Figure 2. Equilibrium in the Keynesian Cross Diagram. If output was above the equilibrium level, at H, then the real output is greater than the aggregate expenditure in the economy. If output was below the equilibrium level at L, then aggregate expenditure would be greater than output.
Only point E can be at equilibrium, where output, or national income and aggregate expenditure, are equal. The equilibrium E must lie on the degree line, which is the set of points where national income and aggregate expenditure are equal. Conversely, consider the situation where the level of output is at point L—where real output is lower than the equilibrium.
In that case, the level of aggregate demand in the economy is above the degree line, indicating that the level of aggregate expenditure in the economy is greater than the level of output. When the level of aggregate demand has emptied the store shelves, it cannot be sustained, either. For Example:. Computation of Value Added for a 5 pound bag of flour:. Value added at each stage represents income to resource suppliers at that stage. Aggregate Income.
And in the end they add up to the same thing GDP. Circular flow of income and expenditure. Income and spending are equal. Assumptions: No depreciation, firms pay all profits to owners. Production of aggregate output GDP supplies equal amount of aggregate income.
Households supply labor, land, capital, entrepreneurial ability, and they receive wages, rent, interest, and profit. Not all income available to households. The government collects taxes. Some of taxes returned as transfer payments. Households receive Disposable Income DI — The income households have available to spend or save after paying taxes and receiving transfer payments. Net Taxes NT — Taxes minus transfers.
Households either spend Consumption or save Savings disposable income. Financial Markets — banks and other institutions that facilitate the flow of loanable funds from savers to borrowers. Firms in our model must borrow to invest all payments go to resource owners. Investment I consists of investment spending on new capital by firms, spending on residential construction investment in new homes by households.
Some spending goes for imports M. X is foreign spending on U. Impact of flow is M-X. Big Picture. Aggregate Income arising from production equals the aggregate expenditure on that production.
Leakage - any diversion of income from the domestic spending stream includes saving, taxes, and imports. Injection — Any payment of income other than by firms or any spending other than by domestic households; includes investment, government purchases, transfer payments, and exports.
Planned Investment v. Actual investment. Planned Investment — The amount of investment firms plan to undertake during a year. Actual Investment - The amount of investment actually undertaken during a year; equals planned investment plus unplanned changes in inventories. Increase in inventory is added to investment. A rise in the aggregate expenditure pushes the economy towards a higher equilibrium and a higher potential of the GDP.
An economy is said to be at equilibrium when aggregate expenditure is equal to the aggregate supply production in the economy. Identify the assumptions fundamental to classical economics in regards to aggregate expenditure at economic equilibrium. In economics, aggregate expenditure is the current value price of all the finished goods and services in the economy.
Aggregate expenditure is a method that is used to calculate the total value of economic activities, also referred to as the gross domestic product GDP. The GDP of an economy is calculated using the aggregate expenditure model.
The economy is constantly shifting between excess supply inventory and excess demand. As a result, the economy is always moving towards an equilibrium between the aggregate expenditure and aggregate supply. On the aggregate expenditure model, equilibrium is the point where the aggregate supply and aggregate expenditure curve intersect. An increase in the expenditure by consumption C or investment I causes the aggregate expenditure to rise which pushes the economy towards a higher equilibrium.
Aggregate Expenditure — Equilibrium : In this graph, equilibrium is reached when the total demand AD equals the total amount of output Y. The equilibrium point is where the blue line intersects with the black line.
This idea stems from the belief that wages, prices, and interest rage were all flexible. Classical economics states that the factor payments wage and rental payments made during the production process create enough income in the economy to create a demand for the products that were produced.
Classical Aggregate Expenditure : This graph shows the classical aggregate expenditure where C is consumption expenditure and I is aggregate investment. The aggregate expenditure equals the aggregate consumption plus planned investment. Classical economics assumes that the economy works on a full-employment equilibrium, which is not always true. In reality, many economists argue that the economy operates at an under-employment equilibrium.
An economy is said to be at equilibrium when the aggregate expenditure is equal to the aggregate supply production in the economy. Demonstrate how aggregate demand and aggregate supply determine output and price level by using the AD-AS model. In economics, the aggregate supply AS is the total supply of goods and services that firms in an economy produce during a specific time period.
It represents the total amount of goods and services that firms are willing to sell at a given price level. The aggregate supply curve is graphed as a backwards L-shape in the short-run and vertical in the long-run. Didn't find yours?
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