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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 GAP 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 = GAP) is a model that uses the relationship between aggregate expenditures and output to determine the equilibrium bevel 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 (GAP) 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 GAP or where C+l 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 l) 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. In the graph above we can see that the equilibrium level of GAP is at $470 billion, where the saving and investment schedules intersect. Only at this point do households and businesses save and invest at the same rates and only here will GAP and C +1 be equal.
Question 2 The ‘national economic stimulus strategy and national building for recovery strategies’ could bring about an economic recovery because of deliberate manipulation of taxes and spending by Mr. Rudder’s government for the repose of altering real output and employment, controlling inflation and stimulating growth. The Government will implement the above strategies by using expansionary fiscal policy which will entail increases in government spending, lower taxes or combine these actions, thus increasing disposable income which leads to increases in spending and will assist the economy to recover from recession or depression.
This will move the government’s budget towards a deficit, but away from recession. In the graph below we can see that government spending increases the equilibrium and causes it to shift o the right. Like investment, government spending is an offset to the leakage of saving. In the graph below we can see the influence taxes have on equilibrium and causes it to shift to the left as taxes are seen to be a leakage. In the graph below we can see the influence exports and imports have on the equilibrium and the effect an increase in net exports (C + + G + NIX)2 has compared to a decrease in net exports (C + + G + NIX)I.
From the analysis of fiscal policy and the open governed economy, the simple multiplier would be inadequate for incorporating all the information above ND leakages likely to stem the expenditure flows that provide a multiplier effect. The multiplier that should be used is the complex multiplier (K) that results when all leakages (saving, taxes and imports) are taken into account and is represented below. The complex version of the multiplier highlights the importance of the size of the MET, MSP and PM.
The larger each of these components and their total, the smaller the size of the multiplier. This is valid, because these leakages are reducing the size of the successive rounds of expenditure on goods and revises that forms the basis of the multiplier process. Question 3 There are two basic determinants which determine the level of investment spending in the economy which are: ;The expected rate of net profits that businesses hope to realism from investment spending. Businesses are motivated by profits and invest if they expect a net profit from their investment. The rate of interest paid to finance investment. The real rate of interest is the inflation adjusted cost associated with borrowing money to purchase the required capital goods and it equals the nominal interest rate sees the inflation rate. Business will only invest if there net expected profit rate exceeds the real rate of interest. The graph below shows the relationship between investment and interest-rate. It shows the cumulative level of investment demanded at various possible levels of the interest rate.
Shifts in the demand curve can occur when there are changes in the non- interest determinants of investment demand (operating costs, business taxes, technological change, the stock of capital goods on hand and expectations). If there are changes which increases net profitability of investment it will shift he investment demand curve to the right. Conversely, anything that decreases the expected net profits ability Of investment will shift the investment demand curve to the left.
The adverse profits and inventories data that was released could lead to a collapse in investment. By there being an excess stock of capital goods on hand it influences the expected profit rate from additional investment in a given industry it also means the industry is well stocked with productive facilities and inventories, which will reduce investment because the industry is fully equipped to fulfill present and future rake demand at prices which give ordinary profits.