This basic model of national income (GDP) determination is based on the following assumptions.
The economy has only two sectors, viz., households and business enterprises. The households spend money on consumption and the business enterprises on investment.
There is no government or the government does not interfere in the economy in any manner. It neither imposes taxes, nor does it spend money on subsidies consumption or investment.
The country has a closed economy. It neither exports, nor imports goods services and thus has no economic relationship with the rest of the world.
Prices of all goods produced in the economy and all inputs used in production are fixed.
The economy has excess capacity, i.e., all the production units are producing less than their capacity output. Hence there are no constraints on expansion of output.
In this model of GDP determination, we are dealing with a short period of time short run here means that a deviation of actual GDP from the potential GDP and the consequent excess capacity, unemployment and recessionary trends, etc., are likely to be maintained during this time span as the time period is not sufficient for the operation of the automatic adjustment mechanism to restore equilibrium at the potential GDP level.