The Equilibrium Formula
Expert reviewed • 14 August 2024 • 4 minute read
What is the Equilibrium Formula?
Economic equilibrium occurs when the quantity of goods produced equals the quantity of goods demanded. This equilibrium is where aggregate supply (AS) equals aggregate demand (AD), also known as the injections-leakages approach. This formula is expressed as:
Where:
- Investment
- Government Spending
- Exports
- Savings
- Taxes
- Imports
This equation highlights the balance between the injections into the economy and the leakages from it.
What are Injections and Leakages?
The key principle of equilibrium is that for an economy to be in equilibrium, the total injections must equal the total leakages. When injections equal leakages, the economy is said to be in equilibrium. This balance ensures that the circular flow of income in the economy remains stable.
Injections:
- Investment (I): Business expenditure on capital goods and inventory.
- Government Spending (G): Expenditures by the government on goods and services, including infrastructure, education, healthcare, and defence.
- Exports (X): Goods and services produced domestically and sold to foreign buyers.
Leakages:
- Savings (S): The portion of income not spent by households.
- Taxes (T): Government revenue collected from households and businesses.
- Imports (M): Goods and services bought from foreign countries.
- Imports (M): Goods and services bought from foreign countries.
Implications of Equilibrium for Economic Growth
Policymakers can attempt to stimulate economic growth by increasing injections or reducing leakages. For example, increasing government spending (G) or encouraging exports (X) can boost aggregate demand and potentially lead to economic growth. However, if leakages consistently exceed injections, it may lead to a slowdown in economic activity.