OUTPUT AND EMPLOYMENT

The equilibrium output in the economy also determines the level of employment, given the quantities of other factors of production (think of a production function at aggregate level). This means that the level of output determined by the equality of Y with AD does not necessarily mean the level of output at which everyone is employed. Full employment level of income is that level of income where all the factors of production are fully employed in the production process. Recall that equilibrium attained at the point of equality of Y(Income) and AD by itself does not signify full employment of resources. Equilibrium only means that, if left to itself, the level of income in the economy will not change even when there is unemployment in the economy. The equilibrium level of output may be more or less than the full employment level of output. If it is less than the full employment of output, it is due to the fact that demand is not enough to employ all factors of production. This situation is called the situation of deficient demand. It leads to a decline in prices in the long run. On the other hand, if the equilibrium level of output is more than the full employment level, it is due to the fact that the demand is more than the level of output produced at full employment level. This situation is called the situation of excess demand. It will lead to a rise in prices in the long run.

The level of output is determined by the .....

Equality of Income (Y) with Aggregate Demand (AD)

The correct answer is Option (4) → Equality of Income (Y) with Aggregate Demand (AD)

As per the passage, the level of output in the economy is determined by the point where Income (Y) equals Aggregate Demand (AD). This is the equilibrium condition. However, this equilibrium does not necessarily indicate full employment—it simply means the income level will remain unchanged if left to itself, even if unemployment exists.

So, output is determined by Y = AD.