Determination of Equilibrium Level of Income and Employment

According to Keynes, “The volume of employment is given by the point of intersection between the Aggregate Demand function and Aggregate Supply function.”

The following table illustrates how equilibrium employment is determined in a hypothetical economy:

How to read this table — Step by step:

• At zero employment, AD is still ₹120 crore while AS is zero. This is because people must spend on basic consumption necessities (food, clothing, shelter) even when they have no income. This spending is called autonomous consumption — it is funded through past savings or borrowing.​
• From 0 to 50 lakh employment, AD exceeds AS at every level. Since buyers want to purchase more than what is being produced, producers have an incentive to increase production and hire more workers. Inventories are depleting, signaling firms to expand output.
• At 60 lakh employment, AD exactly equals AS at ₹600 crore. This is the equilibrium point — producers are selling exactly what they produce. There is no unintended inventory accumulation or depletion. There is no incentive to change production levels.
• Beyond 60 lakh employment, AS exceeds AD. Producers are making more goods than buyers want. Unsold inventories pile up, forcing firms to cut production and lay off workers. Employment falls back toward 60 lakh.

How to read the diagram:

• The horizontal axis (X) represents Employment Income.
• The vertical axis (Y) represents Expected Receipts (AD and AS values).
• The 45° line represents Aggregate Supply (AS) — every point on this line shows where output value equals income.​
• The AD curve starts above the origin (at ₹120 crore) because of autonomous consumption, then slopes upward but less steeply than the 45° line.
• Point E is where the AD curve intersects the AS (45°) line — this is the equilibrium point at 60 lakh employment and ₹600 crore income.
• Left of E: AD > AS → Producers increase output → Employment rises.
• Right of E: AS > AD → Inventories accumulate → Producers cut output → Employment falls.

Keynes' Statement: "The volume of employment is given by the point of intersection between the Aggregate Demand function and the Aggregate Supply function."

A critical insight from Keynesian economics is that equilibrium does not necessarily mean full employment. The economy can settle at a point where millions of workers remain unemployed. This is called an under-employment equilibrium.

To move toward full employment, aggregate demand must increase. In the short run, since consumption remains relatively stable, the primary tool is to increase investment (or government expenditure).

• Equilibrium employment is determined where Aggregate Demand (AD) equals Aggregate Supply (AS).
• When AD > AS, producers increase output → employment rises.
• When AD < AS, producers reduce output → employment falls.
• Full employment is achieved only by increasing aggregate demand, mainly through higher investment; otherwise equilibrium may exist with unemployment (under-employment equilibrium).