aggregate demand have grown by an amount E1G = E2G in the new equilibrium, which is more than the original increase in autonomous expenditure, I = E1F = E2J.

As a result, an initial increase in autonomous expenditure appears to have a multiplier effect on aggregate demand and production equilibrium levels.

Conclusion

Ex-ante consumption, ex-ante investment, government expenditure, and other factors all contribute to aggregate demand for final products. The marginal propensity to spend is the rate of increase in ex-ante consumption owing to a unit increase in income. To assess the amount of aggregate demand for final goods in the economy, we assume a constant final goods price and a constant rate of interest throughout the short run. At this price, we also assume that the aggregate supply is completely elastic. Aggregate production is exclusively governed by the amount of aggregate demand under such conditions. This is referred to as the “effective demand principle.” Through the multiplier effect, a rise (decrease) in autonomous spending leads the collective output of final products to increase (decrease) by a bigger amount.