Determination of Income and Employment

Lesson

Part 1 — aggregate demand, consumption and saving, equilibrium income and the multiplier.

In this lesson you will

Identify the components of aggregate demand and aggregate supply, and distinguish ex-ante from ex-post values
Calculate APC, MPC, APS and MPS and read consumption and saving curves
Find equilibrium income by the AD = AS and saving = investment approaches
Explain the investment multiplier and use K = 1 ÷ (1 − MPC)

Part 1 at a glance

Concept

The short-run model and its assumptions

We study a short-run model in which demand decides output.

Table of the assumptions: a two-sector economy, short run with fixed prices, spare capacity, and autonomous investment
Assumption	What it means here
Two-sector economy	Only households and firms: AD = C + I
Short run, prices fixed	Output responds to demand; prices do not change
Spare capacity	Firms can raise output if demand rises (until full employment)
Autonomous investment	Planned investment does not depend on income

Concept

Aggregate demand (AD) is the total planned expenditure on final goods and services in an economy during a period.

Table: in a two-sector economy AD is C plus I and AS is C plus S; in an open economy with a government, AD is C plus I plus G plus net exports
Economy	Aggregate demand	Aggregate supply
Two-sector (households, firms)	C + I	C + S (= Y)
Open, with government	C + I + G + (X − M)	value of output (= Y)