• So far, we have discussed national income, price level, rate of interest, etc., in an ad hoc manner without investigating the forces that determine their values.
• The main goal of macroeconomics is to develop theoretical tools, known as models, to describe the processes determining the values of these variables.
• Specifically, these models aim to provide theoretical explanations for questions such as what causes periods of slow growth, recessions, price level increases, or rises in unemployment.
• It is difficult to account for all variables simultaneously, so when concentrating on one variable’s determination, we must hold the values of all other variables constant.
• This is known as the assumption of ceteris paribus, meaning “other things remaining equal.”
• The procedure can be thought of as solving for two variables, x and y, from two equations, by first solving for one variable (e.g., x) in terms of y and then substituting it into the other equation for the complete solution.
• The same method is applied in the analysis of the macroeconomic system.
• This chapter focuses on the determination of National Income under the assumption of fixed prices for final goods and a constant rate of interest in the economy.
• The theoretical model used is based on the theory given by John Maynard Keynes.

AGGREGATE DEMAND AND ITS COMPONENTS

• Consumption, investment, and the total output of final goods and services in an economy (GDP) have dual connotations.
• In Chapter 2, these terms were used in the accounting sense, representing actual values of these items measured by the economy’s activities in a given year.
• These actual values are called ex post measures of the items.
• However, these terms can also have a different meaning, where consumption refers to what people planned to consume, not what they actually consumed.
• Similarly, investment can denote what a producer plans to add to her inventory, which may differ from the actual outcome.
• For example, if a producer plans to add Rs 100 worth of goods to her stock by the end of the year, her planned investment is Rs 100.
• However, due to an unforeseen upsurge in demand, she sells more goods than planned, and to meet the extra demand, she sells goods worth Rs 30 from her stock.
• Therefore, her actual investment at the end of the year is Rs (100 – 30) = Rs 70.
• The planned investment was Rs 100, while the actual (ex post) investment was Rs 70.
• The planned values of variables like consumption, investment, or the output of final goods are referred to as ex ante measures.
• In simple terms, ex-ante refers to what has been planned, while ex-post refers to what has actually happened.
• To understand the determination of income, it is important to know the planned values of different components of aggregate demand.