LEARNING OBJECTIVES

• To learn about the concept of short run .

• Determination of equilibrium output .
• To learn about multiplier mechanism .
 CONCEPT OF SHORT RUN
• According to Keynes ,short run is defined as a period of time during which
‘technology ‘plays no role in the determination of output in the economy .
• Output is determined exclusively by the level of employment in the
economy .
• Higher level of income leads to higher level of output .
• Thus if employment is doubled output will also be doubled .
• Accordingly output (GDP) cannot increase once there is full employment in
the economy .
 EQUILIBRIUM OUTPUT (GDP)
• Equilibrium output ( also called equilibrium GDP or equilibrium income )
where

• AS =AD (Aggregate supply =aggregate demand )

• The equilibrium GDP means that level of GDP where what the producers
wish to produce (or plan to produce) is exactly equal to what the buyers wish
to buy ( or plan to buy) during an accounting year .So that there is no excess
production or there is no shortage of output in relation to its demand .
 Determination of equilibrium output or
equilibrium income
• Two approaches
• (i) AS =AD
• (ii) S=I
AS =AD approach and Equilibrium GDP or Equilibrium
income
 S and I Approach
• According to this approach equilibrium GDP or equilibrium is achieved when
S=I .
S –function
• We know S=f(Y) .S is positively related to Y .However at lower level of income
S can be negative .Because at lower level of income C may be greater than Y .
I –function
As regards I function ,we are considering only autonomous .It is independent of
level of income Y .
Graphical presentation of equilibrium income at S=I
 THREE BASIC
ASSUMPTIONS
RELATED TO
EQUILIBRIUM GDP
 NUMERICALS

1.Find equilibrium S and equilibrium I when Y =4400,MPC =0.75 and

_
C =100

2.Let C=20+0.25Y,I=100
Find Equilibrium level of income .
The level of consumption at equilibrium
The level of saving at equilibrium

3.Let S=-10+0.5Y
I=-3+0.4Y
Find equilibrium level of income.
 SHIFT IN EQUILIBRIUM :IMPACT OF
ADDITIONAL INVESTMENT
• Increase in investment causes increase in level of AD .AD function
shifts upward .
• Owing to an additional investment ,level of income increases .
• Increase income is more than increase in investment .
• Additional investment carries a multiplier effect
 INVESTMENT MULTIPLIER AND IT’S
MECHANISM
• Additional investment causes additional output/income in the economy .
The factor by which the increase in output/income is greater than the
increase in investment is called investment multiplier or output multiplier .
• It is measured as the ratio between increase in output /income and increase
in investment .
• Investment multiplier is number of times by which the increase in
output/income exceeds the increase in investment .It is measured as the
ratio between change in output /income and change in investment .
 Concept of multiplier
Change in output /income
• K= Change in investment
• Relationship between multiplier and MPC
• K = __1___
• 1-MPC
 MULTIPLIER
MECHANISM
• In different time
periods ,income will go
on increasing as a result
of increase in
consumption expenditure
.

• Higher MPC would have

caused greater increase in
income implying a higher
value of multiplier.
 Forward action & backward action
multiplier .
• Multiplier action is forward when there is a multiple increase in income
caused by an increase in investment .
• Multiplier action is backward when there is a multiple decrease in income
caused by decrease in investment .
Explain the multiplier process
 Differentiated Activity
CHALLENGE 1 CHALLENGE 2 CHALLENGE 3
What is autonomous What is equilibrium GDP ? Value of investment multiplier
investment ? varies between zero and
Why AS is assumed to be infinity .Justify
perfectly elastic ,in Keynesian
model of equilibrium GDP ?