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output Y is Y F, which is greater than the value of output 0Y = Y E by an* 1 1 1 1 1 amount E F.1E F 1easures the amount of excess demand that emerges in the economy as a result of the increase in autonomous expenditure. Thus, E no 1 longer represents the equilibrium. To find the new equilibrium in the final goods market we must look for the point where the new aggregate demand o line, AD 2 intersects the 45 line. That occurs at point E , 2hich is, therefore, the new equilibrium point. The new equilibrium values of output * and aggregate demand are Y and2 AD ,2respectively. Note that in the new equilibrium, output and aggregate demand have increased by an amount E G =1E G, wh2ch is greater than the initial increment in autonomous expenditure, D I = E F = E J. Thus an initial 1 2 increment in the autonomous expenditure seems to have a multiplier on the equilibrium Fig. 4.7 values of aggregate demand and Equilibrium Output and Aggregate Demand in output. What causes aggregate the Fixed Price Model demand and output to increase by an amount larger than the size of the initial increment in autonomous expenditure? We discuss it in section 4.3.3. 4.3.3 The Multiplier Mechanism It was seen in the previous section that with a change in the autonomous expenditure of 10 units, the change in equilibrium income is equal to 50 units (from250to300).Wecanunderstandthisbylookingatthemultipliermechanism, 61 which is explained below: n D The production of final goods employs factors such as labour, capital, E re land and entrepreneurship. In the absence of indirect taxes or subsidies, the m m total value of the final goods output is distributed among different factors of l an m o production – wages to labour, interest to capital, rent to land etc. Whatever is e n left over is appropriated by the entrepreneur and is called profit. Thus the t f sum total of aggregate factor payments in the economy, National Income, is n equal to the aggregate value of the output of final goods, GDP. In the above m e example the value of the extra output, 10, is distributed among various factors as factor payments and hence the income of the economy goes up by 10. When income increases by 10, consumption expenditure goes up by (0.8)10, since people spend 0.8 (= mpc) fraction of their additional income on consumption. Hence, in the next round, aggregate demand in the economy goes up by (0.8)10 and there again emerges an excess demand equal to (0.8)10. Therefore, in the next production cycle, producers increase their planned output further by (0.8)10 to restore equilibrium. When this extra output is distributed among factors, the income of the economy goes up by (0.8)10 and consumption demand increases further by (0.8) 10, once again creating excess demand of the same amount. This process goes on, round after round, with producers increasing their output to clear the excess demand in each round and consumers spending a part of their additional Reprint 2026-27