Question

Using the 'saving and investment' approach explain how is the equilibrium level of national income determined? Also explain what will happen if the equilibrium condition is not fulfilled.

Answer 1

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.