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
Policies to increase national income
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:
- Time lags
- Crowding out effect.
- Other components of AD
- Higher Government borrowing
- For more details see: Evaluation of fiscal 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.
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
- Lower taxes
- spending on education and training