Aggregate Spending of the Country - Essay Example

Aggregate spending refers to the value of all finished goods and services in the economy, that is, all the expenses incurred on the consumer goods, planned and unplanned savings and investments, expenses made by the government, and the difference between exports and imports. Arithmetically, it can be denoted as AE=C+ Ip+lu+ G+Xn where Ae=Aggregate expenditure; C = Household Consumption; Ip = Planned Investment; Iu = Unplanned Investment; G = Government spending and Xn = Net exports (Exports-Imports)
According to Keynesian theory (Arnon, Weinblatt, & Young, 2011), earnings increases only when spending increases in the economy. He believed that one person's spending would always be the other person's earnings, thereby supporting his or her earnings. This cycle would keep on repeating itself thereby supporting a normal functioning economy. An economy normally attains equilibrium when the joint expenditure equals the joint production, but Keynes believed that the economy does not stay in this state. He argued that the total spending and production tend to adjust themselves toward equilibrium. When there is excess supply than expenditure and demand, the prices and output go down thereby reducing the gross domestic product of the economy, but when there is an excess of expenditure than supply, demand goes up thereby making prices and output go up. It is clear that the economy keeps on shifting between excess supply and demand which enables it to keep on moving towards equilibrium.
Keynesian equilibrium is only a balance between total expenditure and production and not necessarily other aggregate markets. This makes full employment not be fully achieved. The major components of spending, in this case, are consumption, net exports, government purchases and investment. A change in all or any of them would affect the aggregate demand.
Actual gross domestic product refers to the sum of all the activities of the economy while potential gross domestic product on the other hand refers to the sum of all possible maximum economic activities which can be achieved through the maximum deployment of the factors of production, which include expertise, normal resources, labor and capital. This difference between the potential and real gross domestic product is important in the sense that monetary policymakers use it to decide whether the economy needs more or less monetary stimulus with regard to the gap amid them (Arnon et al, 2011).
Multipliers refer to the measure of the extent to which businesses and households are interrelated in an economy. They normally measure the impact caused by the introduction of an external change such as new investment or export expansion in an economy. Multipliers are therefore essential since they can be used to measure the influence of a proposed or recent adjustment in the economy; they can also be used to make projections given the variations in a specific segment (Eatwell, & Milgate, 2011).
The market price is always set through an interaction of supply and demand curves at a point denoted as equilibrium. This equilibrium price can change from one point to another given the spending changes. An outward shift in spending always leads to a short-term rise in price due to the fall in available stock in the market. This higher price then motivates suppliers to raise their output leading to a movement up the short-term supply curve towards the new equilibrium point. Read More