9 Demand Side Demand Side Equilibrium Equilibrium Unemployment Unemployment or or Inflation Inflation AAdefinite definiteratio ratio to tobe becalled calledthe the Multiplier Multiplier can canbe be established establishedbetween betweenincome incomeand andinvestment investment JOHN JOHNMAYNARD MAYNARDKEYNES KEYNES Contents Contents The The Meaning Meaning of of Equilibrium Equilibrium GDP GDP The The Mechanics Mechanics of of Income Income Determination Determination The TheAggregate Aggregate Demand Demand Curve Curve Demand Side Demand Side Equilibrium Equilibrium and and Full Full Employment Employment The The Coordination Coordination of of Saving Saving and and Investment Investment Changes Changes on on the the Demand Demand Side Side Multiplier Multiplier Analysis Analysis Copyright 2006 South Western Thomson Learning All rights reserved Contents Contents continued continued The The Multiplier Multiplier Is Is aa General General Concept Concept The The Multiplier Multiplier and and the theAggregate Aggregate Demand Demand Curve Curve Appendix AppendixA A The The Simple SimpleAlgebra Algebra of of Income Income Determination Determination and and the the Multiplier Multiplier Appendix Appendix B B The The Multiplier Multiplier With With Variable Variable Imports Imports Copyright 2006 South Western Thomson Learning All rights reserved The The Meaning Meaning of of Equilibrium Equilibrium GDP GDP GDP GDP cannot cannot be be at at its its equilibrium equilibrium ifif total total spending spending differs differs from from the the value value of of output output IfIf spending spending exceeds exceeds output output inventories inventories fall fall and and firms firms increase increase production production IfIf output output exceeds exceeds spending spending inventories inventories rise rise and and firms firms reduce reduce production production Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 1 1 The The Circular Circular Flow Flow Diagram Diagram I G 3 G ha s I ing S 4 C I 1 G Consumers Go ve rnm Investors X I M Government le ab os s Taxe s f er Trans sp Di In c om e D I IM X s rt po rts I m xp o E es 2 en tP ur c n C I C v Sa io pt m su n Co C Inv es tm en t Financial System Rest of the World 5 6 Firms produce the domestic product ss ome o r G Inc nal o i t a N Y Copyright 2006 South Western Thomson Learning All rights reserved The The Meaning Meaning of of Equilibrium Equilibrium GDP GDP The The equilibrium equilibrium level level of of GDP GDP on on the the demand demand side side is is the the one one at at which which total total spending spending equals equals production production In In such such aa situation situation firms firms find find their their inventories inventories remaining remaining at at desired desired levels levels so so there there isis no no incentive incentive to to change change output output or or prices prices Copyright 2006 Southwestern Thomson Learning All rights reserved The The Mechanics Mechanics of of Income Income Determination Determination Constructing Constructing the the total total expenditure expenditure schedule schedule Expenditure Expenditure Schedule Schedule table table showing showing the the relationship relationship between between GDP GDPand and total total spending spending Induced Induced Investment Investment the the part part of of investment investment spending spending that that rises rises when when GDP GDPrises rises and and falls falls when when GDP GDPfalls falls Copyright 2006 Southwestern Thomson Learning All rights reserved TABLE TABLE 2 2 The The Determination Determination of of Equilibrium Equilibrium Output Output Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 2 2 Construction Construction of of the the Expenditure Expenditure Schedule Schedule C I G C I G X I M X IM 100 Real Expenditure 6 100 6 000 C I G 1 300 C 4 800 I 900 3 900 5 200 5 600 6 000 6 400 Real GDP 6 800 7 200 Copyright 2006 South Western Thomson Learning All rights reserved The The Mechanics Mechanics of of Income Income Determination Determination Both Both the the expenditure expenditure table table and and the the corresponding corresponding income expenditure income expenditure diagram diagram or or 45 45 degree degree line line diagram diagram show show the the equilibrium equilibrium level level of of GDP GDP All All other other levels levels of of GDP GDP are are disequilibrium disequilibrium points points at at which which GDP GDP will will move move in in the the direction direction of of the the equilibrium equilibrium Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 3 3 Income Expenditure Income Expenditure Diagram Diagram Output exceeds spending 7 200 45 6 800 C I G X IM Real Expenditure 6 400 E 6 000 Equilibrium 5 600 5 200 4 800 0 Spending exceeds output 4 800 5 200 5 600 6 000 6 400 6 800 7 200 Real GDP Copyright 2006 South Western Thomson Learning All rights reserved The The Aggregate Aggregate Demand Demand Curve Curve price price level level consumption consumption price price level level purchasing purchasing power power of of wealth wealth not not real real income income A Achange change in in real real income income would would be be illustrated illustrated as as aa movement movement along along the the consumption consumption function function not not aa shift shift Copyright 2006 Southwestern Thomson Learning All rights reserved The The Aggregate Aggregate Demand Demand Curve Curve price price level level consumption consumption Therefore Therefore price price level level total total expenditures expenditures and and equilibrium equilibrium GDP GDP Therefore Therefore price price level level equilibrium equilibrium level level of of real real aggregate aggregate quantity quantity demanded demanded Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 5 5 The The Effect Effect of of the the Price Price Level Level on on Equilibrium Equilibrium AD AD 45 45 C2 I G X IM E0 C1 I G X IM E1 45 E2 Real Expenditure Real Expenditure C0 I G X I M E0 C0 I G X I M 45 Y1 Y0 Real GDP a Y0 Y2 Real GDP b Rise in Price Level Fall in Price Level Copyright 2006 South Western Thomson Learning All rights reserved The The Aggregate Aggregate Demand Demand Curve Curve The The negatively sloped negatively sloped aggregate aggregate demand demand curve curve shows shows all all the the equilibria equilibria of of price price