A surplus of goods in the economy will induce firms to lower prices to reduce their stocks which will lead to a fall in the general price level.
When goods and services produced at a particular point of time is multiplied by the respective prices of goods and services, it provides the total value of the national output.
A shortage of goods in the economy will induce firms to raise prices to increase their profits which will lead to a rise in the general price level. Nevertheless, government expenditure on transfer payments does affect aggregate expenditure through its effect on disposable income and hence consumption expenditure.
In other words, an increase in disposable income will lead to an increase in induced consumption and vice versa. Autonomous Investment Autonomous investment refers to investment that is independent of national income and is determined by interest rates, business sentiment, business costs, capital costs, corporate income tax, technological advancements and the availability of credit.
Therefore, the initial increase in aggregate demand due to the increase in aggregate expenditure as a result of the increase in autonomous expenditure will lead to increases in consumption expenditure and hence further increases in aggregate demand resulting in a larger increase in national output and hence national income.
Consumption expenditure depends to a large extent on expected future income. Many consumer durables are purchased on credit and hence an increase in the availability of credit will allow households to increase consumption expenditure.
As taxes flow from households to the government and transfer payments flow from the government to households, we can incorporate transfer payments into the circular flow model by subtracting them from taxes to derive net taxes.
Withdrawals are the factor income received by households that does not return to domestic firms as revenue. Similarly, beneath point E, the AD and AS schedules represent that the aggregate demand is more than aggregate supply. Unlike the Classical aggregate supply curve which is vertical, the Keynesian aggregate supply curve is inverse L-shaped.
Therefore, they seldom change substantially and hence do not affect consumption expenditure to a large extent. Therefore, the Keynesian aggregate supply curve is inverse L-shaped.