Why must aggregate demand be equal to aggregate supply at the equilibrium level of Income and output? Explain with the help of a diagram.
According to AD= AS approach,
the equilibrium is determined only when aggregate demand (AD) equals aggregate
supply (AS) because at this level there is no tendency for income and output to
change and the economy may achieve full employment equilibrium.
In the diagram the equilibrium is at K where AD
intersects 45 line. At this point, AD = AS.
When AD is more than AS (say, at point R), 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 (say, at point S), 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 K,
when AD = AS.
According to AD= AS approach,
the equilibrium is determined only when aggregate demand (AD) equals aggregate
supply (AS) because at this level there is no tendency for income and output to
change and the economy may achieve full employment equilibrium.
In the diagram the equilibrium is at K where AD
intersects 45 line. At this point, AD = AS.
When AD is more than AS (say, at point R), 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 (say, at point S), 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 K,
when AD = AS.
