I have in my mind that: GDP = AD = National Income (Y) = C + I + G + (X - M) Could someone tell me whether this is correct please? It's just that I'm seeing in ASET for Sept 2012 paper (both Q19 and Q36) this: AD = C + I + G + X Y = C + S + T+ M and I'm not quite sure I'm following...
Aggregate Demand (AD) is equal to total spending on domestically produced goods and services. AD is always equal to Cd + I + G + X, ie the sum of the different types of spending on domestically produced goods and services. National output (Y) is equal to the total output of domestically produced goods and services by all firms. We assume that the value of this output is paid as income to the owners of factors of production (in return for using their labour, capital etc), ie it is also equal to total national income. This income is then assumed to be spent on either domestic consumption (Cd) or it is withdrawn from the circular flow of income, as net savings (S), net taxes (T) or imports (M). So, by definition: national output / national income, Y = Cd + S + T +M If AD is then equal to Y, then the total output produced by firms will exactly equal to the total spending on that output, in which case the economy is in equilibrium and there is no reason for anything to change. However, it is quite possible for AD not to equal Y. For example, if firms produce 100, so Y = 100, but total spending on that output is only AD = 90, then firms will be left with 10 of unsold goods and so will cut back output to 90 next period. This means households will receive only 90 as income and so they'll cut back consumption and AD will fall to 85 say. So firms will cut back output further in the next period and pay even less income. Consequently, the economy will go round and round the circular flow of income, with output, income and expenditure all decreasing until Y and AD are again equal at a new lower level of national income. So, Y = AD only when the economy is in a state of equilibrium. In addition, exam questions will require you to solve this equation (or equivalently injections = withdrawals, I + G+ X = S + T + M) to find the equilibrium level of national income Y, at which this is the case. Finally, note that GDP is one of a number of measures of national output or income Y used in practice. Albeit, it's the measure that referred to most often in the book and it may be used to refer to national income Y. I hope this makes things clearer. Graham
