There are certain forces which help aggregate expenditure to reach equilibrium. This can be better understood through an example in which there is disparity between equilibrium and aggregate expense.
From Below Equilibrium
To understand converge of equilibrium from below Figure 11.4 can be taken as an example. Assume the value of real GDP to be fixed at $14 trillion dollars. If this is the case and the real GDP is set at $14 trillion than the value of aggregate expenditure will be $14 trillion as well. The departure occurs when the amount of the aggregate planned expenditure is $ 15 trillion. Therefore as per this example it can be stated that there is a disparity of $ 1 trillion between the real GDP and aggregate expenditure on one side and the aggregate planned expenditure on the other hand. This indirectly shows that investments of $15 trillion reaped production of only $14 trillion, thus the inventory which we already know is part of the components of expenses to be considered has decreased when compared to the planned amount.
There is no cause to believe however that the inventory remains static. Any disparity in numbers can be easily made up by the firms by increasing production and making attempts to fill in the deficits. Sales and inventory have a close connection. If the need is felt to increase labor power for bringing out equilibrium than appropriate steps are undertaken. Attention must be paid to this part of the illustration. When the deficit of $1 trillion is eliminated and the real GDP matches the aggregate planned expenditure and becomes $15 trillion the problem does not end. By the time the real GDP matches the planned expenditure. The expenses increase again, for example from $15 trillion it becomes $15.5 trillion. It must be noticed the increases is lesser than before yet cannot be ignored. The deficit now which is affecting the equilibrium is $0.5 trillion. Efforts are again made by increasing production and higher labor to meet the deficit. Each time the real GDP reaches the planned estimate that it sets out for and reaches it; the value of the planned estimate undergoes a hike. However this process reaches equilibrium by the time the planned estimate reaches $16 trillion. The value of the unplanned inventory reaches zero at this stage and production becomes static.
From Above Equilibrium
When one seeks to understand convergence of equilibrium from above all they are simply required to do is to twist the idea of equilibrium from below. Again focusing on the figure if one assumes the value of real GDP and the aggregate expenditure is taken to be $17 trillion then the value for the aggregate planned expenditure is $16 trillion. This means that the actual expense as well as the GDP both exceeds the planned amount. When there is an increase in the inventory of $1 trillion the real GDP faces a significant drop.
It is observed when the actual GDP exceeds the planned one then the inventory undergoes a rise. Due to this rise in the amount of inventory the production rate has to be reduced. In the case of equilibrium convergence from below just as labor and production had to be increased to fill up the deficit. In the case of the equilibrium convergence from above these components involved in aggregate expenditure have to undergo a drop to reach the point of equilibrium.
The process of adjusting and regulating production and expenses continues till the real GDP matches the planned expenses and the value reaches the stage of equilibrium. Here the inventory once again reaches zero and the firms again continue to become static in production. As the level of price is fixed, the GDP gets determined at a value the equilibrium expense. Production responses which are a result of the changes of an unplanned manner in inventory cause this equalizing effect with respect to the real GDP and aggregate planned expense.
After studying the concepts of equilibrium and the ways to cause equilibrium from above and below it is time to delve into the idea of multiplier. Multipliers can be simply understood as concepts leading to amplification in economics.
Links of Previous Main Topic:-
- Definition of Economics
- Economic Problem
- Expenditure Multiplier Know the Keynesian Model
- Fixed Prices and Expenditure Plans
Links of Next Macroeconomics Topics:-
- Multiplier
- The Basic Idea of the Multiplier
- The Multiplier Effect
- Why Is the Multiplier Greater Than 1
- The Size of the Multiplier
- Imports and Income Taxes
- The Multiplier Process
- Business Cycle Turning Points
- The Multiplier and the Price Level
- Adjusting Quantities and Prices
- Aggregate Expenditure and Aggregate Demand
- Deriving the Aggregate Demand Curve
- Changes in Aggregate Expenditure and Aggregate Demand
- Equilibrium Real GDP and the Price Level
- Expenditure Multiplier Know the Keynesian Model
