It is one of our eternal economic truths that without sufficient aggregate spending we can have no economic growth and no full employment. Aggregate spending or aggregate demand has four components (see core concept 2) which generate aggregate output – C,I,G, and (X-M). The question arises: what determines each of these elements of total spending? In this section we illustrate two ways of describing the effect of aggregate spending on output and prices: the first is the Keynesian 45 degree line and Keynesian consumption function diagrams. The 45 degree line is a set of equilibirum points where aggregate demand equals aggregate output (or income). Where the AD line intersects, we have an equilibrium point where there are no forces for change. The second and more popular depiction is an aggregate demand curve which plots price (or inflation) against output (or real GDP). We build this up carefully with a handout and a powerpoint. What we are seeking to understand are two things:

1. What causes the change in AD and how big will that change be on final output after multiple movements around the circular flow have resulted from the initial change in one of our four components. We repeat – without total spending going up there can be no economic growth year on year.
2. Under what circumstances is this spending growth inflationary? And what level of inflation might be thought of as ‘too much’? Here the expectations-augmented Phillips curve theory gives us crucial insights into how price rises feed on themselves, through their effects on wages, into an inflationary spiral.

And keep an eye on the Government’s current policy mix – to what extent is it using monetary or fiscal policy to fine tune some desired outcome? Or, as in the neoclassical school, does HM government leave the economy to find its own equilibrium, and simply strengthen market forces?