Question

State with reasons whether you agree or disagree with the following statements.
1) Aggregate demand depends only on the consumption expenditure.
2) Aggregate supply is influenced by the state of technology only.
3) Positive net earnings from foreign transactions add to aggregate demand.
4) At break-even point, consumption (C) is equal to income (Y).
5) Savings are negative before break-even point.

Answer 1

1) The above statement is incorrect. Apart from consumption expenditure, the aggregate demand also depends on the investment, government expenditure and net exports. It consists of the following components.

Demand by households - Private consumption expenditure (C)
Demand by firms - Private investment expenditure (I)
Demand by government - Government expenditure (G)
Demand by foreign sector- Net exports (X – M)
Where, X is exports and M is imports.
Thus,
AD = C + I + G + (X – M)

2) The above statement is incorrect. Besides, the state of technology, the aggregate supply is affected by various other factors as well, namely, natural resources, labour force and stock of capital. The aggregate supply function can be represented as follows.
$AS=f\left(\overline{N},\overline{L},\overline{K},\overline{T}\right)$
Where,
AS = Aggregate supply
N = Natural resources
L = Labour
K = Stock of capital
T= State of technology

3) Positive income from foreign transactions implies that the income of the people increases. Aggregate demand is a direct function of the net positive income earnings from foreign transactions. As such income increases the aggregate demand also increases.

4) Breakeven point is a point where consumption exactly equals income and correspondingly, savings are zero. Graphically, it is determined at the intersection of the income line or the 45 degrees line and the curve. Algebraically, breakeven is achieved when Y = C

5) The above statement is correct. Breakeven point is achieved where consumption exactly equals income and correspondingly, savings are zero. Below this point consumption exceeds income. In such a situation consumption is financed by drawing from past savings, that is the savings are negative.