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Short Run Equilibrium Output Class 12 Notes PDF

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Short Run Equilibrium Output Class 12 Notes

Short-run is defined as a period of time during which ‘technology’ plays no role in the determination of output in the economy. It is assumed to remain constant. Output is determined exclusively by the level of employment in the economy. A higher level of employment leads to a higher level of output, and vice versa.

Concept of Equilibrium Output

Equilibrium output (also called equilibrium GDP or equilibrium income) refers to that level of output in the economy where:

AS [Aggregate Supply] = AD [Aggregate Demand]

Determination of Equilibrium Level of Income

According to the Keynesian Theory, the equilibrium condition is generally stated in terms of aggregate demand (AD) and aggregate supply (AS). An economy is in equilibrium when aggregate demand for goods and services is equal to aggregate supply during a period of time.

So, equilibrium is achieved when:

AD = AS

We know, AD is the sum total of Consumption (C) and Investment (I):

AD = C + I

Also, AS is the sum total of consumption (C) and saving (S):

AS = C + S

Substituting (2) and (3) in (1), we get:

C + S = C + I

Or, S = I

It means, according to Keynes, there are Two Approaches for determining the equilibrium level of income and employment in the economy.

Two Approaches for Determination of Equilibrium Level

The two approaches to determine the equilibrium level of income, output and employment in the economy are:

1. Aggregate Demand-Aggregate Supply Approach (AD-AS Approach)
   
2. Saving-Investment Approach (S-I Approach) It must be kept in mind that AD, AS, Saving and Investment are all planned or ex-ante variables.

Assumptions

• The determination of equilibrium output is to be studied in the context of two- Sector model (households and firms). It means, it is assumed that there is no government and foreign sector.
  
• It is assumed that investment expenditure is autonomous, i.e. investments are not influenced by level of income.
  
• Price level is assumed to remain constant.
  
• Equilibrium output is to be determined in context of short-run.

Aggregate Demand-Aggregate Supply Approach (AD-AS Approach)

According to the Keynesian theory, the equilibrium level of income in an economy is determined when aggregate demand, represented by C + I curve is equal to the total output (Aggregate Supply or AS). If there is any deviation from the equilibrium level of output, i.e. when planned spending (AD) is not equal to planned output (AS), then a process of readjustment will start in the economy and the output will tend to adjust up or down until AD and AS are equal again.

When AD > AS

When planned spending (AD) is more than planned output (AS), then the (C + I) curve lies above the 45° line. It means that consumers and firms together would be buying more goods than firms are willing to produce. As a result, the planned inventory would fall below the desired level.

To bring the inventory back to the desired level, firms would resort to increasing in employment and output until the economy is back at output level OY, where AD becomes equal to AS and there is no further tendency to change.