Class 12 Macro Economics Notes · CBSE

Equilibrium Condition and Approaches

Equilibrium Condition and Approaches — understand the equilibrium condition where AD equals AS and the two approaches to determine equilibrium output. CBSE Class 12 Macroeconomics notes.

Last updated: 16 Aug 2026

Notes

The Equilibrium Condition

An economy is in equilibrium when total planned demand for goods and services equals total planned supply during a period. This is the foundational concept of Keynesian income determination.

Core Equilibrium Condition

Equilibrium

AD = AS

Aggregate Demand (AD)

AD = C + I

Total planned expenditure on goods and services by households and firms.

Aggregate Supply (AS)

AS = C + S

Total output of goods and services, equal to income generated.

Derivation: AD = AS reduces to I = S

Substituting the components: C + I = C + S

Subtracting C from both sides: I = S

According to Keynes, equilibrium level of income and employment can be determined when planned saving equals planned investment.

Important: AD, AS, Saving, and Investment discussed here are all planned or ex-ante variables — they represent intentions, not actual outcomes. This distinction is exam-critical.

Two Approaches for Determination

Keynesian theory provides two approaches to determine equilibrium income, output, and employment. Both approaches yield the same equilibrium level — they are two sides of the same coin.

AD-AS Approach

Aggregate Demand — Aggregate Supply

Determines equilibrium where total planned expenditure equals total output. The AD curve (C+I) is plotted against the 45-degree AS line.

Where: AD curve intersects the 45-degree line → equilibrium point E

S-I Approach

Saving — Investment

Determines equilibrium where planned saving equals planned investment. The saving curve (S) intersects the autonomous investment line (I).

Where: S curve intersects I line → equilibrium point E

Both approaches are equivalent. In a two-sector model, if AD = AS then automatically S = I, and vice versa. You can use whichever is more convenient for the problem.

Assumptions of the Model

The Keynesian equilibrium model rests on four key assumptions. Understanding these is essential for applying the model correctly.

Two-sector Model

Only households (consumers) and firms (producers). No government or foreign sector.

Think of a closed economy where you either consume or save — no taxes, no imports.

Autonomous Investment

Investment expenditure is not influenced by the level of income.

A factory owner decides to invest ₹50 lakh in new machinery regardless of whether the economy is booming or slowing.

Constant Price Level

Prices are assumed to remain fixed in the short run.

The price of your morning chai stays ₹10 for the entire analysis period — no inflation adjustment.

Short-run Analysis

Determination of equilibrium output is analyzed in the short-run context.

We look at what happens today, not over years. Firms adjust output, not prices.