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If the received signal level drops down to certain level, squelch circuit cuts off audio output to prevent the listener to hear very disturbed noise.
If you designa AGC circuit, squelch circuit observe the a certain voltage of the output of AGC circuit and when this voltage drops to low level it switches to cut off the audio amplifier.
FM squelch circuits are typically based on noise.... they look at the amount of noise above the audio passband and when this noise "quiets" (drops), it is an indication that a signal is present.
It is important to look outside of the audio passband as otherwise the actual voice would/could cause the squelch to close again....
there is a lot of information on this topic on the web... particularly some schematics and such in the context of amateur radio repeater building...
using RSSI or AGC based squelch may work for some cases but is generally a weak approach for FM voice/FSK data/etc.
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