The actual investment equals planned investment formula is an important concept in macroeconomics, specifically in the Keynesian model. It describes the equilibrium condition where total actual expenditure in an economy equals total planned expenditure. This condition is key to understanding how output and income are determined in the short run. The formula relates to core Keynesian ideas about the determinants of consumption and investment spending, and how changes in autonomous expenditure can lead to changes in equilibrium income through the expenditure multiplier. In this article, we will explore the meaning and intuition behind the actual investment equals planned investment formula, and analyze its significance within the Keynesian framework for macroeconomic analysis.
The formula equates actual expenditure with planned expenditure
The actual investment equals planned investment formula simply states that AE = PE, where AE is actual expenditure and PE is planned expenditure. Actual expenditure refers to the total amount actually spent on consumption, investment, government spending and net exports in the economy over a time period. Planned expenditure is the total amount that firms, households and governments intended or planned to spend over that time period. The equilibrium condition is that actual spending matches planned spending. If actual spending falls short of planned spending, inventories build up unexpectedly, causing firms to cut back production. If actual spending exceeds planned spending, inventories decline unexpectedly, prompting firms to increase production.
It reflects equilibrium where supply meets aggregate demand
This condition of equality between actual and planned expenditure reflects an equilibrium where production meets aggregate demand. The total value of goods supplied in the economy equals total planned expenditure or aggregate demand. When the equilibrium is disturbed, market forces drive the economy back to equilibrium. For example, if planned expenditure falls short of actual production, there is excess supply. Firms are left holding unintended inventories and respond by cutting production. This reduces income and actual expenditure, moving the economy back towards equilibrium where AE=PE.
It relates to the Keynesian cross diagram
The actual investment equals planned investment formula is represented visually in the Keynesian cross diagram. This shows planned aggregate expenditure as a function of national income. The 45 degree line shows actual expenditure, which by definition must equal actual income or production. Equilibrium occurs where the two lines intersect at the point where actual expenditure equals planned expenditure. If planned spending exceeds actual income, production ramps up. If actual income exceeds planned spending, production declines. The adjustment occurs through changes in inventories.
It underpins the expenditure multiplier concept
The equilibrium condition that actual spending equals planned spending is key to the Keynesian multiplier concept. An initial increase in autonomous expenditure, such as investment, leads to a greater increase in equilibrium income through the multiplier effect. Higher income induces more consumption spending, further increasing aggregate demand and income. The process continues in rounds until the increase in actual expenditure matches the initial increase in planned expenditure. The multiplier effect is made possible by the induced consumption resulting from the actual investment equals planned investment equilibrium condition.
The actual investment equals planned investment formula is a core part of Keynesian macroeconomics. It represents the equilibrium where actual expenditure matches planned expenditure, and any divergence sets market forces in motion that restore equilibrium. The formula relates to Keynesian concepts of aggregate demand, the expenditure multiplier and the determinants of consumption. By equating actual and planned spending, it lays the foundation for explaining how output and income are determined in the short run.