3.17: Planned Aggregate Expenditure IV

One way to check if the economy is in equilibrium is by using numbers to compare planned spending and actual output. This involves adding up how much people plan to consume and how much businesses plan to invest at different income levels. If total planned spending is equal to total output, the economy is said to be in balance.

Let’s say households always spend a basic amount, even if income is zero. As income rises, they spend more, but not the entire increase. On top of this, businesses plan to invest a steady amount, no matter the income level. These two parts—consumption and investment—make up the total planned expenditure.

Now imagine the total income is 350. If planned consumption and investment together amount to 370, that means people are planning to spend more than what’s being produced. As a result, businesses will see their goods selling out faster than expected. This can lead them to raise production.

At an income of 400, planned spending also totals 400. In this case, everything produced is being bought. Firms don’t need to change their production levels, and inventory stays steady. This is the point of equilibrium.

If income rises to 450 but planned spending is only 430, then businesses are producing more than what people want to buy. Unsold goods start to build up. Firms may respond by lowering their output.

Looking at how planned spending compares to output helps us see whether the economy is in balance or needs to adjust. This simple approach makes it easier to understand how equilibrium works without needing complex tools.

The equilibrium for a simple and closed economy with consumption and planned investment, like that which was determined graphically in the previous video, can also be determined mathematically.

In this example, the consumption function is defined as consumption equals one hundred plus zero point seven five times income. Planned investment remains fixed at twenty-five dollars.

Begin by evaluating an income level of four hundred dollars. Substituting this value into the consumption function yields four hundred. Adding investment results in total planned expenditure of four hundred and twenty-five dollars. Since planned spending at this level of income exceeds output, this leads to an unplanned reduction in inventories. The economy is not in equilibrium.

Next, evaluate income at 500 dollars. At this level of income, planned expenditure equals output, confirming this as the equilibrium level of income

Finally, at six hundred dollars, planned spending falls short of output, resulting in unplanned inventory accumulation.

Thus, only at five hundred dollars does planned expenditure equal output, indicating equilibrium income.