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GDP and total planned spending
When the level of income increases either through employment or other sources of income such as business, the gross domestic product also increases. People tend to do more purchases, and this means increased spending. However, this does not influence people’s interest in obtaining money from banks and other lending institutions. Interest rate is the key factor that determines whether people take loans or not, when the rates go down, demand goes up. Changes in prices may not have a direct effect on the gross domestic product and the planned expenditures because this is determined by the money that is in supply. Prices affect demand for funding negatively. This is because when prices go up, demand goes down hence people are constrained from doing extra purchases by the increased prices.
When people get employment and money from other sources of income, they gain wealth. How they spend their accumulated money is not determined by its availability but other factors; they include prices of imported products and foreigner’s income. Interest rates affect the way money is spent because if they go down, people borrow to invest and establish businesses. If the rates go up, the level of spending goes down because people avoid borrowing. Therefore, whether prices go down or not, it is the interest rate that influences spending. However, the rates do not affect the gross domestic product directly given that spending does not reflect its results immediately. It is a long term process.
GDP and the aggregate planned expenditure will always remain balanced as long as the autonomous expenditures do not influence the level of GDP. These expenditures are controlled by adjusting the interest rates to favor or discourage autonomous expenditure accordingly. When the rates rise, autonomous expenditure goes down and increases in the fall of interest rates. Therefore, the interest rates, do not affect the GDP but the other expenditures which are not factored while obtaining the GDP.
Aggregate demand for funding about expenditure is not significant because purchasing is not influenced by the money available. It is influenced by the money that is in circulation which is consequently influenced by the interest rates. On the other hand, Aggregate supply of funding increases spending thus the gross domestic product is only influenced by increased levels of output.
For a firm to obtain maximum profits, the costs should increase at the same rate as the revenue generated. When the cost of production decreases and the prices of units increase, revenue increases. Exceeding the minimum profits expected by a company yields economic profits. This attracts new entrants. An increase in the number of firms is expected to bring the prices down to their original position. However, this does not happen because entry barriers limit the number of new entrants that join the industry. Thus despite the new entrants, demand cannot be adequately met thus the prices remain higher than the original ones. The output is also limited by an increase in costs as a result of industry expansion.
Economic profits go down with the expansion of an industry because the more the players, the more demand for raw materials, which triggers price increase. Demand for labor also makes the employees ask for higher wages. Thus, the cost of production increases. Once this increase, it is evident that increased demand only results in a rise in prices and output while the profits remain the same. On the other hand, if the cost of production decreases the output level increase. This increases supply and firms are bound to increase the demand for their products. This is achieved by price reduction, which leads to increased economic profits. This attracts new entrants who consequently lead to decreased sales volume. If the sales volume decreases, the output is reduced. The revenue goes down by the same amount that costs had gone down.
If demand goes down, a firm reduces its output and the profits obtained will be unusually low. This will trigger other firms to leave the industry. If they leave, output reduces, and this increases demand. The prices go back to normal and the firm remains in business while still making profits. If costs increase, prices go up, and output levels go down. Firms leave the industry, and this triggers production costs to go down because of the demand for raw materials and labor decreases. Therefore, the size of an industry determines the prices of products and profitability achieved. If the industry is small, profitability is easily achieved. If the industry expands, profitability goes down.
Funding adjustment is necessary when the aggregate demand for funding is unequal with the aggregate supply of funding. GDP and the aggregate planned expenditure imbalance also cause output adjustments. When the aggregate demand for funding is greater than the aggregate supply of funding, the people who have more than sufficient funding seek to lend while those with insufficient seek to borrow. This process is unconscious and is driven by individual needs. If the money deposited by those with access money is not enough to loan those with insufficient, then the financial institutions raise interests on the money deposited and the loans, as well. This causes aggregate supply for funding to rise while aggregate planned expenditure falls and the demand for funding may fall.
When the supply for funding is more than the demand, those with excess funds will seek to lend while those with insufficient funds will seek to borrow. Since funds are more, money for lending will be more than what people are willing to borrow. The financial institutions will raise lower the interest rates on money deposited to discourage deposits and lower the interest rates on loans to encourage borrowing. These processes are carried out to adjust funding, but they also affect the Gross domestic product and the planned expenditures. These consequently trigger the output price adjustments among the producers. When the GDP is less than the planned expenditures, this is adjusted through increased employment, higher output in industries, and lowering the interest rates. On the contrary, when the planned expenditures are less than the GDP, firms experiencing excess demand will raise output and increase prices while those experiencing less demand will cut their prices and lower their output.
When the planned expenditures exceed the gross domestic product there will be a demand shortage and firms will decrease prices and output. This causes the GDP and prices to go down. This is adjusted through less employment, less output, and also increasing the interest rates. Macroeconomic coordination is an automatic process that is controlled by individual needs and production costs. The financial institutions serve to facilitate this process by adjusting interest rates.
An increase in the aggregate planned expenditure
An increase in the aggregate supply of funding and a fall in GDP are some of the shocks that affect the macroeconomic coordination process. When demand increases, funding is inadequate because of the planned expenditures increase. This will cause a rise in the interest rates and also an increase in output from the suppliers. This also causes increased employment and prices. The GDP then rises with the rise in the planned expenditures obtaining equilibrium in the economy.
The money in circulation increases with the demand for funding. The lending institutions respond by lowering the interest rates, and this increases the borrowers. The availability of funds encourages businesses to increase their output and prices, as well. This also creates a demand for funding and the gross domestic product becomes less than the planned expenditures. When the supply for funding is increased, the interest rates fall, and the adjustment process necessitates interest rates to rise. This way the output by producers will be increased, prices and the profitability go down.
A decline in the production cost attracts many firms into the industry. As a result the output increases. Once output rises, the prices also go down because demand is exceeded by supply. Employment and profitability rises resulting in increased economic profits. This triggers the interest rates to fall because there is enough money in circulation. Once the prices start falling, employment decreases, interest rates go down, and the prices go down, as well. The situation goes back to its initial level before the reduction in costs.
During the adjustment process, when the interest rates drop the GDP also goes down. When this happens, the planned expenditures are expected to be rising, and this is when inflation occurs. The force that triggers GDP to fall, also causes the output in production to rise, and this responds to meet the demand created by increased expenditures. This triggers the prices and interest rates to increase, and this begins the restoration process for the GDP. It is also adjusted through increasing employment and output.
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Ashby, David B. Money Mechanics Monetary Economics Reengineered with an Attitude and a Policy Agenda. 2009. Web.