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24 February, 2016 - 16:12

The equilibrium occurs where aggregate expenditure (AE) is equal to aggregate real output (NNP):

AE=NNP. Should firm produce more, they will be forced to cut back production because of excess inventories. Should they produce less, they will have to increase production because their inventories will be depleted. The equilibrium may very well occur below the full employment level of output.

Figure 8.2 Aggregate Expenditure C+I

Businesses adjust their production to sales by observing their inventories. If the inventories are insufficient, production is increased. If the inventories are excessive, production is cut back.