Determination of Equilibrium of Income, Output,

8/3/2019 Determination of Equilibrium of Income, Output,

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DETERMINATIONOFEQUILIBRIUMOFINCOME,OUTPUT, EMPLOYMENT

In the context of Keynesian economics the conceptsIncome,output,employment are closely related to each other.

Output refers to value addition and value addition implies generation ofincome.

Further Keynes believes that there is one to one relationship betweenthe level of output and level of employment. Accordingly the level ofoutput is identified with the level of employment. Thus equilibrium levelof output implies equilibrium level of income, equilibrium level of outputimplies equilibrium level of employment.


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WHATISEQUILIBRIUM?

Equilibrium is a state of balance.


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WHATISEQUILIBRIUMLEVELOFINCOME

Equilibrium level of income ( output) refers to thatlevel of income where

AS= AD

What is AS?

What are its components?

What is AD?What are its components?


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Another angle of looking at the equilibrium,

AS = AD

AS = C+S

AD = C+I

AS = AD = C+S = C+I

AS = AD

OR

S= I


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AS FUNCTION

(As function is assumed to be constant in the Keynesianframework)

AS is identified as 45 degree line from the origin. This is because each point on the 45-degree line equates

the variable measured on the vertical axis with thevariable measured on the horizontal axis.


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AS curve does not move upward or downward. Movingalong the AS function

Any movement from left to right shows increase in AS(corresponding to the proportionate increase inemployment)

Any movement from right to left is decrease in AS (

corresponding to the proportionate decrease inemployment)


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AS ISSAIDTOBEPERFECTLYELASTIC.

It means that AS converges at all levels of AD. IfAD happens to be more than of less than AS,then AS will adjust itself to AD to restore theequilibrium level of output.


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QUESTIONS

What is Aggregate demand (AD)?

What is Aggregate supply? (AS)?

List the components of Aggregate demand and

Aggregate supply.


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AD FUNCTION

AD is the sum of C+ I

What is consumption function?

The relationship between consumption and income.

C= Autonomous consumption + marginalPropensity to consume.

There is consumption even when the income is zero.That is autonomous consumption.

Consumption increases with increase in income. Theratio of change in consumption to the change in incomeis called marginal propensity to consume.


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DIFFERENCEBETWEENAVERAGEPROPENSITYTOCONSUMEANDMARGINALPROPENSITYTOCONSUME

The average propensity to consume is the ratio ofconsumption expenditure to any level of income.

If income is Rs.100 crore and consumption isRS.80 crores then,

Then the average propensity to consume is 80/100.


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If the income increases from 100 to 200 crores andconsumption from 80 -120 crores the

Marginal propensity to consume = ratio of increasein consumption/ increase in income.

Thus MPC = 40/100


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MARGINALPROPENSITYTOCONSUME

Diagramatic illustration


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DIAGRAM ( CONSUMPTIONFUNCTION)

In the diagram OC is the minimum level of consumption. =(a)

C increases as Y increases

Increase in C, per unit increase in Y refers to Marginalpropensity to consume. It is the slope of the C function.

Rate of increase in C < Rate of increase in Y.

Eg. Increase in income by Rs.100 part of it used forconsumption and rest is saved.

At point Q, Y=C Prior to the point Q , C> Y

Beyond point Q , C< Y

.


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INVESTMENTFUNCTION

In the context of equilibrium level of income/output , Keynes focuses on autonomousinvestment rather than induced investment.

What is autonomous investment?

An investment which is not influenced byprofitability or level of income is calledautonomous investment.

Hence investment function of Keynisianframework is drawn as a horizontal line. Whateveris the level of income ,the investment remainsconstant.


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INVESTMENTFUNCTION ( DIAGRAM)


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SUMMATIONOF C FUNCTIONAND I FUNCTION

Diagram.

Cfunction and I function are combined to get AD

function. Constant value of I is added to different values of

C to get C+I

Example

If I = 20 and C= 40 so that C+I= 60 .this is whenY=0.

Likewise when Y= 80 , when C= 60 and I=20 andC+I= 80.


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EXPLAIN WITHTHEHELPOF ADIAGRAM AD=ASDETERMININGEQUILIBRIUMLEVELOFINCOME

Equilibrium level is determined at that point whenAD=AS.

AD represents total expenditure on goods andservices.

AS refers to total production or countrys national

income. Thus AS =Y

Diagram.


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WHY is there an equilibrium when AS=AD

It is a situation in an economy all that is producedis fully purchased. The producer do not suffer 1)the burden of unwanted supply

2) the loss of unfulfilled demand due tolack of stocks.


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S=I Approach

Explain with the help of S&I curve the equilibriumlevel of income in an economy.

Diagram.

The equilibrium level of income is determined ata point where saving and Investment are equal.

In the diagram Q is the point of equilibrium where

S= I.


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TABLE

Income (Y) ConsumptionC Saving (Y-C) Investment

0

100175300350400450

500

25

100156250287.5325362.5

400

-25

0195062.57587.5

100

75

757575757575

75

Equilibrium isstruck whenS=I=75

Equilibrium levelof income=400.


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SIMULTANEOUSEQUALITYBETWEENAD=AS ASWELLAS S=I.

Diagram.

In the diagram OL is the equilibrium level of income, output and employment.

Explain the equilibrium level of income with thehelp of Saving and Investment curves andaggregate supply and aggregate demand curves.


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WHATHAPPENS IF AS> AD

The flow of goods and services in the economytends to exceed their demand.

Some of the goods remain unsold.

To clear unwanted stocks, the producers wouldplan a cut in the production .

In the following year , AS would reduce to becomeequal to AD.


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WHATHAPPENSIF AS


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DIAGRAMATICREPRESENTATION

AS >AD

AS < AD


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WHATHAPPENSWHEN S>I ORS


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WHATHAPPENS WHENTHEECONOMY ISNOT INEQUILIBRIUM ANDSAVINGEXCEEDSINVESTMENT

This leads to accumulation of unintendedinventories. To avoid this, businessmen will reduceproduction . Consequently output , income, andemployment will be reduced till the equilibrium

level of income.


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UNDEREMPLOYMENTEQUILIBRIUM

It is a situation of equilibrium between aggregatedemand and aggregate supply at which all theresources are not fully used. Some resources areunderutilised.

This situation is caused not by low level ofaggregate supply but by the deficiency ofaggregate demand. When level of demand is lessthan full employment level of output it is called

deficient demand which pushes the economy intounderemployment.

Diagram.


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Equilibrium level of income , output or employmentdoes not necessarily mean full employment.

What the producers plan to produce and what thebuyers plan to buy may or may not coincide withfuller utilisation of resources.

Your resources may permit production worth Rs.10

million in an accounting year. but with a view tomaximising profit , you may plan output worth Rs.5billion in the accounting year. Equilibrium will bestruck if buyers also plan to buy worth Rs. 5 billiononly. Thus resources are not fully utilised , you

could increase output by Rs. 5 billion.


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SHIFTIN EQUILIBRIUM

Injections can cause increase in the level of AD,

withdrawals cause decrease in AD. Injections come in the form of government

expenditure or exports or such variables.

Withdrawals come in the form of government

govt taxes or imports or such other variables. Diagram.

Owing to injections of govt expenditure ,equilibrium level of income /output shifts upwards

from point A to point B and Owing to withdrawals in the form of taxes,

equilibrium level of income/output shiftsdownwards from A to C.


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INJECTIONSANDWITHDRAWALSHAVEMULTIPLIEREFFECT.

Documents

Determination of Equilibrium of Income, Output,