Autonomous Expenditure: Formula, Components, Determinants

What’s it: Autonomous expenditure is unaffected by income level. In other words, they will still exist even if the income equals zero. Spending on items such as food and drink is an example. They are essential for meeting our basic needs. So, we keep buying them because our lives are at stake without them – we die if we don’t eat and drink.

Such spending also exists in macroeconomics – and this article focuses on that. To measure income, economists use real GDP to represent it. Thus, autonomous spending in macroeconomics refers to items in aggregate expenditure whose changes are unaffected by changes in real GDP.

Exports are an example of autonomous spending. It is an autonomous expenditure because it represents goods purchased by foreigners. Thus, it is not affected by domestic income but rather foreign income.

Government spending is another example. Some items in government spending are considered autonomous because they are necessary to run a nation, even during difficult times such as an economic depression.

What is the autonomous expenditure formula?

As defined above, autonomous spending is independent of income levels. The value is constant, even if income is zero. Then, economists write it into a linear mathematical formula like the equation below:

AE = c + bY

AE represents aggregate expenditure. c represents autonomous spending. Y represents income (real GDP).

Meanwhile, b represents the slope, which represents the change in AE when Y changes. Economists also refer to it as the marginal propensity to consume (MPC).

From the above formula, when real GDP equals zero, the aggregate expenditure equals autonomous spending. It’s always positive; why? Let’s take some examples. First, the household sector will continue to spend on food or beverages even when they have no income. They may draw wealth from the savings they have accumulated in the past. Or they borrow to finance consumption.

Autonomous expenditures vs Induced expenditures

Second, exports are also unlikely to be negative. It can only be zero, which means no goods are shipped to foreign markets.

Third, government spending is also impossible to zero. The government also has to budget for spending to run the government, for example, personnel spending, so it’s never negative either.

Those three explanations show why autonomous spending is always positive.

Economists then plot the above formula into a curve, where the Y axis represents total spending and the X axis represents real GDP. The combination point between aggregate expenditure and real GDP will form a straight linear line with a positive slope. And when real GDP is equal to zero, aggregate expenditure is equal to autonomous spending, and since the value is always positive, it will be greater than zero.

What is the difference between autonomous spending and induced spending?

Autonomic expenditures are the opposite of induced expenditures. The latter is influenced by income. Below are two curves to represent their relationship to real GDP.

Induced spending fluctuates with changes in aggregate income, as indicated by changes in real GDP. As a result, some induced spending will also increase when real GDP rises. Vice versa, its value will decrease when real GDP falls.

Household spending and business investment are good examples. When real GDP grows during expansion, households see improved income and employment prospects. It encourages them to spend money shopping, increasing the demand for goods and services. Businesses see these conditions as favorable. Growing demand stimulates them to increase production by investing, hoping to make more profits.

Meanwhile, autonomous spending does not depend on fluctuations in real GDP. Its value is constant, even if the real GDP is zero. The graph represents the intercept of the linear aggregate expenditure curve as described in the previous section.

What are the factors affecting autonomous spending?

Although unaffected by income, other factors play a role in influencing autonomous spending. Wealth is an example. Households still keep spending even though their income is zero. For example, they can sell assets such as shares held to raise money and finance expenses. Or, they borrow from relatives and pay it back after finding a job.

In addition to wealth, other factors play a role in influencing autonomous spending, including:

Interest rates affect borrowing for consumption and investment. For example, low-interest rates encourage households to borrow to finance spending.
Trade policies affect exports and imports. For example, imposed tariffs by the government in the destination country affects exports.
Political uncertainty has an impact on investment decisions. It disrupts the investment climate, prompting businesses to delay investment.
Government discretionary policy. For example, the government takes expansionary fiscal policy during a recession to stimulate economic growth.
Consumer expectations influence current shopping decisions. For instance, suppose we expect the price of the item we love the most to rise in the next month. In that case, we might be willing to borrow money to buy it now even if we are unemployed and have no income.
Exchange rates affect exports and imports. For example, depreciation makes domestic goods cheaper to foreigners, encouraging exports.

What are the components of autonomous spending?

Before discussing the components of autonomous spending, let’s refresh about aggregate expenditure. Economists refer to it as what four macroeconomic actors spend: household, business, government, and external (foreign) sectors. Consumption represents household expenditure. Investments represent expenditures by the business. Fiscal expenditures represent spending by the government. And net exports represent spending by foreigners on goods and services produced by the domestic economy after deducting what the other three sectors spend on foreign goods.

The four expenditures contain an autonomous component. Some tend to contain predominantly autonomous components. Others tend to be minimal. So, we conclude, the components of autonomous spending include:

Household consumption
Investment spending
Government spending
Net exports

Household consumption

Some household expenditures are autonomous. For example, as exemplified earlier, we have to buy food even with no income. So, where does our money come from? It can come from our savings. Or we borrow money from our relatives.

Unaffected by income does not mean there are no expenses. In addition, although not influenced by income, how much we spend as autonomous can also change by other factors such as wealth and interest on loans.

Investment spending

Some business investment spending is also autonomous. Indeed, typically, businesses invest during economic expansion when real GDP is growing strongly. In this period, they see strong demand prospects, prompting them to invest in increasing production. As a result, they hope to sell more and earn more profit by investing.

However, the above case does not always apply. Sometimes, businesses continue to invest because they see strong growth opportunities in the future even though the economy is deteriorating. Examples are companies in non-cyclical sectors such as basic goods and utilities. Demand for their products has been relatively stable during the economic downturn. So, they will continue to invest if their existing production capacity is insufficient.

In other cases, businesses find their production machines obsolete, incurring costs. However, they keep investing because outdated machines incur higher costs (decrease in output) than investing.

In general, businesses usually look to the future when investing, not the current state of the economy. So as long as they generate high returns, they will likely keep investing, such as building a new factory or ordering new capital goods.

Factors such as interest on investment loans also influence investment decisions. Low-interest rates – during a recession, interest rates are low because central banks typically loosen monetary policy to stimulate economic growth – allowing them to get funds at a lower cost.

Government spending

Unlike tax revenues, some government spending is autonomous. For example, personnel spending and other expenditures such as defense will remain even if real GDP does not grow. Such expenditures are essential for government administration activities and providing public services.

The current economic cycle may be a consideration in designing the expenditure budget. And it usually depends on the government’s discretion. For example, the government may increase its spending during a recession when the real GDP is negative. This policy is known as expansionary fiscal policy.

Expansionary fiscal policy aims to stimulate economic growth. Increased spending will increase the demand for goods and services in the economy, directly or indirectly, such as through infrastructure projects. As a result, aggregate demand increases, prompting businesses to increase production. As a result, real GDP recovered and grew positively.

Net exports

Net exports are exports minus imports. Some imports are autonomous, much like household consumption. In contrast, exports are autonomous.

Exports represent spending by foreigners on domestic goods and services. For this reason, it is autonomous because it is unaffected by domestic real GDP but rather by the destination country’s real GDP. And in a broad definition, it is affected by global economic growth.

Why autonomous spending is important to the economy

Autonomic spending is important because it creates a multiplier effect. Increased autonomous spending boosts real GDP. Higher GDP increases disposable income, which in turn encourages induced spending. Then, higher induced spending increases real GDP and, in turn, increases induced spending further. Finally, an increase in autonomous spending creates a multiplier in real GDP, where – in the absence of income taxes or imports – the multiplier is equal to the following:

Multiplier = 1 / (1-MPC)

Where MPC is the marginal propensity to consume, representing the additional consumption due to one additional income.

Take government spending as an example to explain how the multiplier works. First, by increasing the infrastructure budget, the government launches an expansionary fiscal policy to stimulate growth as the economy is in recession.

Then, the increase in infrastructure spending creates demand for related goods and services. Infrastructure-related businesses eventually increased production as the demand for their products increased. They increase overtime or add new workers. As a result, the additional infrastructure budget creates more jobs and income for households, both directly and indirectly – through infrastructure-related businesses.

Improved income prospects encourage workers in the infrastructure sector to increase spending, creating greater demand for goods and services. Businesses responded to the stronger demand by increasing production. They invest capital goods and add new workers to meet the increasing demand. As a result, the unemployment rate decreased.

Then, households see their income and employment prospects as stronger. Finally, it encourages them to increase consumption and stimulates demand further. Businesses then invest in increasing output further. As a result, an increase in the infrastructure budget eventually leads to increased output (real GDP) in the economy many times over, more than it would generate in nominal increments.

Autonomous Expenditure: Formula, Components, Determinants

What is the autonomous expenditure formula?

What is the difference between autonomous spending and induced spending?

What are the factors affecting autonomous spending?