Assume, for a hypothetical economy, the following data is given :
Income (Y) Consumption (C) Investment (I) Aggregate Demand (AD) 0 40 20 60 100 120 20 – 200 200 20 – 300 280 20 300
On the basis of the given data, it can be said that the equilibrium level of income is 200.
Do you agree ? If not, explain the adjustment mechanism that may take place to attain equilibrium level of income.
Assume, for a hypothetical economy, the following data is given :
| Income (Y) | Consumption (C) | Investment (I) | Aggregate Demand (AD) |
|---|---|---|---|
| 0 | 40 | 20 | 60 |
| 100 | 120 | 20 | – |
| 200 | 200 | 20 | – |
| 300 | 280 | 20 | 300 |
On the basis of the given data, it can be said that the equilibrium level of income is 200.
Do you agree ? If not, explain the adjustment mechanism that may take place to attain equilibrium level of income.
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Solution and Explanation
AD = C + I, so AD is 60, 140, 220 and 300 for income of 0, 100, 200 and 300.
In the income and expenditure approach, equilibrium is reached where AD = AS. Here AS equals the income Y.
Step 2: Test the income of 200:
At Y = 200, AD = 200 + 20 = 220. AS = 200.
AD is more than AS by 20, so 200 is not the equilibrium level. We do not agree with the statement.
Step 3: Find the true equilibrium:
At Y = 300, AD = 280 + 20 = 300, which equals AS. So the equilibrium level of income is 300.
| Income (Y) = AS | Aggregate Demand (AD) | AD compared with AS | What happens to output |
|---|---|---|---|
| 0 | 60 | AD > AS by 60 | Rises |
| 100 | 140 | AD > AS by 40 | Rises |
| 200 | 220 | AD > AS by 20 | Rises |
| 300 | 300 | AD = AS | Stays at 300 (equilibrium) |
Step 4: Explain the adjustment mechanism:
ex-ante AD is more than ex-ante AS. It means that households and firms plan to spend more than the firms plan to produce.
So the goods in stock with the producers fall below the desired level of inventories.
To rebuild the desired stock, the producers raise output. More output means more income and more employment.
This continues till output reaches 300, where ex-ante AD equals ex-ante AS. Then there is no push to change output.
Final Answer:
No. At income 200, AD (220) is more than AS (200), so the inventories fall and producers raise output until the equilibrium income of 300 is reached.
\[ \boxed{\text{Equilibrium income} = 300} \]
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