Potential output is the economy’s output when inputs are fully employed.

Since markets trade the smaller of supply and demand, output is demand-determined when there is excess supply and wages and prices have yet to adjust to restore long-run equilibrium. Output then depends only on aggregate demand.

Personal disposable income is the income households receive from firms, plus transfer payments received from the government, minus direct taxes paid to the government. It is the net income households can spend or save.

The consumption function shows aggregate consumption demand at each level of personal disposable income.

The marginal propensity to consume is the fraction of each extra pound of disposable income that households wish to consume.

The saving function shows desired saving at each income level.

Investment demand is firms’ desired or planned additions to physical capital (factories and machines) and to inventories.

Aggregate demand is the amount firms and households plan to spend at each level of income.

When prices and wages are fixed, at short-run equilibrium output aggregate demand or planned spending equals the output actually produced.

The multiplier is the ratio of the change in equilibrium output to the change in autonomous spending that caused the change.

The marginal propensity to Save is the fraction of each extra unit of income that households wish to save.