In economics, economic equilibrium is the situation where there is no tendency for an
economic variable to deviate from this point. In other words, when we talk about equilibrium we refer an economic environment in which economic agents do not change their decisions and behaviors as everything goes planned.

In the equilibrium approach of the Classical model, thanks to the smooth operation of the market mechanism, the economy is in constant balance, that is, at full  eployment.

The classical model explains the continuous realization of employment in the economy, based on Say’s Law, which states that “every supply creates its own demand”. According to this law, a certain amount of income is generated as a result of the production of goods and services. This income is used again to buy goods and services. Firms purchase or lease the resources required in the production process. They pay their owners in the form of fees, interest, rents, and profits. The amount that the producers pay to the owners of the production factors has to be equal to the value of the goods and services produced. Here, the production factor consumes all the income that the owners have gained and everything produced is sold. Thus, according to Say’s Law, every supply creates its own demand. It is not the case that the aggregate expenditures are insufficient in terms of full employment level. In some economies, when there is supply surplus or excess demand in some markets, the price mechanism is engaged and the market returns to the equilibrium level again. Therefore,

There may be some economic events that cause the failure of Say’s Law. For example, if the production factors want to save money rather than spend a portion of their income, then the all return from productions of the firms will not be expended. Therefore, the quantity demanded for goods and services will be lower than the quantity produced. In case of production or supply surplus, firms will decrease their production and start to lay their workers. This means that the economy diverges from the level of full employment.

The amount of goods and services produced in the economy varies not only with the aggregate expenditures, but also according to the prices the firms require for these goods and services. For instance, if there is an unsold part of production, companies reduce their prices to sell their products. All products are sold with decreasing prices and full employment production level is provided. However, in order to process in
this way, it is necessary to reduce the prices of the production factors. The reason is that the firms whose income has fallen because of falling prices are going to lose their profit if there is no decrease in the costs of production factors. Classical economists argue that in such a case, the prices of production factors will also fall due to the dynamics of perfect competition market. Equilibrium in the labor market will be provided at a lower wage level because of the flexibility of wages and the competition among the workers in the labor market. This equilibrium point is also the point of equilibrium where full employment level is achieved in the labor market.

The views of the classical model which guarantee full employment equilibrium were began to be questioned as a result of the long-term economic stagnation and the associated high unemployment during Great Depression that occurred in the 1930s. In order to solve this problem, British economist John Maynard Keynes argued that the
economic equilibrium, as put forward by Classical economists, does not mean that the level of full employment income is provided at the same time. According to Keynes, equilibrium income can be achieved at the level of underemployment or overemployment.

The views of the classical model which guarantee full employment equilibrium were began to be questioned as a result of the long-term economic stagnation and the associated high unemployment during Great Depression that occurred in the
1930s. In order to solve this problem, British economist John Maynard Keynes argued that the economic equilibrium, as put forward by Classical economists, does not mean that the level of full employment income is provided at the same time. According to Keynes, equilibrium income can be achieved at the level of underemployment or
overemployment. What is important here is the level of aggregate demand.Since it is difficult to change the production capacity that determines aggregate supply in the short term, the level of income depends on aggregate demand or aggregate
expenditures. In other words, firms give their production decisions according to the expected aggregate expenditure or aggregate demand level. If the economic units plan to spend more, the sales expectations of the companies will increase and they will make more production. As it is seen, Keynes links the deviations from full employment
to the inadequacy of aggregate expenditures in the economy. Accordingly, full employment in the economy can be achieved by an adequate level of aggregate expenditure. Then, Keynesian theory criticizes the views expressed by Classics on
investment as a function of the interest rate and on wage-price elasticity.

The Keynesian theory argue that the economy is not always be at full employment equilibrium because flexible prices and wages are not always valid. According to this opinion, there are many factors that prevent wages and prices from being flexible. For this reason, markets are moving away from fully competitive structure. In some sectors the existence of firms that do not want to reduce prices may be the case. Prices in these sectors can remain at the same level for a long time instead of falling when there is a fall in demand or expenditure. Because of the existence of strong labor unions and long term wage contracts, the same is also true in labor markets.

According to Keynesian model, one reason why equilibrium income is not always at full
employment level is that investment and saving equality cannot always be provided as Classics argue. The reason for this is that the economic units that save and invest in the economy are generally different from each other. These economic units give savings and investment decisions for different reasons. For example, when savings for households occur as accumulation for future days, firms’ investment decisions are directed at expanding facilities or purchasing new capital goods to increase their profitability. In this case, it may not happen that savings at an income level that close to full employment equal investments. Savings can also lead to an increase in the amount of money held, rather than being used for financing investments. In this case, savings-investment equality will not be provided again.

Equilibrium level of income in the economy means that aggregate supply and aggregate demand are equal to each other. Aggregate supply refers to the amount of goods and services that are desired to be produced in the economy. At the same time,
income from the sale of these goods and services is national income. Aggregate demand represents the level of expenditure that economic units are planning to make at various income levels. Therefore, the determination of equilibrium income and
expenditure level for an economy is the period of determining the level of income and expenditure, which is equal to what is planned and realized.

the answer to this problem is aggregate demand or aggregate expenditure. Keynesian
economy argues that equilibrium level of income is realized at the level where aggregate demand equals aggregate supply. Since the economy’s shortterm
production capacity is difficult to change in the short-run, the effective factor that determines the short-run equilibrium level of income is aggregate demand. Aggregate demand is called effective aggregate demand, at the level where the aggregate demand is equal to the aggregate supply. Accordingly, the level of equilibrium income that emerges shows the level of actual employment in that economy.

AE = C + I + G + NX
According to equation above, aggregate expenditures (AE) are the sum of consumption
expenditures (C), investment expenditures (I), government expenditures (G) and net exports (NX).

For example, when the planned expenditure is greater than the value of current
production, production will increase to meet the demand for goods and services. The fact that aggregate expenditures are greater than GDP means that more than the amount of goods and services currently produced in the economy is planned to
purchase. To meet this demand, firms sell goods and services that they have produced in the past and are waiting in stock. In other words, if the planned expenditures are greater than GDP, firms’ stocks decrease. The change in stocks compensates
the planned expenditure exceeding the GDP. Thus, actual expenditures, including unplanned changes in stocks, are equalized to GDP. Decreasing stocks will cause firms to increase their production. Thisincrease in production will cause an increase in
income or GDP. If the total expenditures are less than GDP, the entire goods and services produced in the economy will not be bought, and the stocks of the firms will start to increase. In this case, firms that cannot sell the goods and services they produce will preduce their production. This decrease in production will lead to a decline in income or GDP.

This will lead to increasing production and it will continue until the economy reaches level of equilibrium income.

This will lead to decreasing in production and it will continue until the economy reaches level of equilibrium income.

AE=C+I+G+NX=300+500+500+700=2000.

Uplanned stock Change=-300-500-500-700=-2000

AE=C+I+G+NX

2500=300+700+500+I olduğu için I=1000

NX=X-M=500-300=200

AE=C+I+G+XN= 2500=300+I+700+200 ise I=1300

AE=C+I+G+NX=3100+500+700+100=4400. 

Unplanned stock change= 4400-GDP=4400-4000=400