Real equilibrium GDP is determined by the intersection of aggregate expenditure.
AE i measures the current value of finished goods and services at a given price level. It is the summation of expenditures on consumption, investment, government purchases and net export. AE is not aggregate demand and does not vary directly with real GDP. Real GDP is the total production.
Autonomous expenditure is different from induced expenditure which varies positively with real GDP.
Injections such as government spending, investment and net exports into the macro economy kick starts a multiplier effect.
Ceteris paribus, If government reduces spending in one sector of the economy, this sets off a multiplier effect. A multiplier effect occurs when consumer spending changes as a result of a decrease or increase in autonomous expenditure. This decrease affects real GDP and also the price level. Price increase cause less spending in the economy at every level of GDP.
For example, if government reduce spending by $12 billion, national income falls by $12 billion. Workers will save, marginal propensity to withdraw creates a shortfall of $12 billion in the economy. Reduced savings cause a decrease in output which leads to unemployment. Firms lay off workers and reduce salaries. MPC lowers real GDP.Reduced spending leads to lower demand in another sector of the economy.
Oct 27th, 2014
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