Equilibrium level of national income means that level of national income where the aggregate demand is equal to the aggregate supply.
If aggregate demand is less than aggregate supply, there will be a tendency of decrease in production and national income. Similarly, if the aggregate demand is more than the aggregate supply there will be a tendency of increase in production and national income. We can illustrate our view point with the help of adjoining diagram.
In the diagram equilibrium of national income is at point E where equilibrium income is OY. When the economy is not in equilibrium, there may be either of the following situation.
1. Excess Demand (AD > AS) – When aggregate demand is more than aggregate supply, it will lead to fall in inventories with the producers. The producers will produce more to reach the desired level of inventories. This Will raise aggregate supply till it becomes equal to aggregate demand.
2. Deficient Demand (AD < AS) – When aggregate demand is less than aggregate supply, it will lead to build-up of inventories of unsold goods with the producers. The producers will cut back the production to reduce the unsold inventories to the desired level. This will continue until aggregate demand and aggregate supply are equal.
