How to explain this question
10. Explain national income determination through the two alternative approaches. Use diagram.
Equilibrium level of Income or National Income can be derived from using the following two approaches.
1. Aggregate Demand and Aggregate Supply approach (AD and AS approach)
2. Saving and Investment approach (S and I approach).
Aggregate Demand and Aggregate Supply approach ( AD and AS approach)
Under this approach, the equilibrium level of income is determined at the point where Aggregate Demand ( AD ) is equal to Aggregate Supply ( AS ).
In the diagram, the consumption curve is depicted by C and the investment curve is depicted by the horizontal straight line parallel to the output/income axis. Summing-up the investment curve and consumption curve we get the Aggregate Demand curve represented by AD= C + I. The Aggregate Supply curve is represented by the 45° line. Throughout this line the planned expenditure is equal to the planned output. The point E is the equilibrium point, where the planned level of expenditure (AD) is equal to the planned level of output (AS). Accordingly, the equilibrium level of output (income) is OQ.
Saving and Investment approach (S and I approach)
Under this approach, the equilibrium level of income is determined at the point where Savings ( S ) is equal to Investment ( I ).
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In the diagram, SS represents the saving curve and II represents the investment curve. The point E represents the equilibrium point, where the saving curve SS and the investment curve II intersects . Accordingly, OQ is the equilibrium level of income (output).
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