1. Demand Side Equilibrium
Chapter 9
Demand Side Equilibrium

2. Y
C= *Y I G X M AE
DInventories
Firm's Reaction
10000
9500
400
300
200
100
10,300
-300
Increase Production; hire more workers
11000
10400
11,200
-200
12000
11300
12,100
-100
13000
12200
13,000
Equilibrium
14000
13100
13,900
Decrease Production Hire less workers
15000
14,800

3. Consumption changes with Disposable Income Yd
C = a + MPC*Yd
C = a + MPC*(Y-Tx+Tr) C1
DC=MPC*DYd Y
National Income :
Wages
Profits
Interest
Rents
Move UP Along C C0
Yd= Y- Tx+ Tr
Yd0
Yd1

4. Consumption changes with National Income Y
C = a + MPC*(Y+ Tr – Tx)
C = a + MPC* (Tr – Tx) + MPC*Y
C will shift with an increase in Transfers or a drop in Taxes
New Intercept: A
C = A + MPC*Y C1
DC=MPC*DY
Move UP Along C Y
National Income :
Wages
Profits
Interest
Rents C0
Increase in National Income Y Y Y0 Y1

5. National Income Y(wages, Profits, Interest, Rents)
Aggregate Expenditures
~Total Sales
AE = C + I + G + NX
AE = 6,400
NX= 300
G = 500
I = 1000
AE = 6,400
C= 4,600
C = Y
C = 4600
Y = 5,000
National Income Y(wages, Profits, Interest, Rents)

6. National Income Y(wages, Profits, Interest, Rents)
Aggregate Expenditures AE
NX= 300
AE = C + I + G + NX
NX= 300
G = 500
NX= 300
~Total Sales
NX= 300
G = 500
G = 500
G = 500
I = 1000
I = 1000
AE = 24,400
I = 1000
AE = 19,000
AE = 10,900
I = 1000
AE = 6,400
C = 22,600
C = 17,200
C = Y
C = 9,100
C = 4600
Y = 10,000
Y = 5,000
Y = 19,000
Y = 25,000
National Income Y(wages, Profits, Interest, Rents)

7. Equilibrium Y = 19,000 ~Total Sales Firms decrease production
No change in production
~Total Sales
+600 AE AE
Firms increase production
Change in Inventories = 10,000 – 10,900 = -900 (decrease)
Change in Inventories = 5, ,400 = -1,400 (decrease)
Change in Inventories = 19,000 – 19,900 = 0 (no change)
Change in Inventories = 25,000 – 24,400 = +600 (increase)
-900
-1,400
Y =25,000
If total production Y = 25,000
If total production Y = 19,000
If total production Y = 5,000
If total production Y = 10,000
AE=19,000
AE=24,400
Y=19,000
AE=10,900
AE=6,400
Aggregate Expenditures AE = 19,000
Aggregate Expenditures AE = 6,400
Aggregate Expenditures AE =10,900
Y=10,000
Y=5,000
Equilibrium Y = 19,000
Y = 5,000
Y = 10,000
Y = 19,000
Y = 25,000

8. Distances into Vertical Distances.
The 45 line
Converts Horizontal
Distances into Vertical
Distances.
Y = 19,000
Y = 10,000
Y = 5,000
450
Y = 5,000
Y = 10,000
Y = 19,000
Y = 25,000

9. Total Sales=Aggregate ExpendituresAE
Total Sales=Aggregate Expenditures
Total Production
450
Y = 5,000
Y = 10,000
Y = 19,000
Y = 25,000

10. At Equilibrium there is NO change in Inventories Total Production AE
Inventories Increase Y
Aggregate Expenditures AE AE
AE (Sales)
Inventories Decrease
Y(Production)
For any output level below equilibrium
For any output level above equilibrium
Total Production (Y)

11. AE = 24,400 AE = 10,900 C, AE C If consumption, I, G or NX increase
AE = C+I+G+NX
G = 500
NX= 300
If consumption, I, G or NX drop
G = 500
I = 1000
AE = 24,400
The AE line shifts up
The AE line shifts down
I = 1000
AE = 10,900
C = Y
C = 22,600
C = 9,100
100
Y = 10,000
Y = 25,000
Real Income = Real GDP = Y

12. Total Sales or Aggregate ExpendituresAE
AE= C+I+G+NX
Total Sales or Aggregate Expenditures
Total Production or Total Income (Y)
450
GDP/Income
Y = 5,000
Y = 10,000
Y = 19,000
Y = 25,000

13. Production > sales Inventories increase
GDP/Income
Equilibrium
Equilibrium AE
AE= C+I+G+NX
If C,I,G or NX Decrease, AE line shifts down
Production > sales Inventories increase
Firms decrease output
Equilibrium output decreases
Lower Y*

14. Sales > Production Inventories DecreaseAE
New Equilibrium
Equilibrium
Equilibrium output increase
Sales > Production Inventories Decrease
If AE line shifts up
Firms Increase Output
450
Higher Y1*
Y0*

15. Equilibrium AE Potential GDP AE
Where it should be: zero unemployment, no excess capacity
Where the economy is stuck
450
Equilibrium GDP
Potential GDP

16. E B Equilibrium AE Potential GDP AE AE
To increase AE: increase in C, I, G or NX
To eliminate a recessionary gap, AE must rise. AE
Equilibrium
Decrease Taxes/Increase Transfers
Decrease interest Rates
Increase Government Spending
Make Dollar Weaker E B
Distance E-B
Economy is producing less than desired output
Recessionary Gap
Recessionary gap: GDP is lower than full employment GDP
7,000-6,000 =1,000
450
Equilibrium GDP: 6,000
Potential GDP : 7,000

17. E B Equilibrium AE To decrease AE: Increase Taxes/Decrease Transfers
Increase interest Rates
Decrease Government Spending
Make Dollar Stronger
Trying to produce more than possible
Zero Unemployment, No excess capacity AE
Working at full capacity: equipment breaks down more often: costs rise
Labor shortages: hiring workers who already have a job: Labor costs rise
To eliminate an Inflationary gap, AE must fall. AE
Equilibrium
Rising costs = rising prices E B
Distance E-B
Inflationary Gap
7,000-8,000 = -1,000
450
Potential GDP : 7,000
Equilibrium GDP: 8,000

18. Which AE line will cause a recessionary gap?
Which AE line will cause an Inflationary gap?

19. Assume the Economy is at Equilibrium
GDP = ?
Is total spending larger than/smaller than/equal to Output?
Do Inventories fall, rise or remain unchanged?
Does the economy experience a recessionary/inflationary gap?
What is the size of the gap?
How can the gap be closed?

20. Assume the Economy is at Equilibrium
GDP = ?
Is total spending larger than/smaller than/equal to Output?
Do Inventories fall, rise or remain unchanged?
Does the economy experience a recessionary/inflationary gap?
What is the size of the gap?
How can the gap be closed?

21. At Y=3000 At Y=4000 At Y=5000 Potential GDP AE=C+I+G+NX
Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Does the economy experience a (recessionary, inflationary) gap? Size of the Gap = __________
Is the economy experiencing unemployment or labor shortages?
Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Once the Economy reaches equilibrium, will the economy experience a (recessionary, inflationary) gap? Size of the Gap = __________
Is the economy experiencing unemployment or labor shortages?
Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Once the Economy reaches equilibrium, will the economy experience a (recessionary, inflationary) gap? Size of the Gap = __________
Is the economy experiencing unemployment or labor shortages?

22. At Y=3000 At Y=4000 At Y=5000 Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Once the Economy reaches equilibrium, will the economy experience a (recessionary, inflationary) gap?
Is the economy experiencing unemployment or labor shortages?
Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Does the economy experience a (recessionary, inflationary) gap?
Is the economy experiencing unemployment or labor shortages?
Is the economy at equilibrium ?
Total Spending( > = < )Output
Inventories (rise, fall, remain the same)
Firms will (increase, decrease, not change)output.
Once the Economy reaches equilibrium, will the economy experience a (recessionary, inflationary) gap?
Is the economy experiencing unemployment or labor shortages?

23. Income that does not come back to buy goods and servicesNI
Spending Leakages
Taxes
Imports
Income that does not come back to buy goods and services
Saving
GDP

24. NI GDP Spending Injections Imports Taxes Government spending Exports
Saving
Investment

25. Equilibrium Leakages S+T+M I+G+X Injections
Not enough spending Inventories accumulate
Spending = Output inventories do not change
Leakages
S+T+M
Leakages larger than Injections
I+G+X
I+G+X=S+T+M
Injections
Larger than
Leakages
Injections
Ybelow equilibrium
Y Equilibrium
Yabove equilibrium
Too much spending inventories fall

26. Equilibrium AE S+T+M I+G+X > Inventories increase Inventories fall45
Too much Demand for output
Y > AE
Inventories increase
Y < AE
C+I+G+NX
Inventories fall AE
Not enough Demand for output
Equilibrium
Leakages = Injections
Y Equilibrium
S+T+M
Leakages > Injections
Injections
>
Leakages
I+G+X
I+G+X=S+T+M
Y below equilibrium
Y Equilibrium
Y above equilibrium

27. At equilibrium, Leakages = Injections S+T+M = I + G + X Rearrange:
S = I + (G-T) (X-M)
Savings finance
Government’s Deficit: Spending > Tax Revenue
Trade Deficit: Buy more from other countries than we sell to them
Investment

28. At Y = 3,000 are inventories rising? Falling? Unchanged?
What is the equilibrium GDP?
For what value of GDP is:
Y = AE?
For what value of GDP is:
Y = AE?
For what value of GDP is:
S = I +(G-T) +(X-M)?
I + (G-T) + (X-M)