3.1 Equilibrium Level of National Income - Effects of a Change in AD Flashcards
How would you fully explain how a change in AD leads to a change in RNY/GPL?
(Assume initial equilibrium level of economy), rise in AD ==> real total expenditure by the 4 sectors on domestically produced goods to increase ==> all output produced is sold (no surpluses), not all demand is met (leading to shortages). Firms respond by drawing down on inventories ==> unplanned disinvestment causes actual stock levels to fall below optimum levels ==> firms increase production in the next time period to replenish stocks ==> and employ more FOPSs ==> pay out more factor income to households’ ==> NY (sum of all households income) rises OR increase in the COP ==> GPL rises.
Brief explanation: AD > AS at given GPL ==> planned AE exceeds total output produced at P1 ==> unplanned fall in inventories ==> firms bid for additional FOPs to (increase output and meet excess demand) ==> increase in COP ==> upward pressure on GPL until excess demand is cleared at P2 ==> RNY increases from Y1 to Y2.
