A2 Economics – National income equilibrium

Unit 9 of the new CAIE Economics course looks at national income and the 45 degree line graph. The graph below covers what you need to know and is one of the more complex graphs in the course. Aggregate expenditure shows the quantity of goods and services which households, firms and government are prepared to buy at different values of the general price level. The early classical economists believed that the size of the aggregate expenditure for output would be sufficient to employ everyone who wanted to work. John Maynard Keynes suggested that the achievement of a full and stable level of employment required the government to play an active part in determining the level of total expenditure. This policy known as demand management, was adopted by most governments in the post-war period. If a government is to manage aggregate demand effectively, it must be capable of influencing the components of aggregate demand i.e.. C+I+G+X-M. Government spending and taxation will be important instruments for this purpose, and by running budget deficits (spend more than they earn) or surpluses(spend less than they earn), the government can inject or withdraw purchasing power into or from the economy. Demand management policies were applied with considerable success in the two decades following the end of Second World War. Unemployment and inflation remained at very low levels throughout this period. However, these policies have proved to be much less successful since the mid-1960s.

The components of Aggregate Demand   – AD = C + I + G + X – M

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