At the present level of employment in a hypothetical economy, the aggregate demand is falling short of aggregate supply. What will be the likely change in the level of national income of this economy?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → National income is likely to fall.
When aggregate demand (AD) falls short of aggregate supply (AS), it means that producers are unable to sell all their output.
As a result:
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Unintended accumulation of inventories takes place.
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Producers reduce production to avoid excess stock.
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This leads to a fall in output, employment, and income in the economy.
Hence, when AD < AS, the national income is likely to fall until equilibrium is restored where AD equals AS.