Determination of Equilibrium Income and output

Saving And Investment Approach for determination of equilibrium income and Output

An alternative approach to the determination of equilibrium level of income is Saving Investment approach.According to this approach, equilibrium is struck at that level where planned investment equals planned saving.

i.e S = I

Since S refers to ‘withdrawal’ from the circular flow and I refers to ‘injection’ into the circular flow, equilibrium condition can be stated as:

Withdrawal = injection

Determination of Equilibrium Income and output

After discussing about consumption and investment function in my previous posts, we are now in a position to study and analyse the equilibrium level of income and output.

Basic Assumptions:

1) Short Period analysis – Keynesian theory of equilibrium output is determined only with reference to short period of time.Short run is defined as a period of time during which level of output is determined exclusively by the level of employement in the economy. Technology is assumed to remain constant.

2) Closed economy – Keyenes discuss the theory of equilibrium GDP in the context of a closed economy.This is an economy which has no relations with  the rest of the world,there is no import or export.

Its two sector economy consisting of the household sector and business sector.All the decisions concering consumption expenditure is taken by the individiula household, while the business firms take decisions regarding investment.