Posted by Anjali Kaur on Sep 30, 2020

Concept of Short-Term Equilibrium (AD-AS)

According to the Keynesian theory, equilibrium is determined in terms of aggregate demand and aggregate supply. We reach an equilibrium level of output or employment, where AD = AS. In this post, we will discuss the Concept of Short-Term Equilibrium (AD-AS). Let’s learn more about it.

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Short-Term Equilibrium

We know that,

AD = C + I

AS = C + S

So, if equilibrium is achieved when AD = AS, then

C + I = C + S

I = S

Investment = Savings

Equilibrium level of output implies that there is no surplus or deficiency in the economy. Whatever is produced is demanded by the economy.

Derive the two alternative conditions of expressing national income  equilibrium. Show these equilibrium conditions on a single diagram.

Under AD and AS approach, following things are assumed:

  1. AD is a planned level of demand by various sectors of the economy.
  2. AS is the planned level of supply, which the producers are planning to sell.
  3. Equilibrium is achieved when planned expenditure (AD) becomes equal to the planned level of supply of goods and services (AS).

According to Keynesian theory, the equilibrium level of output is determined at the full level of employment or at the underemployment level or at the overfull employment level.

Classical theory versus Keynesian theory

Classical TheoryKeynesian Theory
Classical theory assumes that the economy is always at full employment, that is, AD = AS.Keynesian believes that the economy is at full employment when AD = AS. The economy is at over full employment equilibrium when AD > AS. The economy is at underemployment when AD < AS.
The government does not interfere because the economy is always at full employment.The Government interferes where there is excess demand or deficient demand
This theory assumes that supply creates its own demand.This theory assumes that demand creates its own supply.

Thank You for reading.

You can read the related post on macroeconomics:

Aggregate Supply

Aggregate Demand

Introduction To Money

Central bank and its function

Process of credit creation

Precautions while calculating the national income

Real and nominal GDP

National income

National income formula list

Value-added method

Income method

Expenditure method

GDP and welfare

Domestic territory and national residents

Circular flow of income

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