Firstly, equilibrium output is the level of total output that exists when the flow of income created by the production of the output gives rise to a level of total expenditures sufficient to clear the product market of that output. To explain graphically the determination of the equilibrium GDP for the private sector we can use the following models to identify the equilibrium output. (i)
The aggregate expenditures – output approach (Consumption + Investment = Gross Domestic Product or C + I = GDP) is a model that uses the relationship between aggregate expenditures and output to determine the equilibrium level of national income. A graphical portrayal of the aggregate expenditures – output approach is below.
In the graph above the 45 degree line shows that at any point on the line the value of what is being measured on the horizontal axis (GDP) is equal to the value of what is being measured on the vertical axis (aggregate expenditures). Above we can see the equilibrium level is where aggregate expenditure equals GDP or where C+I intersects through the 45 degree line and in this case is at $470 billion. Only at $470 billion will the level of total expenditures be sufficient to clear the product market of that output. (ii)
The leakages – injections approach (Savings = Investment or S = I) is a model that uses the required relationship between leakages from and injections back into the expenditure flow to determine the equilibrium level of national income. Firstly, a leakage is the part of income paid to households that is not consumed by households, representing a withdrawal or diversion of potential spending from the income – expenditures stream (e.g. savings). Secondly, an injection is the component of spending that is not related to consumption spending by households, representing a supplement or addition to the income – expenditures stream (e.g. investment expenditure by businesses). A graphical portrayal of the leakages – injections approach is below....
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