What happens to the level of national income when aggregate demand falls short of aggregate supply?
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- In keynesian theory, economy will be in equilibrium when aggregate demand represented by (C + I) curve is equal total output (Aggregate Supply).
- In the above mentioned figure, at point P, income = consumption, which is known as to be a break - even point. The equilibrium level of national income is attained at point E, where aggregate demand = aggregate supply.
- If, due to some disturbance, we divert from our position like, i. When Aggregate Demand is less than Aggregate Supply:
- At any greater level of output, (C + I) line lies below 45° line that is, planned spending is less than planned output.
- This means that consumers and firm together would be buying less goods than firms were producing.
- This would lead to an unplanned, undesired increase in Inventories of unsold Goods. Firms would then respond to this unplanned inventory increase by decreasing employment and hence output.
- This process of decrease in output will continue until economy is back at point E, when Aggregate Demand is equal to Aggregate Supply.
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