Menu
Home
Log in / Register
 
Home arrow Economics arrow Keynes and the Classical Economists
< Prev   CONTENTS   Next >

THE EQUILIBRIUM LEVEL OF OUTPUT

Now that we have analyzed the individual components of spending in our hypothetical economy, we are ready to combine them to see how total spending determines the level of output and employment. Remember, according to Keynesian theory, the level of demand—that is, total spending—determines the amount of output that will be produced and the number of jobs that will be made available. To see how the spending plans of consumers and investors determine the level of output and employment, we turn to Exh. 5.

Column 1 in Exh. 5 shows several possible levels of output (GDP) that our hypothetical economy could produce. Which level will be chosen by businesses depends on how much they expect to sell. Let's assume that businesses believe they can sell $600 billion worth of output. To produce this output, they hire economic resources: land, labor, capital, and entrepreneurship. This transaction provides households with $600 billion of income, an amount exactly equal to the value of total output. Recall that total income must equal total output because all the money received by businesses must be paid to someone.

EXHIBIT 5. Determination of Equilibrium Income and Output (data in billions)

(1)

TOTAL OUTPUT AND INCOME* (GDP)

(2)

PLANNED

CONSUMPTION EXPENDITURES

(3)

PLANNED

SAVING (1 - 2)

(4)

PLANNED

INVESTMENT

EXPENDITURES

(5)

TOTAL PLANNED EXPENDITURES

(2 + 4)

(6)

TENDENCY OF

OUTPUT

$300

$325

$-25

$50

$375

Increase

400

400

0

50

450

Increase

500

475

25

50

525

Increase

600

550

50

50

600

Equilibrium

700

625

75

50

675

Decrease

800

700

100

50

750

Decrease

*In our simplified economy, total income = total disposable income = GDP.

Column 2 shows the amount that households plan to consume for each level of income (GDP) given in column 1. If the tabular data in column 2 were plotted on a graph, you would recognize the consumption function (Exh. 2). You can see that when GDP is $600 billion, households desire to consume $550 billion. Moving to column 3, you see that households want to save $50 billion when GDP is $600 billion.

The next category of spending is investment spending (column 4). Our example assumes that investment spending is autonomous, or independent of the level of current output. Unlike consumption spending, investment spending is determined by the factors described earlier: the rate of interest and expectations regarding future revenues and costs. The level of investment spending changes only if those determinants change. Here we've set the level of investment spending at $50 billion. (Later we'll allow the level of investment to change so that we can trace the impact of that change on the level of output and employment.)

In our simplified economy, total spending (column 5) is the sum of consumption spending and investment spending. Note that the amount of total spending rises with the economy's GDP; higher levels of GDP signal higher levels of total spending because consumption spending increases with income. If the business sector produces $600 billion of output, the result will be the creation of $550 billion of consumption spending and $50 billion of investment spending, or a total of $600 billion. This amount will be precisely enough to clear the market of that period's production. Most important, because businesses can sell exactly what they have produced, they will have no incentive to increase or decrease their rate of output. This means that the economy has arrived at its equilibrium output, the output that it will tend to maintain. Businesses can be expected to produce the same amount every year until they have reason to believe that the spending plans of consumers or investors have changed.

 
Found a mistake? Please highlight the word and press Shift + Enter  
< Prev   CONTENTS   Next >
 
Subjects
Accounting
Business & Finance
Communication
Computer Science
Economics
Education
Engineering
Environment
Geography
Health
History
Language & Literature
Law
Management
Marketing
Philosophy
Political science
Psychology
Religion
Sociology
Travel