Page 3 - lesson note -Income Determination and Multiplier-44

In the above diagram

• Planned level of equilibrium is at point E, where planned aggregate
demand is equal to planned Aggregate supply accordingly OM is the full
employment.
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• Actual Aggregate demand is higher than the required level of
Aggregate demand AD to maintain full employment equilibrium.
|
• Actual equilibrium is determined at point which corresponds to over
full employment of resources.

Determination of Equilibrium Output under short run Fixed price Analysis: -

Under the effective demand principle, the equilibrium output of final
goods is determined by aggregate demand (AD) alone, as AS is assumed
to be price elastic.

AD = C + I
Usually the consumption function is given in the form C = + .
In two-sector model, we take investment to be ‘autonomous’ i.e. =

We can now write the AD equation from (i) as:
= + . +
0
= + + .

= ˃ = + .

We see that the AD curve ‘cuts’ the 45º line at point ‘E’, which is the equilibrium
point. Corresponding output level, OY is the equilibrium output. This is the
equilibrium situation for fixed prices in the short-run.