Meeting aggregate expenditure (meeting demand)

### Introduction Naturally, the country’s output should adjust itself to the scope of demand. If in a small country A people want to eat 1000 loaves of bread every day, then the output will amount to 1000 loaves of bread. If the demand decreases to 500 loaves of bread per day, the output will be reduced to 500 loaves. The market will always adjust the scope of output to demand, as long as the demand does not exceed the country’s production capacity. In other words, as long as the market has not reached a state of full employment and cannot increase output. We are focusing for now on a closed economy that cannot import. ### Use of synonymous terms The terms: economic output, economic GDP and total economic income are synonymous terms and each of them can be used equally. However, there are circumstances in which it is better to use one over the other. ## The mechanism that causes the equality between aggregate expenditure (demand and output) We will use a diagram that shows the aggregate expenditure curve and draw a diagonal line that rises from the beginning of the axes at a slope of 45° and call it **45° line**. The 45° line has a geometric property, in that every point on it is equidistant from both axes, that is – every point on the 45° line represents equality between E and Y=E. ## Adjusting output to expenditure (to demand) ### Stage A (blue) In stage A, there is still no income in the economy (Y=0), but there is an initial demand of E₀ that must be supplied. When the economy produces output equal to E₀, it will be at point a on the 45° line. The output at that point is denoted by Y₀. At the end of stage A, the economy is at point a where there is a balance between demand and output. E₀=Y₀. ### Stage B (orange) Following the increase in output in stage A from 0 to Y₀ and the marginal propensity to consume at a rate of C, consumption will increase by Y₀*C NIS. This amount is called C₁. To satisfy C₁, the economy will have to increase output by the same amount and will therefore be located at point b on the 45° line. The total aggregate expenditure at point b is denoted by E₁ where: **E₁=C₁+C₀+I₀+G₀**. The total output that is equal to it is denoted by Y₁. The increase in output from Y₀ to Y₁ is denoted by ΔY₀. ΔY₀=Y₁-Y₀. At the end of stage B, the economy is at point b where there is a balance between demand and output E₁=Y₁. ### Stage C (green) Following the increase in output by ΔY₀ in stage B, consumption will increase by ΔY₀*C. This amount is called C₂. To satisfy demand The economy will increase output by the same amount and will be located at point d on the 45° line. The total aggregate expenditure at point d is denoted by E₂ where E₂ = C₀+C₁+C₂+I₀+G₀. The total output that is equal to it is denoted by Y₂. At the end of stage C, the economy is at point d where there is a balance between demand and output Y₂ = E₂. ### Additional stages and thus each increase in income will in turn affect the increase in consumption. To satisfy the additional consumption, the economy will increase output by the same amount and thus aggregate expenditure will increase and correspondingly output (Y). ### End of the process The stages will continue with each additional stage the additional consumption will decrease until it finally stops at the intersection of the 45° line with the aggregate expenditure curve (point e). The total aggregate expenditure related to the breakeven point (e) is denoted by Eₓ (F is short for Final). And the aggregate output related to the breakeven point (e) is denoted by Yₓ. At any level of output up to Yₓ, E is greater than Y and therefore output in the economy will continue to increase. At any level of output beyond Yₓ, there is excess output over aggregate expenditure (demand) and therefore output will decrease over time until it equals aggregate expenditure.

### Multiplier The ratio between the final aggregate expenditure Eₓ and the initial aggregate expenditure E₀. That is: Eₓ/E₀ is called **multiplier**. The multiplier is: the ratio between the change in national income and the original change that caused it (for example, an increase in investment or an increase in government spending). For example – an increase in G or C or I or all three together, will cause an increase in national income, more than the increase in G, C or I. The reason for this is that with the increase in national income, consumption also increases – C – which again increases income and so on. If, for example, E₀=$100 million and Eₓ=$300 million, then the multiplier is 3. The multiplier indicates the contribution of each $1 in E₀ to the final aggregate expenditure in the economy (=GDP). If, for example, the multiplier is 5 and the government increases its expenditure by $1 million, then aggregate expenditure will increase by $5 million and revenue (=GDP) will also increase by the same amount. As can be seen immediately, the multiplier is equal to 1/(1-c). If, for example, c=0.8, the multiplier is equal to 5.