Aggregate Forces

• Aggregate Production: The first half of the balance is aggregate production, the total quantity of final goods and services produced in the economy. This total or aggregate production is most commonly measured by gross domestic product.


• Aggregate Expenditures: The other half of the equilibrium balance is aggregate expenditures, the combined expenditures on final goods and services undertaken by the four macroeconomic sectors (household, business, government, and foreign). The four aggregate expenditures (and their common abbreviation) are: consumption expenditures (C), investment expenditures (I), government purchases (G), and net exports (X - M). Aggregate expenditures are commonly represented by an simple equation:

  AE

  =

  C

  +

  I

  +

  G

  +

  (X

  -

  M)

• First, the adjustment mechanism that achieves and maintains equilibrium is aggregate production. If aggregate expenditures are not equal to aggregate production, then aggregate production changes to restore balance.


• Second, Keynesian equilibrium is ONLY a balance between aggregate expenditures and aggregate production. Other aggregate markets, especially resource markets, need not be in equilibrium. Shortages and surpluses can exist and persist in resource markets. In other words, full employment is NOT automatically achieved with Keynesian equilibrium.

Setting the Keynesian Stage

Keynesian Cross
Equilibrium
Disequilibrium

Consider the exhibit to the right. This illustrates the standard framework for the Keynesian model, with aggregate production measured on the horizontal axis and aggregate expenditures measured on the vertical axis.

• One of two items needed to identify equilibrium is the 45-degree guideline. This can be displayed by clicking the [45-Degree Line] button. The resulting line is labeled Y = AE.


• The other item needed is the aggregate expenditures line. This can be displayed by clicking the [Aggregate Expenditures Line] button. The resulting line is labeled AE.

An Intersecting Equilibrium

• Equilibrium is achieved with $12 trillion of aggregate production. At this level, aggregate expenditures are also $12 trillion.


• Only at $12 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production.


• At this $12 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have.


• The lack of surpluses and shortages means equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level.


• A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories.

Out of Balance

Disequilibrium in the Keynesian model results when aggregate expenditures are not equal to aggregate production. More specifically, this is an aggregate production level that does not coincide with the intersection of the aggregate expenditures line and the 45-degree line.

A graphical analysis of disequilibrium is in order. The exhibit to the right displays equilibrium in the Keynesian model. Aggregate production is $12 trillion at the intersection of the aggregate expenditures line and the 45-degree line. If aggregate production is greater than or less than $12 trillion, we have disequilibrium. Let's consider each alternative.

• Greater Than $12 Trillion: Suppose aggregate production is $18 trillion. Click the [$18 Trillion] button to highlight this alternative. At $18 trillion, the aggregate expenditures line lies beneath the 45-degree line and aggregate expenditures are $16.5 trillion, less than aggregate production.

  The difference between aggregate expenditures and aggregate production means that economy-wide production surpluses exist. Economy-wide surpluses result in unplanned increases in inventories because the business sector sells less output than current production. The $1.5 trillion vertical distance between the aggregate expenditures line and the 45-degree line indicates the increase in business inventories.

  The build-up of inventories motivates the business sector to reduce aggregate production. The decrease in aggregate production then moves the economy to the $12 trillion equilibrium level. In the course of this adjustment, aggregate expenditures decline from $16.5 trillion to $12 trillion.



• Less Than $12 Trillion: Now suppose aggregate production is $6 trillion. Click the [$6 Trillion] button to highlight this alternative. At $6 trillion, the aggregate expenditures line lies above the 45-degree line and aggregate expenditures are $7.5 trillion, greater than aggregate production.

  The difference between aggregate expenditures and aggregate production means that economy-wide production shortages exist. Economy-wide shortages result in unplanned decreases in inventories because the business sector sells more output than current production. The $1.5 trillion vertical distance between the aggregate expenditures line and the 45-degree line indicates the decrease in business inventories.

  The reduction of inventories motivates the business sector to increase aggregate production. The increase in aggregate production then moves the economy to the $12 trillion equilibrium level. In the course of this adjustment, aggregate expenditures rise from $7.5 trillion to $12 trillion.