Question

Show on the same diagram the additional investment expenditure required to reach full employment equilibrium.

Answer 1

In Fig., the aggregate expenditure curve AD₀ intersects the 45° line at E, which gives us the equilibrium income OY_f. This is the full employment level of income. Now, suppose government expenditure falls, as a result of which the new aggregate expenditure curve shifts to AD₁. At the full employment level of income, the aggregate supply is OY_f or EY_f. This is greater than the actual aggregate demand of AY_f. The deficient demand at the full employment income level is EA.

Whenever deficient demand occurs, the economy cannot be in equilibrium at full employment level. The situation of deficient demand will lead to a fall in output and income to OY₁ (below full-employment level), causing unemployment in the economy. As the aggregate demand is not sufficient to purchase the potential output, producers in the economy would like to produce less. As a result, income, output and employment in the economy will fall. Thus, a situation of deficient demand points to underutilisation of resources. Deficient demand leads to fall in prices as well because of excess supply. Thus, deficient demand causes the economy's income, output, employment and prices to decline, pushing the economy into underemployment equilibrium. Underemployment equilibrium is the level of income which is less than full employment level of income.