Page 4 - lesson note -Income Determination and Multiplier-44

Let us examine the situation where autonomous consumption increases from C o to
C 1. This causes a shift of the curve and AD shifts upward from AD to AD 1. At
the current output level, there will be excess demand (EG) but in the short-run,
prices cannot change so quickly. So, the equilibrium must change. The new AD
curve (AD 1) intersects the 45º line at a higher point ‘E 1’. This is the new
equilibrium point and the corresponding output level has increased from OY to
OY 1.