In an economy Equilibrium level of Income, output and Employment is determined where Aggregate Supply in the Economy is equal to aggregate demand.
Aggregate supply refers to total production of goods and services in the economy. It is represented by C+S.
Aggregate Demand refers to the sum of total expenditure on goods and services in the economy. It is represented by C+I+G+(X-M) in four sector economy. But in two sector economy it is just C+I.
C=Autonomous consumption +MPC(Y)
Suppose autonomous consumption( consumption at zero level of Income) is 60 and MPC is 0.8 then consumtion at income level of 500 is 460.
C= 60+0.8 X500
C curve is straight line (as MPC is constant).
It starts from Y axis due to autonomous consumption.
And it is upward slopping (Income increases consumption also increases).
Now Investment is autonomous mean it does not depend on level of Income. It is expected that the firms will invest atleast a level which is equal to previous level. Investment curve is parellel to X axis.
So AD is C+I. Hence AD curve is parellel to C curve and posses same properties of C.
Output, Income is measured at X axis. Aggregate Demand is measured at Y axis. Now how to compare these two.
we Use 45 degree line. It is the property of 45 degree line that both the axis from any point on this line are at equal distance. so Income or output or Aggregate Supply is represented by 45 degree line.
Now compare AS and AD.
The level of output where AS and AD are equal is equilibrium level of output. it means economy is producing a level of output equals to aggregate demand in the economy.
