An economy is in equilibrium when either of the two conditions are satisfied.
(i) Aggregate Demand = Aggregate Supply
(ii) Saving = Investment (Saving and Investment Approach)
According to this approach, the equilibrium is determined at that point, where the saving and investment are equal to each other. In other words, the equilibrium is established, where leakages are equal to the injections.
In the diagram, SS represents the saving curve and II represents the investment curve. The investment curve is a horizontal line as it represents the autonomous investment. At point E, Savings = Investment, thus point E represents the equilibrium point, where the saving curve SS and the investment curve II intersects. Accordingly, OQ is the equilibrium level of income (output).
To the left of point E, saving is less than investment. When I exceeds S i.e., when injections into the circular flow of income is greater than withdrawal from the income, implies that available supply of goods and services is less than what is required to meet the current demand for goods and services. In other words, we can understand this as low saving implies high consumption, which means that the output demand (due to high consumption) is greater than the planned output. Thus, there exists a portion of demand that remains unsatisfied, thereby, leading to an unplanned decline in the inventory. Thus to prevent inventories from falling, savings in the economy must be increase. This will happen till savings are again equal to investment and the equilibrium is restored.
To the right of point E, savings is greater than investment. When S exceeds I i.e., when withdrawal from the income is greater than injections into the circular flow of income, implies that total consumption expenditure is less than what is required to purchase the available supply of goods and services. In other words, we can understand this as high saving implies low consumption, which means that the output sold (due to low consumption) is less than the planned output. Thus, there exists a portion of produced output that remained unsold, thereby, leading to accumulation of unplanned inventory. Thus to prevent accumulation of inventories, savings in the economy will be reduced. This will happen till savings are again equal to investment and the equilibrium is restored.