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19_EQUILIBRIUM IN THE ECONOMY

 

 

 

 

ECONOMICS (CLASS-XII)

 

Chapter-19

EQUILIBRIUM IN THE ECONOMY

 

EQUILIBRIUM IN THE ECONOMY

Equilibrium is at the point where quantity of output produced is equal to the quantity demanded. There are two approaches of equilibrium in the economy.

AD-AS APPROACH

Under AD-AS approach, when the planned expenditure of an economy (AD) is equals to the planned availability of goods and services, (AS) the economy is said to be at equilibrium. Thus equilibrium is when

AD = AS = Y     AD = C + I

Therefore                                 C + I = Y at Equilibrium

This equilibrium implies that there is no surplus or shortage in the production of output.

AD Curve

 

Income Consumption Investment Savings AD AS  
0 100 100 –          100 200 0 AD > AS
100 150 100 –          50 250 100
200 200 100 0 300 200
300 250 100 50 350 300
400 300 100 100 400 400 Equilibrium
500 350 100 150 450 500 AD < AS
600 400 100 200 500 600

 

(a)         When AD > AS

 

At an income level below the equilibrium level of income, the planned expenditure i.e. AD is greater than the aggregate supply. This implies that there is a short fall in the availability of goods and services in the economy. This extra demand or shortfall is met by selling the inventory. The reduction in stock induces the producers to increase the production which will lead to an increase in income and employment in the economy. The process will continue till
AD = AS.

In the schedule, at an income level of 300 crores, the total planned exp. Is (250 +100) i.e. 350 crores where as total availability of goods and services is 300 crores. This extra demand is met by selling the unsold stock or inventory which induces the producers to produce more.

(b) AD < AS

AT the income level above the equilibrium level of income, the planned exp. i.e. AD is less than the aggregate supply. This implies that there is an excess m availability of goods and services in an economy. This surplus in goods is added to the inventory stock of goods. This rise in the inventories above a desired level reduces the production which will lead to decrease in income and employment in the economy. This process will continue till AD = AS.

In the schedule, at an income level of 500 crores, the total planned exp. Is (350 + 100) i.e. 450 crores where as total availability of goods and services i.e. 500 crores. This excess supply is met by increasing the inventory which reduces the production.

 

SAVING AND INVESTMENT APPROACH

An economy attains equilibrium level of income only when planned savings are equal to the planned investment. Investment is assumed to be autonomous. It can be understood with the help of following:

(a)        When Planned Saving are Less than Planned Investment

At the income level below the equilibrium level of income the planned savings is less than planned investment. This means that households are consuming more then what the firms are expecting. This implies that realized investment is less than the planned investment. The firms will witnessed shortfall in their inventory stock. This is termed as unplanned investment. To have a desired level of inventory, firms will increase the production, leading to increase in output, income and employment. In the schedule, at income level of 300 crores, the planned saving is 50 crores while planned investment is 100 crores. The firms realized investment at this level is only Rs. 50 crores. Thus there is an unplanned investment of (- 50) crores.

 

(b)        When Planned Savings are More than Planned Investment

At the income level above the equilibrium level of income, the planned saving is more than the planned investment. This means that households are consuming less than what the firms are expecting. This implies that realized investment is more than planned investment. The firms will witness a rise in their inventory stocks. Thus there is an additional investment or unplanned investment. To have a desired level of inventory, firms will stop the production, leading to low output, income and employment. In the schedule at the income level of 500 crores, planned saving is 150 crores while the firms planned investment is 100 crores. The firms realized investment in this place is Rs.150 crores. Thus there is an unplanned investment of 50 crores.

 

 

 

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