Aggregate demand is the desired expenditure on the purchase of domestically produced goods and services at a given level of income during an accounting year. AD=C+I+G+X-M, Where AD=Aggregate Demand, C=Private Final Consumption, I=Investment Demand and X-M=Net Exports.
Aggregate supply refers to flow of goods and services planned to produce by the producers during an accounting year. It is identical with national income (Y=C+S). Thus, AS=C+S, Where AS=Aggregate Supply, C=Consumption Expenditure and S=Saving Consumption function shows the functional relationship between consumption and income. The two concepts used in explaining consumption function are the average propensity to consume and marginal propensity to consume.
Saving Function shows the functional relationship between saving and income. The two concepts used in explaining saving function are the average propensity to save and Marginal propensity to save.
Distribution of income, age distribution of income, availability of credit, rate of interest, price level and price expectations are the factors which determine the propensity to save and consume.
Investment refers to the expenditure incurred by the producers on the purchase of capital goods such as machinery, plant etc. Investment function is written as: I = f( i , MEI )
Here, I = Investment, f=functional relationship, i = Rate of interest, MEI = Marginal efficiency of investment. Investment can be categorised as: Private investment, Public Investment, Induced Investment and Autonomous Investment.
The equilibrium income is that level of GDP where what the producers wish to produce is exactly equal what the buyers are wishing to buy in a year. The two approaches to study the determination of equilibrium income are as follows: AS=AD approach and S=I approach. Equilibrium level of income is determined at the point where aggregate demand is equal to aggregate supply. S=I Approach: Equilibrium level of income is determined at the point where planned investment equals to planned savings.
The mechanism which shows how increase in investment leads to multiple increases in the income levels in the economy is called investment multiplier.
Full Employment refers to a situation in which all those people, who are willing and are able to work at the existing wage rate, get work without any undue difficulty. Full employment does not mean zero unemployment. Two types of unemployment under full employment are: Frictional Unemployment and Structural Unemployment.