Equilibrium
Level of the
National Income
7.1
Introduction
The equilibrium level of the national income is defined as that point where the
aggregate supply and the aggregate demand are equal to each other. We are here
restating the equilibrium point accepted in Chapter 4. Once that point is reached
the entrepreneurs will individually be at their profit maximising positions and
they will therefore have no reason to change from that level of production and
national income. The economy will remain in equilibrium until some outside, or
exogenous, force moves it to a new equilibrium position.
In Figure 7.I we will assume that such an equilibrium is achieved at an output
FIGURE7.1
Shift in Equilibrium Position
Expenditure and
factor incomes
AggS 1
0
J. Evans-Pritchard, Macroeconomics
© John Evans-Pritchard 1985
NN 1
124
Physical output
Equilibrium Level of the National Income
125
of 0 N. The revenue from sales or 'costs' of all factor incomes is OC. Supply and
demand are equal at this level and the circular flow of income will continue at OC
until it is interrupted.
If we observe that the output level, or the cost level, or both, have changed,
then this is only possible if either the aggregate supply and/or the aggregate
demand have changed. If we know that the output has risen to ON1 the system
can only have moved to such an output by either an increase in supply to Agg S 2
or an increase in demand to Agg D2, or a combination of both. To discover which
is the cause all that is required is to check what has happened to the 'cost' of the
output. Has it risen to C 1 or to C2, or somewhere in between?
The ease, or difficulty, with which we could discover the actual cause of a
change in output will depend on how accurately we had drawn the lines on the
graph in the first place. Even then the lines themselves would not tell us which
factor in the supply or the demand had been responsible for the change. To
determine that, we need to look in much greater depth at what the aggregate
demand and supply are made up from. That should guide us towards the answer
to the question 'What makes the equilibrium position of the economy change?' It
will also, however, raise some of the central problems of theoretical economics,
and especially the problem of how different or similar the theories actually are.
The sort of problem that we face can be illustrated by this question: 'When a man
receives a wage increase, is that a change in the costs of production, thereby
decreasing supply, or is it a change in his income, thereby increasing demand?' As
there are thousands of such dichotomies, the theoretical answers provided here
will do little to stop the Keynesian and Classical debate of what could happen in
the real world.
7.2
Aggregate Supply - Composition
We have already seen in Chapter 4 (p. 65) that the aggregate supply is the total of
factor incomes that firms will pay out in order to produce a specific output of
goods and services. Over any particular period of time it is therefore an
expression of the total of factor incomes earned in that period of time: it is the
GNY. At the same time it is also how we measure the goods and services
produced in that period of time: it is the GNP. It is in this physical sense of the
quantity of production that we are most interested, because that not only
provides us with our standard of living but it also determines the level of
employment. The use of factor incomes simply gives us a standard unit in which
to add it all up. Aggregate supply, then, is the same thing as the goods and
services supplied at any particular level of national income.
Components ofaggregate supply
A breakdown of the GNP figures for any particular year will identify where the