Determination of Equilibrium Income and Employment

In the Keynesian model, the equilibrium level of income and employment is fixed where aggregate demand equals aggregate supply, i.e. at the point of effective demand. Equivalently, using the simple two-sector model, equilibrium occurs where planned output equals planned expenditure:

where $Y$ is national income (equal to output and to aggregate supply in equilibrium), $C$ is planned consumption and $I$ is planned investment.

How the economy reaches equilibrium. Suppose aggregate demand exceeds aggregate supply ($AD > AS$). Producers find their goods selling out and stocks falling, so they expand output and hire more workers — income rises. Conversely, if $AD < AS$, unsold stocks pile up and producers cut output and employment — income falls. Only where $AD = AS$ is there no tendency to change, so that is the equilibrium.

An equivalent condition, in the two-sector model, is that planned saving equals planned investment:

since $Y = C + S$ and $Y = C + I$ in equilibrium together imply $S = I$. …