The equilibrium level of GDP will be established at a point where aggregate demand is equal to aggregate supply. Aggregate demand shows the various amount of aggregate expenditure which the buyers, as a whole, intend to make at different levels of output or GDP. Aggregate supply shows the various amounts of total revenue which the entrepreneurs, as a whole, expect from the different levels of output of GDP produced. Since, what the buyers spend on the purchase of output is the same as what the entrepreneurs get by way revenue from the sale of output, the equilibrium is established only at that level of output (GDP) where what the buyers intended to spend is exactly equal to what the entrepreneurs expect in the form of total revenue. If at a given level of output the buyers spend more than what the entrepreneurs expected, it would give abnormal profits to the producers. There will thus an inducement to expand output and maximize profits. If, on the other hand, the buyers spend less than what the entrepreneurs expected of them, then that level of output cannot be maintained. The entrepreneurs in this case will be left with unsold stock, and will thus be obliged to cut down the level of production. Only at that level of output or GDP be in equilibrium At this level of output, the entrepreneurs will neither have the inducement to expand nor disincentive to contract the volume of production. Hence, we can define the equilibrium level of GDP as where,
Intended aggregate expenditure by the = Expected revenue of the spending groups as a whole producers and entrepreneurs as a whole
Aggregate demand price = Aggregate supply price
Aggregate Expenditure (AE)= National output (GDP)
Now, in the short run, the condition of aggregate supply is assumed to be fixed and given. In others words, the maximum level to which aggregate supply can be increased (with full use of all the resources at their normal rates of utilisation) in response to the expected total revenue is fixed by the potential GDP. Within this limit of the potential GDP, the actual level of output or the level of actual GDP will depend upon the aggregate demand price, that is, the aggregate expenditure which the buyers as a whole are expected to make on various amounts of output produced. The concept of aggregate demand price or aggregate intended expenditure, therefore, occupies the pivotal position in the modern theory of income, output and employment determination. Aggregate expenditure consist of consumption expenditure, investment expenditure, government expenditure and expenditure by the rest of the world what determines consumption, investment, government expenditure and net exports.SUBMIT ASSIGNMENT NOW!