Finding equilibrium income

In this chapter the price level is fixed. That is reasonable when there are unused resources (idle machines, unemployed workers): firms can produce more without raising prices.

On a diagram with income Y across and spending up the side:

• the AD line is the consumption line plus the horizontal investment line, so it runs parallel to the consumption line, higher by Ī;
• aggregate supply is the 45° line: at every point on it, spending equals output, because at fixed prices firms will supply any level of GDP that is demanded.

Equilibrium is where the AD line crosses the 45° line.

With algebra: Y = A + cY, so Y − cY = A, and Y = A ÷ (1 − c) = (C̄ + Ī) ÷ (1 − c).

Example: C̄ = 30, Ī = 20, c = 0.75. Y = 50 ÷ 0.25 = 200.

Equilibrium income rises when autonomous consumption or investment rises, or when the MPC rises. But equilibrium does not have to be at full employment: the economy can settle with resources still idle.