SESSION 1: THE DETERMINATION OF ECONOMIC ACTIVITY
In the previous session, we illustrated the flows of outputs, incomes, and expenditures around an economy in the form of the circular flow of income model, which is a useful diagrammatic summary of economic activity.
We now turn to discuss the determination of these flows, i.e. the underlying dynamics of the macroeconomy.
- Session 1: Macroeconomics and Business
- Session 2: Macroeconomic Policies and Economic Policies
- Session 3: Government and the Economy
- Session 4: National Income Accounting
- Session 5: Factors Influencing the Size of National
- Session 6: Circular Flow of Income
We are essentially interested in understanding what causes the level of economic activity to rise or fall in the short term around an economy’s long-term growth path. Such fluctuations in economic activity give rise to what are known as business cycles, in which the rate of growth in production periodically rises and falls.
Objectives By the end of this session, students should be able to:
- (a) appreciate the meaning of national income equilibrium
- (b) explain planned (ex-ante) and realized (ex-post) expenditures
- (c) distinguish between planned (ex-ante) and realized (ex-post) expenditures
- (d) recognize the factors that impact Planned spending
Now read on…
In the previous session, we established the meaning of equilibrium in an economy. This concept will now be used in terms of the level of national income.
1.1 National Income Equilibrium
The starting point for an analysis of fluctuations in economic activity is the concept of an equilibrium national income, as introduced in the previous session.
By the term equilibrium, economists mean a state of affairs in which the forces that are influencing change in opposite directions are perfectly balanced so that there is no tendency to change.
National income equilibrium occurs when the planned expenditure on goods and services is just equal to the actual supply of goods and services available in the economy. There is then no tendency for economic activity to rise or fall. If planned expenditure exceeds the output of goods and services, however, either output or prices, or both, will tend to rise, and if output exceeds planned expenditure either prices or output, or both, will tend to fall.
Therefore, National Income Equilibrium occurs when Aggregate supply is the total output of the economy (i.e. national income) and is commonly denoted by the letter Y while Aggregate planned expenditure (denoted as AE) is made up of planned Consumption, planned Investment, planned Government spending and planned expenditure on Exports minus planned expenditure on Minus.
Therefore, the national equilibrium condition income can be expressed as: Ye = AE = C + I + G + (X − M) where Ye represents the equilibrium level of national income (output)
1.2 Distinction between Planned and Actual Expenditure
Before proceeding, it is crucial to grasp the significance of planned and actual expenditure with respect to the determination of national income equilibrium.
1.2.1 Planned expenditure
Planned expenditure is also referred to as intended or ex-ante expenditure. It is made up of planned spending by consumers, the investment plans of firms, planned spending by the government as well as export and import spending plans. These plans will be based on a host of factors including
- the current (and perhaps expected) level of income of consumers
- business confidence and employment levels,
- government objectives, the government’s budgetary position
- foreign exchange rates and so on
1.2.2 Actual expenditure
Actual expenditure is also referred to as realized or ex-post expenditure It refers to the consumption, investment, government spending, and net exports actually achieved.
This outcome may differ from the planned amounts; i.e. planned expenditure may differ from actual expenditure.
In this session, we introduced the meaning of national income equilibrium and explain planned (ex-ante) and realized (ex-post) expenditures. We also distinguished between planned (ex-ante) and realized (ex-post) expenditures and concluded by looking at the factors that impact planned spending.
Questions Exercise 2.1
- Briefly explain the national income equilibrium
- Distinguish between (ex-ante) and (ex-post) expenditures.
- List the factors that impact Planned spending
- What are the components of equilibrium national income?