Author:  Lori Alden

Keynes (rhymes with brains) argued that macroeconomic equilibrium occurs when spending is equal to output.  

To see why, recall that equilibrium is a state in which there is no tendency to change.  Suppose that spending is less than output, or that purchasers aren't willing to buy all of the output that firms are producing.  When this happens, firms are left with unsold merchandise, which makes them reduce their output. 

If spending is instead greater than output, purchasers must be buying more output than firms are producing.  Firms would quickly discover that their storerooms were running out of products and increase output. 

Rising or falling output exhibits a "tendency to change" that tells us that the economy is not in equilibrium.  Clearly, equilibrium can occur only when spending equals output.  Only then are firms satisfied with the amount of output they're producing.

Spending is made up of these components:  consumption, investment, government spending, and net exports.  Spending will rise if consumption, investment, government spending, or exports go up, or if imports go down.   It falls if consumption, investment, government spending, or exports go down, or if imports go up.  

In the simple Keynesian model, spending is what determines the level of output or GDP.  Output passively rises or falls to match it.

 

 

Lori Alden, 2005-7.  All rights reserved.  You may download the content, provided you only use the content for your own personal, non-commercial use.  Lori Alden reserves complete title and full intellectual property rights in any content you download from this web site. Except as noted above, any other use, including the reproduction, modification, distribution, transmission, republication, display, or performance, of the content on this site is strictly prohibited.