SHORT RUN

Equilibrium output
Class-12 Macro
 SHORT RUN

It is defined as a period of time during which output is

determined exclusively by the level of employment and
technology is assumed to remain constant (it plays no role) in
the economy.
 Employment leads to  in output, and vice versa.

In other words, the level of output (GDP)  with the level of 

employment in the economy only upto full employment in the
economy.
 CONCEPT OF EQUILIBRIUM OUTPUT (GDP)

Equilibrium output (equilibrium GDP or equilibrium Y) refers to that level of output in the economy
where: AS = AD
AS is the level of GDP that the producers wish to produce (or plan to produce) during an accounting year
(also called ex-ante AS).
AD is level of GDP that the buyers wish to buy during an accounting year (also called ex-ante AD).

So, Equilibrium GDP means that level of GDP where what the producers wish to produce (or plan to
produce) is exactly equal to what the buyers wish to buy (or plan to buy) during an accounting year.

So that, there is no excess production (or unwanted stocks with the producers).
Or, there is no shortage of output in relation to its demand.
Equality between AS and AD implies the equality between Y and AD.
Because Y = AS.
Thus, we can write that the equilibrium is struck when:
 CONCEPT OF EQUILIBRIUM OUTPUT
(GDP)
Equilibrium GDP implies a situation, when: AS = AD or Y = AD
Actual stocks of the producers = Required (Desired) stocks of the producers
In case AS > AD (or Y > AD),
Actual stocks > Required stocks

The producers suffer losses because of excessive stocks or unsold stock of

goods.
In case AS < AD (or Y < AD),
Actual stocks < Required stocks
The producers suffer losses on account of unfulfilled demand in the economy.
 S=I approach
Equilibrium is struck when: ex-ante saving (S) = ex-ante investment (I)
Ex-ante Saving: (Desired or planned saving) Savings which people intend to make in
the economy during the period of one year.
Ex-ante Investment: (Desired or planned investment). Investment expenditure which
is intended to be made in the economy during the period of one year. It does not include
unplanned investment like unsold stock of goods which is treated as inventory
investment. But this is 'undesired inventory'.)
Ex-post Saving: It refers to 'actual saving' in the economy during the period of one
year.
Ex-post Investment: It refers to 'actual investment' in the economy during the period of
one year. It includes both planned as well as unplanned investment.
DETERMINATION OF EQUILIBRIUM OUTPUT (GDP) OR EQUILIBRIUM INCOME

1. AS = AD Approach and Equilibrium GDP or Equilibrium Income

AS- Planned output in the economy. It is indicated by 45° line from the
origin. The 45° line indicates that AS and GDP are identical to each other.

AS is not related to price, as we are considering an economy where price

remains constant. It is an economy with excess capacity where AS responds
proportionately to AD and price remains unaffected
 DETERMINATION OF EQUILIBRIUM
OUTPUT (GDP) OR EQUILIBRIUM
INCOME
AD refers to desired expenditure (planned expenditure) in the economy
during an accounting year. It has two components:
 Desired investment expenditure is assumed to be autonomous, so that it
is not related to the level of income in the economy.
 Desired consumption expenditure is related to the level of income:
there is a positive relationship between C and Y, (C  Y ).
However, there is always some minimum level of C, independent of Y.
 Effect on equilibrium output
• If AS > AD: Supply exceed demand. Some of the goods would remain unsold.
Unwanted stocks  Production  Consequently AS  to become equal to AD.
Briefly, equilibrium is restored through a change in output or a change in Y.

• If AS < AD: Producers would suffer the loss of unfulfilled demand.

Desired stocks  Production  AS  to become equal to AD.
This is how AS converges with AD. Thus, equilibrium is restored through a change
in output or a change in Y.
 DETERMINATION OF EQUILIBRIUM
OUTPUT (GDP) OR EQUILIBRIUM
INCOME
2. S and I Approach and Equilibrium GDP or Equilibrium Income when S = I
S-function We know, S = f(Y). S is positively related to Y. However at the lower
level of income, S can be negative. Because, at lower level of income C may be
greater than Y. S becomes negative to the extent C > Y. We are considering a
straight line s-function
I-function As regards I-function, we are considering only autonomous I . It is
independent of the level of Y. Accordingly, it is a horizontal straight line (shooting
from the Y-axis). n called a linear function
 Effect on equilibrium output
If S > I: Aggregate expenditure would be less than what is needed to buy the planned
output.
Producers will have undesired stocks (Unsold Goods) lesser output lesser
income lesser saving. The process would continue till S = I .
Thus, the equality between S and I is restored through change in the level of Y.
If S < I: Aggregate expenditure in the economy would be greater than what is required
to buy the planned output.
Producers would suffer the loss of unfulfilled demand plan higher output higher
income higher saving.
The process would continue till S = I
Here again, the equality between S and I is restored through change in the level of Y.
 Three basic assumptions of the Keynesian theory

(i) Short Period Analysis: Technology remains constant and level of GDP depends on
level of employment.

(ii) Two Sector Closed Economy: Economy has no economic relations with the rest of
the world means there are no exports or imports. Also, there is no government sector, so
no taxes and subsidies.
Accordingly, AD = C + I (when only household sector and producer sector are
considered).
(iii) AS is Perfectly Elastic: Economy is having an 'excess capacity’ i.e. production
capacity is lying idle or there is unemployment of resources. Whenever AD  there is
a corresponding  in AS.
Thus, AS always aligns itself with AD, without causing any change in the price level
 SHIFT IN EQUILIBRIUM
IMPACT OF ADDITIONAL INVESTMENT

Increase in investment causes increase in the level of AD. Accordingly, AD function shifts upward
 INVESTMENT MULTIPLIER AND ITS MECHANISM

Multiplier: Additional investment (ΔI) causes additional output (ΔY) in the

economy.

Investment/output multiplier: The factor by which the Δoutput/income > Δ in

investment.
It is measured as the ratio between increase in output/income and increase in
investment.
Investment multiplier (K)= ΔY/ΔI
Relationship between Multiplier and MPC
K = 1 / (1-MPC)
Illustrate Multiplier mechanism with the help of table
 Multiplier process
•

Cha nge i n investment ca uses cha nge i n income. As a result, there is change in consumption.

Consumption expenditure of one person is an income of the other. Hence, Δ in C leads to Δ in Y.

This process continues Δ C reduces to 0.

MPC is the core factor in the process of income generation. MPC  conversion of Y into C also . Accordingly,
greater is the generation of income. Expenditure is an injection into income generation process, saving is a leakage.
Forward and Backward Action of the Multiplier: Investment multiplier works both ways, positive and negative
(i) Additional investment causes multiple increase in income. This is forward action of the multiplier.
(ii) Decrease in investment causes a multiple decrease in income. This is backward action of the multiplier.