Explain national income determination through the two alternative approaches. Use diagram.
The national income determination can be better understood with the help of given diagram. The two alternative approaches of national income determination are:
1. AD=AS
According to Keynes,
the equilibrium is reached only when aggregate demand (AD) equals aggregate
supply (AS) because at this level there is no tendency for income and output to
change.
In the diagram the equilibrium is at E where AD
intersects 45o line. At this point, AD = AS.
When AD is more than AS , then
the planned inventory would fall below the desired level. To bring back the
Inventory at the desired level, the producers expand the output More
output means more income. Rise in output means rise in AS and rise in
income means rise in AD. Both continue to rise till they reach K, where AD =
AS.
When AD is less than AS), then
the planned inventory rises above the desired level. To clear the unwanted
increase in inventory, firms plan to reduce the output till AD becomes equal to
AS.
So, equilibrium takes place only at point E,
when AD = AS.
2. S=I.
According to this approach of
equilibrium, the equilibrium is reached only when Investment(I) equals
Savings(S) because at this level there is no tendency for income and output to
change.
In the diagram the
equilibrium is at E1 where savings intersects investment curve At this
point, I=S.
When S is more than I , then
the planned inventory would fall below the desired level. To bring back the
Inventory at the desired level, the producers expand the output More
output means more income. Rise in output means rise in I and rise in
income means rise in S. Both continue to rise till they reach E1, S=I.
When S is less than I, then
the planned inventory rises above the desired level. To clear the unwanted
increase in inventory, firms plan to reduce the output till S becomes equal to
I.
So, equilibrium takes place
only at point E1, when S=I.
The national income determination can be better understood with the help of given diagram. The two alternative approaches of national income determination are:
1. AD=AS
According to Keynes,
the equilibrium is reached only when aggregate demand (AD) equals aggregate
supply (AS) because at this level there is no tendency for income and output to
change.
In the diagram the equilibrium is at E where AD
intersects 45o line. At this point, AD = AS.
When AD is more than AS , then
the planned inventory would fall below the desired level. To bring back the
Inventory at the desired level, the producers expand the output More
output means more income. Rise in output means rise in AS and rise in
income means rise in AD. Both continue to rise till they reach K, where AD =
AS.
When AD is less than AS), then
the planned inventory rises above the desired level. To clear the unwanted
increase in inventory, firms plan to reduce the output till AD becomes equal to
AS.
So, equilibrium takes place only at point E,
when AD = AS.
2. S=I.
According to this approach of
equilibrium, the equilibrium is reached only when Investment(I) equals
Savings(S) because at this level there is no tendency for income and output to
change.
In the diagram the
equilibrium is at E1 where savings intersects investment curve At this
point, I=S.
When S is more than I , then
the planned inventory would fall below the desired level. To bring back the
Inventory at the desired level, the producers expand the output More
output means more income. Rise in output means rise in I and rise in
income means rise in S. Both continue to rise till they reach E1, S=I.
When S is less than I, then
the planned inventory rises above the desired level. To clear the unwanted
increase in inventory, firms plan to reduce the output till S becomes equal to
I.
So, equilibrium takes place
only at point E1, when S=I.
