Question

How do consumption and investment spending affect aggregate expenditures and output over the business cycle?

Which is more responsible for volatility - consumption or investment spending or both? Explain your choice.

How do government actions affect consumption and investment?

Answer 1

1. Aggregate expenditures is comprised of private consumption (C), Private Investment (I), Government (G) and Net export (NX). The overall output in the economy must equal the aggregate expenditure at a given point in time. Thus, if consumption and investment spending reduce then it will affect the overall spending in the economy. Moreover, there is a multiplier effect of any change in autonomous spending that will affect the overall output level in the economy.

2. Investment spending is more responsible for volatility in output. When overall sentiment in the economy is weak, then the firms may cut down on their investment spending. Consumption spending may not face a huge hit since households will continue to spending irrespective of the expected output level in the economy.

3. Government actions affect consumption and investments by means of fiscal policy. The government may pursue an expansionary fiscal policy by cutting down taxes, giving unemployment benefits or transfers to those who are unemployed in the country. That may increase the consumption. It can increase investment by giving tax credits or investment subsidies to firms which can then increase the investment.