Policies to Increase Equilibrium National Output

Equilibrium national income occurs where aggregate supply equals aggregate demand.

An increase in equilibrium national income requires an increase in long-run aggregate supply and aggregate demand.


Equilibrium national income and Keynesian Consumption function

consumption-function-effective-demand We can also show equilibrium national income using a Keynesian consumption function. In this case, an increase in domestic aggregate demand (C+I+G) leads to higher real national income.

Policies to increase national income

Fiscal Policy

To increase AD, the government can pursue expansionary fiscal policy. This involves cutting taxes and increasing government spending. This injection into the circular flow will increase AD (AE) and cause Real GDP to increase.

However, expansionary fiscal policy has many limitations including:

Monetary Policy

To increase AD, the government or monetary authorities can reduce interest rates to boost AD.

Lower interest rates reduce the cost of borrowing and therefore encourage firms to invest and consumers to increase spending. This leads to higher aggregate demand.

More on monetary policy

Exchange rate policy

In a semi-fixed exchange rate, the government could also devalue the exchange rate, making exports more competitive and imports more expensive. This will lead to greater domestic demand. This is not so common, but it can occur as a way to boost domestic demand. For example, the UK devaluation of 1992.

Supply-side policies

Another strategy to boost equilibrium national income is to focus on the supply side of the economy. Boosting productivity will increase aggregate supply and this productivity rise is also likely to have a knock-on effect in boosting domestic demand. Supply-side policies could include

  • Privatisation
  • Deregulation
  • Lower taxes
  • spending on education and training



4 thoughts on “Policies to Increase Equilibrium National Output”

  1. can anyone help me !!!
    1. The diagram depicts the current position of a hypothetical economy using the Keynesian Income/Expenditure approach. If national income is currently at Y1 explain why this cannot be an equilibrium position for the macroeconomy.

    2.From the starting position of national income at Y1 explain the process by which the economy will move towards its equilibrium position.

    3.As the economy adjusts towards this equilibrium what would you expect to be happening to inflation and unemployment? Explain your reasoning.

    4.For this hypothetical economy the current equilibrium level of output/income is £200 billion made up of Consumption £150 billion, savings £15 billion, taxation £15 billion and imports £20 billion. If the government decides to increase its expenditure by £20 billion what will be the new equlibrium level of output/income. Explain your reasoning as well as the process that will lead the economy towards this new equilibrium.

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