Page 73 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes This is the basic approach. From this, we can derive another approach. Since Y equals C+S and
the AE equals C+I, the equilibrium is determined where:
Y = AE

or C + S = C + I
or S = I
The two approaches are explained below:
Y = C + I approach

National income is in equilibrium when income (Y) equals AE (C+I).
Y = C + I
Graphically (Figure 4.5), the equilibrium is at the intersection of the AE curve and the 45 line.
º
The 45 line represents all the points on the graph where Y equals C+I. Therefore, the intersection
º
at E shows equality of Y and C+I. This intersection is sometimes called Keynesian Cross. The
equilibrium level of income is OM.
Figure 4.5

What happens if Y is not equal to C+I ?
If planned income is not equal to planned AE, adjustment takes place to make them equal again.
Suppose Y is less than AE. This is the situation to left of E in the diagram, at A on the AE curve.
1
It means that output produced is less than the output purchased. It is possible only when a
portion of the accumulated stock of goods and services, called inventories is also sold. The
inventories decline. This is an unplanned decline. To raise the inventory level again, the producers
increase output. They make more purchases of inputs including labour. This leads to rise in
income of those from whom the inputs are purchased. National income rises and also rises
along with it is the consumption. Income and consumption continue to rise till the equilibrium
is reached again.
Now suppose Y is more than AE. It means that output produced is more than the output purchased.
The unsold portion goes to increase the inventory level. This is unplanned increase in inventory.
To eliminate the unplanned increase, producers reduce output. They make less purchases of
inputs. This leads to fall in income of the input producers. Consumption also falls along with it.
Income and consumption continue to fall till the equilibrium is reached again.
S = I approach

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