EconomicsCBSE Class 12 · Determination of Income and Employment

Equilibrium Output in the Short Run: AD = AS and Saving = Investment (Class 12)

Q: What is equilibrium output in Class 12 Economics?

The output level at which aggregate demand equals aggregate supply, or planned saving equals planned investment.

Q: Why do AD = AS and S = I give the same answer?

Because AS = Y = C + S and AD = C + I; equating them cancels C and leaves S = I.

Q: How does the economy return to equilibrium?

Through unplanned inventory changes: falling stocks prompt more output; rising stocks prompt less output.

Q: What is assumed about prices?

In this short-run model, prices are fixed and there is spare capacity, so output adjusts to demand.

Updated 15 October 2026 · Fact-checked

In the short run with fixed prices, equilibrium output is the level at which aggregate demand (planned consumption plus planned investment) equals aggregate supply (output, Y), or equivalently planned saving equals planned investment. With C = c̄ + bY and autonomous investment Ī, equilibrium income is Y = (c̄ + Ī) ÷ (1 − b).

Output settles where AD cuts the 45° AS line (S = I); left of Y* AD > AS so output rises, right of it AD < AS so output falls.

Illustration drawn for QuestionBuddy.

Understand Equilibrium Output: AD = AS and S = I

Aggregate demand (AD). In a two-sector economy, AD = C + I = c̄ + bY + Ī: planned spending on final goods. Investment is taken as autonomous (independent of income).

Aggregate supply (AS). In the short run, with prices fixed and unused capacity, firms supply whatever is demanded; AS equals the value of output, which equals income: AS = Y. On a diagram it is the 45° line.

Approach 1: AD = AS. Equilibrium where the AD line cuts the 45° line:

c̄ + bY + Ī = Y → Y = (c̄ + Ī) ÷ (1 − b).

Approach 2: Saving = Investment. Since Y = C + S, AD = AS means C + I = C + S, so planned S = planned I:

−c̄ + (1 − b)Y = Ī gives the same Y.

Adjustment when out of equilibrium (via inventories).

AD > AS (planned S < planned I): demand exceeds output; inventories fall unexpectedly; firms raise output until AD = AS.
AD < AS (planned S > planned I): unsold goods pile up; inventories rise; firms cut output and employment until AD = AS.

Equilibrium need not be full employment. Equilibrium output can be below full-employment output (deficient demand, unemployment) or AD at full employment can exceed full-employment output (excess demand, inflation). Measures such as changes in government spending, taxes and money supply aim to close these gaps.

Change in equilibrium. If autonomous spending (c̄ or Ī) changes, equilibrium income changes by the multiplier times that change: ΔY = ΔĪ ÷ (1 − b).

Equilibrium Output: AD = AS and S = I: key facts

Aggregate demand: AD = C + I = c̄ + bY + Ī
Equilibrium (AD = AS): Y = (c̄ + Ī) ÷ (1 − b)
Saving = investment: −c̄ + (1 − b)Y = Ī; Gives the same Y.
Change in equilibrium: ΔY = ΔĪ ÷ (1 − b); Multiplier effect.
Investment needed for target Y: Ī = (1 − b) × Y* − c̄

How to answer Equilibrium Output: AD = AS and S = I questions

Equilibrium questions are numerical (find Y, I, c̄ or a change) or explanatory (adjustment when AD ≠ AS).

1Write AD = c̄ + bY + Ī and set it equal to Y.
2Solve Y = (c̄ + Ī)/(1 − b).
3Verify with S = I: compute S at equilibrium and compare with Ī.
4For a table, find the income where AD = Y; note excess demand above and excess supply below.
5For changes, multiply the change in autonomous spending by 1/(1 − b).
6In explanations, mention unplanned inventory change and the output response.

Equilibrium Output: AD = AS and S = I in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Inventories signal disequilibrium

Suppose a clothing factory plans production for the month expecting strong sales, but shoppers buy much less than expected, and unsold stock piles up in its warehouse. Many factories face the same.

Using AD and AS, explain what is happening and what firms will do next.

Try it first, then show the solutionSolution

Planned spending (AD) is less than output (AS).
The gap appears as an unplanned rise in inventories (planned S > planned I).
Firms cut production and hire fewer workers until AD = AS.

Answer: AD < AS, shown by unplanned inventory accumulation. Firms reduce output and employment, and income falls until planned spending equals output at a lower equilibrium.

Memory hook: Piling stock means falling output; vanishing stock means rising output.

Tricks to remember Equilibrium Output: AD = AS and S = I

Short memory aids. Say each one aloud once, then use it on a question the same day.

Y = autonomous × multiplier
Equilibrium income = (c̄ + Ī) × 1/(1 − b).
Use it when: Quick computation.
Two doors, one room
AD = AS and S = I lead to the same equilibrium.
Use it when: Theory questions.
Stock up → output down
Unplanned inventory rise means AD < AS; output falls.
Use it when: Adjustment questions.

Equilibrium Output: AD = AS and S = I: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Equilibrium income · 1 mark · MCQBoard level

C = 100 + 0.8Y and investment = 50 (₹ crore). Equilibrium income is:
(a) ₹750 crore
(b) ₹600 crore
(c) ₹250 crore
(d) ₹1,000 crore

Try it first, then show the solutionSolution

Y = (100 + 50)/(1 − 0.8) = 150/0.2 = 750.

Answer: (a) ₹750 crore

Example 2: Both approaches · 3 marks · Short answerBoard level

For C = 100 + 0.8Y and I = 50 (₹ crore), find equilibrium income by the AD = AS approach and verify it by the S = I approach. Also find consumption at equilibrium. (3 marks)

Try it first, then show the solutionSolution

AD = AS: 100 + 0.8Y + 50 = Y → 0.2Y = 150 → Y = 750.
S = −100 + 0.2Y; S = I: −100 + 0.2Y = 50 → Y = 750.
C = 100 + 0.8 × 750 = 700.

Answer: Y = ₹750 crore by both approaches; C = ₹700 crore.

Example 3: Schedule and adjustment · 4 marks · Short answerHarder board level

C = 40 + 0.6Y and I = 60 (₹ crore). Find AD at Y = 100, 200, 250 and 300, identify equilibrium, and explain what happens at Y = 200 and Y = 300. (4 marks)

Try it first, then show the solutionSolution

AD = 100 + 0.6Y: 160, 220, 250, 280.
Equilibrium at Y = 250, where AD = Y.
Y = 200: AD 220 > 200 → inventories fall → output rises.
Y = 300: AD 280 < 300 → inventories pile up → output falls.

Answer: Equilibrium ₹250 crore; below it output rises, above it output falls.

Example 4: Effect of higher investment · 3 marks · Short answerHarder board level

With C = 100 + 0.8Y, investment rises from ₹50 crore to ₹80 crore. Find the new equilibrium income and the change. (3 marks)

Try it first, then show the solutionSolution

New Y = (100 + 80)/0.2 = 900.
Change = 900 − 750 = 150.
Check: k = 5; 5 × 30 = 150.

Answer: New equilibrium ₹900 crore, a rise of ₹150 crore.

Example 5: Finding autonomous consumption · 6 marks · Long answerHOTS / competency

In an economy, equilibrium income is ₹1,000 crore, autonomous investment ₹100 crore and MPC 0.75. Calculate autonomous consumption, consumption at equilibrium and saving at equilibrium, and show that saving equals investment. (6 marks)

Try it first, then show the solutionSolution

Y = (c̄ + Ī)/(1 − b): 1,000 = (c̄ + 100)/0.25.
c̄ + 100 = 250 → c̄ = ₹150 crore.
C = 150 + 0.75 × 1,000 = ₹900 crore.
S = Y − C = ₹100 crore = Ī.

Answer: Autonomous consumption ₹150 crore; C ₹900 crore; S ₹100 crore, equal to investment.

Example 6: Why S = I at equilibrium · 1 mark · Assertion-reasonHOTS / competency

Assertion (A): At equilibrium income, planned saving equals planned investment.
Reason (R): AD = AS means C + I = C + S.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.

Try it first, then show the solutionSolution

Cancelling C on both sides gives I = S; R explains A.

Answer: (a) Both A and R are true, and R is the correct explanation of A.

Where students lose marks in Equilibrium Output: AD = AS and S = I

The slips examiners see most often, and what to write instead.

Mistake: Dividing by MPC
Wrong denominator.
Wrong working
Y = 150/0.8.
Right working
Y = 150/(1 − 0.8) = 750.
Do this: Divide by MPS.
Usually costs: 1-2 marks.
Mistake: Reversing the adjustment
Thinking excess supply raises output.
Wrong working
AD < AS → output increases.
Right working
AD < AS → unsold stock → output decreases.
Do this: Follow the inventories.
Usually costs: 1 mark.
Mistake: Equating equilibrium with full employment
Assuming equilibrium is ideal.
Wrong working
'At equilibrium all resources are employed.'
Right working
Equilibrium can be below full employment.
Do this: Distinguish the two.
Usually costs: 1 mark.
Mistake: Wrong sign in the saving function
Forgetting negative autonomous saving.
Wrong working
S = 100 + 0.2Y.
Right working
S = −100 + 0.2Y.
Do this: S = Y − C.
Usually costs: 1 mark.

Exam tips

Write the equilibrium condition before solving: AD = AS, i.e. C + I = Y.
Verify every numerical with S = I.
In theory answers, mention unplanned inventory change explicitly.
Equilibrium questions carry 3, 4 or 6 marks and often combine with the multiplier.

Practice questions on Equilibrium Output: AD = AS and S = I

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
In a two-sector economy, equilibrium output is determined where:
(a) AD = AS
(b) C = S
(c) I = C
(d) AD = C
Hint
Demand meets supply.
Answer
(a) AD = AS
Q2 · 1 mark · MCQBoard level
When AD exceeds AS:
(a) inventories rise and output falls
(b) inventories fall and output rises
(c) prices must fall
(d) saving exceeds investment
Hint
Demand runs ahead of output.
Answer
(b) inventories fall and output rises
Q3 · 3 marks · Short answerBoard level
C = 50 + 0.5Y and I = 100 (₹ crore). Find equilibrium income. (3 marks)
Hint
Divide by 0.5.
Answer
Y = (50 + 100)/0.5 = ₹300 crore.
Q4 · 3 marks · Short answerHarder board level
The saving function is S = −80 + 0.25Y and investment is ₹120 crore. Find equilibrium income. (3 marks)
Hint
Set S = I.
Answer
−80 + 0.25Y = 120 → 0.25Y = 200 → Y = ₹800 crore.
Q5 · 4 marks · Short answerHarder board level
C = 60 + 0.7Y and I = 30 (₹ crore). Prepare AD for Y = 0, 100, 200, 300, 400 and find equilibrium. (4 marks)
Hint
AD = 90 + 0.7Y.
Answer
AD: 90, 160, 230, 300, 370. Equilibrium at Y = 300 (= 90/0.3), where AD = Y.
Q6 · 3 marks · Short answerHarder board level
Explain the adjustment process when planned saving exceeds planned investment. (3 marks)
Hint
AD < AS.
Answer
Planned S > planned I means AD < AS. Goods remain unsold and inventories rise unexpectedly. Firms cut production and employment; income falls, reducing saving, until planned saving equals planned investment at a lower equilibrium.
Q7 · 3 marks · Short answerHarder board level
C = 100 + 0.75Y. How much investment is needed for equilibrium income of ₹1,200 crore? (3 marks)
Hint
Ī = 0.25Y − c̄.
Answer
Ī = 0.25 × 1,200 − 100 = ₹200 crore.
Q8 · 1 mark · Assertion-reasonHarder board level
Assertion (A): When planned saving exceeds planned investment, output tends to rise.
Reason (R): Planned saving exceeding planned investment means aggregate demand falls short of aggregate supply.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.
Hint
AD < AS.
Answer
(d) A is false, but R is true.
Q9 · 4 marks · Short answerHOTS / competency
C = 200 + 0.6Y and I = 400 (₹ crore). Find equilibrium income, consumption, APC and saving at equilibrium. (4 marks)
Hint
Y = 600/0.4.
Answer
Y = ₹1,500 crore; C = 200 + 900 = ₹1,100 crore; APC = 0.73; S = ₹400 crore (= I).
Q10 · 3 marks · Short answerHOTS / competency
Suppose full-employment output is ₹1,200 crore but equilibrium income is ₹1,000 crore, and MPC is 0.75. What is this situation called, and by how much must autonomous spending rise to reach full employment? (3 marks)
Hint
Deficient demand; use the multiplier.
Answer
It is deficient demand (equilibrium below full employment, with involuntary unemployment). Required ΔY = 200; k = 4; autonomous spending must rise by 200/4 = ₹50 crore.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Equilibrium condition in the S-I approach?Show answer
Planned saving = planned investment.
2.Formula for equilibrium income?Show answer
Y = (c̄ + Ī)/(1 − b).
3.C = 20 + 0.9Y, I = 30: equilibrium Y?Show answer
500.
4.What does an unplanned rise in inventories indicate?Show answer
AD < AS; output will fall.
5.Is equilibrium always at full employment?Show answer
No.

Equilibrium Output: AD = AS and S = I: frequently asked questions

What is equilibrium output in Class 12 Economics?

The output level at which aggregate demand equals aggregate supply, or planned saving equals planned investment.

Why do AD = AS and S = I give the same answer?

Because AS = Y = C + S and AD = C + I; equating them cancels C and leaves S = I.

How does the economy return to equilibrium?

Through unplanned inventory changes: falling stocks prompt more output; rising stocks prompt less output.

What is assumed about prices?

In this short-run model, prices are fixed and there is spare capacity, so output adjusts to demand.