Question
Explain national income equilibrium through aggregate demand and aggregate supply. Use diagram. Also explain the changes that take place in an economy when the economy is not in equilibrium.
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Answer
The national income is in equilibrium when $AD = AS$. In the figure the equilibrium is at $E$, the intersection of the $AD$ curve and the $45^o$ line. The equilibrium income is OM.
When the economy is not in equilibrium $AD$ is not equal to AS. Suppose $AD>AS$, will lead to fall in inventories with the producers. The producers in turn will produce more to reach the desired level of inventories: This raises AS till it becomes equal to $AD$.
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