In the Keynesian framework, the equilibrium level of output is determined solely by the level of aggregate demand. The first section of this chapter will show the determination of the equilibrium level of output in the Keynesian framework. Then, the concept and working of the multiplier will be introduced. The second section will deal with the problems of excess and deficient demand, followed by the measures to correct these problems.

Determination of Equilibrium Level of Output

We shall confine our analysis of the determination of the equilibrium level of output to an economy with only two sectors, households and firms. Hence, the only components of aggregate
demand will be consumption demand and investment demand. The absence of the government sector and the foreign sector means that income equals output, which is equal to Gross National Product.

Output Determination by Consumption plus Investment Approach

We may show output determination using the consumption plus investment (C+I) approach. This is illustrated in Fig. 6.1, which shows total spending or aggregate demand plotted against
output or income. The line CC is the consumption function, showing the desired level of consumption corresponding to each level of income. We now add desired investment (which
is at fixed level Io to the consumption function. This gives the level of total desired spending or aggregate demand, represented by the C + Io curve. At every point, the (C + Io) curve lies above the CC curve by an amount equal to Io.

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