• If AD increases, output also will increase and the level of national

output (i.e national income) will rise. On the other hand, if AD

decreases, the national output or national income will also decrease.

• It follows that the equilibrium level of national income is determined

by AD since AS remains more or less the same during the short
period.

• We assume here that the national output (or income) will be as

much as effective demand
• There are two components of ED:

 Consumption Demand (demand for consumption goods)

 Investment demand (investment goods or capital goods).

Hence, by ED we mean how much the total expenditure the

government and people are willing incur on consumption and
investment goods.

• Thus, AD= C+I (C=Consumption, I= investment)

• Aggregate Demand (C+l): Aggregate demand refers to the

sum of expenditure households, firms and the government is
undertaking on consumption and investment in an economy.
 Aggregate Supply (C+S)

• The aggregate supply refers to the flow of output

produced by the employment of workers in an
economy during a short period.

• In other words, the aggregate supply is the value of

final output valued at factor cost.

• The aggregate supply price is the minimum amount of

money which the entrepreneurs must expect to receive
to cover the costs of output produced by the
employment of certain number of workers.
 Effective demand :
Effective demand represents that aggregate demand or
total spending (consumption expenditure and
investment expenditure) which matches with aggregate
supply (national income at factor cost).

Effective demand is the equilibrium between aggregate

demand (C+I) and aggregate supply (C+S).

This equilibrium position (effective demand) indicates

that the entrepreneurs neither have a tendency to
increase production nor a tendency to decrease
production.
 Determination of Income: Analysis of Keynsian Cross and effect of
increase in ED
The equilibrium level of income output and expenditure is determined at the point
where AD =AS.

At equilibrium AD = AS (1)

• Keynes assumes that level of AS is given in the short period. Hence, the level of AD
determines the level of effective Demand and level of aggregate income.

• Let us assume that simple two sector economy in which all savings are made by
HHs and there is no government spending and taxation. Thus,

AD= C+I (2)

• Further, since for every possible level of output, an equivalent amount of money
income generated. Further income is either spend or saved

Aggregate output= Aggregate income (Y) = C+S (3)

Using eqn ( 2 ) &3 in eqn (1) we get,
C+I= C+S
S=I
• 45 degree line represents aggregate supply curve and it is also called
income line. It is the unit line which represents equality between total
spending and total income (income = expenditure)

• C represents Consumption line.

• Since 45 degree line represents national income, the distance between 45

degree and consumption line represents saving bcz a part of income is
consumed and rest is saved,

• Thus Y = C+S

• It will be seen from the figure that the distance between two goes on
increasing which means that as income increases the amount of saving also
increases.
• Since consumption is more or less stable, variation of national income
depends on the variation of investment.

• The 2nd component of AD is investment.

• At OY level of national income the total income
would be more than total consumption expenditure
and there would be saving gap equal to ae.
• Thus saving gap must be filled by adequate
expenditure when a business community incurs
investment expenditure (I),

• we get AD= C+I

• The distance between C and AD is equal to I. Given
the C, higher the I, Higher will be the AD (C+I).
What level of national Income will be
determined?