Explain the concept of equilibrium output, and describe how to identify equilibrium in the Keynesian model.
The correct answer and explanation is :
Equilibrium Output in the Keynesian Model
In the Keynesian economic model, equilibrium output refers to the level of national income where the total quantity of goods and services produced in the economy equals the total quantity of goods and services demanded. This is where there is no incentive for firms to either increase or decrease production. At equilibrium, the economy is in a state where planned spending (aggregate demand) equals actual output (aggregate supply).
Identifying Equilibrium in the Keynesian Model
In the Keynesian framework, equilibrium is determined where the aggregate expenditure (AE) curve intersects with the 45-degree line, which represents the level where total production equals total income. The aggregate expenditure is the total amount of spending in the economy, which consists of consumption, investment, government spending, and net exports (exports minus imports).
Steps to Identify Equilibrium:
- Aggregate Expenditure Curve (AE): This curve shows the total planned spending at different levels of national income. It includes consumption (C), investment (I), government spending (G), and net exports (NX), i.e., AE = C + I + G + NX.
- 45-Degree Line: This line represents all points where total income (output) equals total spending, i.e., where the economy’s output is equal to aggregate expenditure.
- Equilibrium Condition: Equilibrium occurs at the point where the AE curve intersects the 45-degree line. At this point, the amount of output produced is exactly equal to the amount of output demanded. If the economy produces more than the equilibrium output, inventories will build up, leading firms to reduce production. If production is below equilibrium, there will be unmet demand, leading to increased production.
In the Keynesian model, equilibrium output is not necessarily full employment output. The equilibrium level of output can be below the full employment level due to factors like insufficient demand or investment, leading to unemployment. Therefore, equilibrium output may reflect a level where the economy is not operating at its maximum potential.