ECON 0110 1st Edition Lecture 21EQUILIBRIUM LEVEL OF OUTPUTThe level of output in which planned or desired purchases by consumers, businesses,governments and foreigners equals actual aggregate output.When the economy is in equilibrium, producers have no incentive to increase (or decrease)output.EQUILIBRIUM:AGGREGATE PLANNED EXPENDITURES = TOTAL ACTUAL OUTPUTDuring a specified time period, there is:1. A certain amount that consumers want to spend for new goods and services2. A certain amount that businesses want to spend for new plant and equipment3. A certain amount that contractors want to spend for new construction4. A certain amount that businesses want to spend to increase their inventories5. A certain amount that governments want to spend for new goods and services6. A certain amount that foreigners want to spend for new goods and servicesWhen this total DESIRED SPENDING equals the amount of ACTUAL OUTPUT, then the economyis in EQUILIBRIUM.THREE POSSIBLE SCENARIOSThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.CASE 1. TOTAL OUTPUT > DESIRED PURCHASESIf actual output exceeds desired spending, then producers produced too much and inventorieswill increase above the desired level.Signal to producers: REDUCE OUTPUTCONCLUSION:If actual output exceeds desired output, actual output will decline.CASE 2. TOTAL OUTPUT < DESIRED PURCHASESIf actual output is less than desired spending, people purchase more than expected and thelevel of inventories will decrease below the desired levelSignal to producers: INCREASE OUTPUTCONCLUSION:If desired output exceeds actual output, output will increase.CASE 3. Total OUTPUT = DESIRED SPENDINGIf actual output equals desired spending, then people purchased exactly what the producersexpected and inventories will be at the desired levelSignal to producers: DO NOT CHANGE OUTPUTCONCLUSION:If actual output equals desired output, equilibrium is achieved and output does not change.EQUILIBRIUM INCOME IN THE KEYNESIAN MODELDEFINITIONS:ACTUAL OUTPUT = the actual level of C + I + G + NXThe amount that households, firms, governments and foreigners ACTUALLY purchaseDESIRED SPENDING = the desired level of C + I + G + NXThe amount that households, firms, governments and foreigners WANT to purchaseDESIRED SPENDING depends on the ACTUAL level of output because C depends on Y.Via the consumption function, the desired level of consumption spending depends on the actuallevel of income. Thus, C = f(Y).Assume that desired spending on I, G and NX are autonomous.Let EQUILIBRIUM OUTPUT = Ye = EQUILIBRIUM INCOMEYe = the level of output such that producers have no incentive to change the scale of productionEQUILIBRIUM CONDITION EQUATIONYe = C + I + G + NXDETERMINATION OF THE LEVEL OF EQUILIBRIUM OUTPUT(THE FOLLOWING ANALYSIS ASSUMES THAT THERE ARE NO TAXES. THE RESULTS WILL CHANGEWHEN WE INCLUDE TAXES IN THE MODEL.To solve for Ye, substitute all information concerning C, I, G, and NX into the EQUILIBRIUMCONDITION EQUATION and solve for YeEXAMPLE:Let C = 100 + .75 YeAssume all investment spending, government spending and foreign spending are autonomous.Thus, I = I0; G = G0; NX = NX0Assume I = 15, G = 10, and NX = 0THE EQUILIBRIUM CONDITION IS:Ye = C + I + G + NXSUBSTITUTE ALL VALUES INTO THIS EQUATION:Ye = (100 + .75 Ye) + 15 + 10 + 0Ye = 125 + .75 YeYe - .75 Ye = 125(1 - .75) Ye = 125.25 Ye = 125Ye = 125 / .25 = 500CHECK YOUR RESULTSuppose Ye = 500:Does Ye = C + I + G + NX?C = 100 + .75 Ye = 100 + .75 (500) = 475I + G + NX = 25Therefore, C + I + G + NX = 475 + 25 = 500GENERAL SOLUTION FOR YeLet C = C0 + mpc YeC0 denotes autonomous consumptionLet I = I0Let G = G0Let NX = NX0Ye = C + I0 + G0 + NX0= C0 + mpc Ye + I0 + G0 + NX0Ye – mpc Ye = C0 + I0 + G0 + NX0(1 – mpc)Ye = C0 + I0 + G0 + NX0SOLUTION FOR EQUILIBRIUMYe = [1 / (1-mpc)] x (C0 + I0 + G0 + NX0)In our example, we haveYe = [1 / (1 - .75)] x (100 + 25) = 4 x 125 = 500SECOND EXAMPLE:Let C = 100 + .75 YeLet I = 100 (All investment is autonomous.)Let G = 300 (All government spending is autonomous.)Let NX = 0 (Net export spending is autonomous.)EQUILIBRIUM CONDITION:Ye = C + I + G + NXSUBSTITUTE ALL INFORMATION INTO THE EQUILIBRIUM CONDITIONYe = (100 + .75 Ye) + 100 + 300 + 0SOLVE THE EQUATION FOR YeYe = 500 + .75 YeYe - .75 Ye = 500(1 - .75) Ye = .25 Ye = 500Ye = 500 / .25 = 2000CHECK YOUR RESULTSuppose Ye = 2000Does Ye = C + I + G + NX?C = 100 + .75 Ye = 100 + .75 (2000) = 1600I + G + NX = 100 + 300 + 0Therefore, C + I + G + NX = 1600 + 100 + 300 + 0 = 2000 =