Output is at its equilibrium level when the aggregate demand for goods is equal to
the level of output.
Aggregate demand consists of planned spending by households on consumption, by
firms on investment goods, and by government on its purchases of goods and
services and also includes net exports.
When output is at its equilibrium level, there are no unintended changes in inventories
and all economic units are making precisely the purchases they had planned to. An adjustment process for the level of output based on the accumulation or rundown
of inventories leads the economy to the equilibrium output level.
The level of aggregate demand is itself affected by the level of output (equal to the
level of income) because consumption demand depends on the level of income.
The consumption function relates consumption spending to income. Consumption
rises with income. Income that is not consumed is saved, so the savings function can
be derived from the consumption function.
The multiplier is the amount by which a $1 change in autonomous spending changes
the equilibrium level of output. The greater the propensity to consume, the higher
the multiplier.
Government purchases and government transfer payments act like increases in
autonomous spending in their effects on the equilibrium level of income. A proportional
income tax has the same effect on the equilibrium level of income as a
reduction in the propensity to consume. A proportional income tax thus reduces
the multiplier.
The budget surplus is the excess of government receipts over expenditures. When
the government is spending more than it receives, the budget is in deficit. The size
of the budget surplus (or deficit) is affected by the government’s fiscal policy
variables—government purchases, transfer payments, and tax rates.
The actual budget surplus is also affected by changes in tax collection and transfers
resulting from movements in the level of income that occur because of changes in
private autonomous spending. The full-employment (high-employment) budget
surplus is used as a measure of the active use of fiscal policy. The full-employment
surplus measures the budget surplus that would exist if output were at its potential
(full-employment) level.
