8.1 Introduction<\/strong><\/p>\n In Chapter 7, we introduced the concept of effective demand, within the original aggregate supply-aggregate demand framework (D-Z) developed by Keynes in the General Theory. Recall that Keynes defined the aggregate supply price of the output derived for a given amount employment as the “expectation of proceeds which will just make it worth the while of the entrepreneur to give that employment” (footnote to Keynes, J.M. (1936) The General Theory of Employment, Interest and Money<\/em>, Macmillan, page 24 – check page).<\/p>\n We learned that this concept related a volume of revenue received from the sale of goods and services to each possible level of employment. At each point on the aggregate supply price curve, the revenue received would be sufficient to cover all production costs and desired profits at the relevant employment level.<\/p>\n The other way of thinking about the aggregate supply price Z-function is to express it as the total amount of employment that all the firms would offer for each expected receipt of sales revenue from the production that the employment would generate.<\/p>\n The important point here is that the relationship was expressed in terms of employment and the revenue expected to be received at each output level. We should be clear that Keynes was considering aggregate supply in terms of the expectation of proceeds, which is the money income (revenue) that the firms expect to get from selling their output. Firms are thus considered to formulate plans to gain a volume of money or nominal profits.<\/p>\n Why did he choose to employment instead of output itself? The reason relates to the developments in statistical gathering in the period that he was developing his theory (published 1936). National Accounting as we know it today (analysed in Chapter 5) did not exist in 1936. There were no reliable estimates of output (real GDP) but estimates of total employment were more accurate and more readily available.<\/p>\n It is for that reason that Keynes used employment instead of output as his measure of aggregate activity. <\/p>\n In this Chapter, we thus have two tasks. First, to express the model developed in Chapter 7 in terms of output rather than employment. Second, to express the supply side and the demand in real terms.<\/p>\n There are two aspects to conceiving of the income-expenditure framework in real terms. First we consider that consumers, firms and governments desire to achieve real outcomes in terms of the command on real resources (output) they gain when they spend. Second, to overcome the fact that the aggregate supply approach developed in Chapter 7 was cast in money (nominal) terms (revenue or proceeds) we need to recast the supply-side in real terms.<\/p>\n We can do that by using the National Accounting concept of GDP at constant rather than current prices as our measure of economic activity. In other words, we are considering that firms cast their price and output decisions based on expectations of aggregate spending in order to achieve a real return over costs.<\/p>\n In this way, we do not diminish the importance of expectations in driving production and supply decisions by firms but we abstract from price changes and assume that firms react to changes in aggregate spending by adjusting the quantity of output rather than the price and quantity. There are various ways in which we can justify considering firms to be quantity adjusters.<\/p>\n First, we might assume that there is typically excess capacity and firms use mark-up pricing (adding a mark-up to unit costs) and face roughly constant unit costs over the relevant range of output.<\/p>\n Second, we might assume that firms face various costs in adjusting prices and as a result only periodically make such adjustments. It has been said that firms use “catalogue pricing”, whereby they make their prices known to their prospective customers through advertising and other means and thus stand ready to sell goods and services at those prices irrespective of demand. At the end of the current catalogue, they will then make any necessary adjustments.<\/p>\n We consider pricing models in more detail in Chapter 9.<\/p>\n In terms of advancing a theory of employment, we now need to consider an employment requirements function, which relates the output that firms expect to sell (and therefore produce) to employment via a productivity relationship. If we know how many employment units (we abstract here from the issue of how we will measure these units – in hours or persons) are required to produce one unit of real output then once we know the sum of the firm’s production plans then we also will know the aggregate or macroeconomic demand for labour. We consider those issues in Chapter 10 when we formally introduce the labour market.<\/p>\n 8.2 Aggregate Supply<\/strong><\/p>\n Figure 8.1 depicts the constant price aggregate supply relationship that we will work with in this Chapter to concentrate on the way the economy adjusts to changes in aggregate demand. It is drawn as a 450<\/sup> line emanating from the origin with total revenue (in constant dollars) on the vertical axis and real output on the horizontal axis.<\/p>\n
![\"\"](\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2012\/08\/Figure_8_1.jpg\" "\\"Figure_8_1\\"")
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