In the remainder of this section, we build a framework around the ideas that we have just put forward. The framework focuses on the determinants of aggregate spending because, in this approach, the output of the economy is determined not by the level of potential output but by the level of total spending. This model is based around the idea of sticky prices—or, more precisely, it tells us what the output of the economy will be, at a given value of the overall price level. Once we understand this, we can add in the effects of changing prices.
Earlier, we introduced the national income identity:
production = consumption + investment + government purchases + net exports.
This equation must be true by the way the national income accounts are constructed. That is, it is an accounting identity. We also explained that
GDP = planned spending + unplanned inventory investment.
It is possible for firms to accumulate or decumulate inventories unintentionally, but such a situation will not persist for long. Firms quickly respond to such imbalances by adjusting their production. The aggregate expenditure model takes the national income identity and adds to it the condition that unplanned inventory investment equals zero—equivalently, gross domestic product (GDP) equals planned spending:
planned spending = consumption + investment + government purchases + net exports.
Another way of saying this is that as long as we interpret investment to include only planned investment, the national income equation is no longer an identity but instead a condition for equilibrium.
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