Equilibrium expenditure occurs when
A) aggregate planned expenditure equals real GDP.
B) disposable income equals real GDP.
C) disposable income equals consumption expenditures plus imports.
D) real GDP plus net taxes equals disposable income.
E) real GDP minus net taxes equals disposable income.
The correct answer and explanation is :
Correct Answer: A) Aggregate planned expenditure equals real GDP.
Explanation:
Equilibrium expenditure in macroeconomics refers to the level of output (or real GDP) at which the total amount of goods and services produced (real GDP) is exactly equal to the total amount that households, businesses, government, and foreign buyers plan to spend (aggregate planned expenditure). This concept plays a critical role in the Keynesian model of income determination.
In this model, aggregate planned expenditure (AE) is the total amount that economic agents intend to spend at each level of income or output. It includes:
- Consumption expenditure (C)
- Investment (I)
- Government spending (G)
- Net exports (exports minus imports)
Mathematically:
AE = C + I + G + (X – M)
On the other hand, real GDP represents the actual output or income generated in the economy.
Equilibrium expenditure occurs when:
AE = Real GDP
At this point, there is no unplanned inventory accumulation or depletion. In other words, businesses are selling exactly what they produce—neither more nor less. If AE is greater than real GDP, businesses experience unplanned inventory depletion and will increase production. If AE is less than real GDP, businesses face unplanned inventory buildup and will cut production.
The Keynesian cross diagram often illustrates this equilibrium visually, showing where the AE line intersects the 45-degree line, which represents all points where AE equals real GDP.
Incorrect Options Explained:
- B) Disposable income equals real GDP — Incorrect because disposable income is real GDP minus net taxes.
- C) Disposable income equals consumption plus imports — Incorrect; imports are not part of disposable income.
- D & E) Both are identities relating to income distribution and taxes but not definitions of equilibrium expenditure.