Explain the meaning of equilibrium level of income and output using saving and investment approach. Use a diagram.
According to this approach of
equilibrium, the equilibrium level of income or output 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.
According to this approach of
equilibrium, the equilibrium level of income or output 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.
