Macro Dey

The Divine Book
Macroeconomics XII
(with Solution Booklet for Teacher’s Reference)
Subhash Dey
A wealth of ‘Objective Type Questions,
MCQs’ based on latest CBSE Sample
Question Paper (2020)
(‘Check List to Objective Type Questions’ is

given at the end of each chapter.)
‘Numerical Questions (with solutions)’
based on new pattern of questions included
in CBSE Sample Question Paper 2020
‘Do it yourself’ Exercise with every Numerical

Question for self-evaluation of the students
(Answers have been given in Solution Booklet
for Teacher’s Reference only)
‘Analysing, Evaluating and Creating type
questions’ with answers
(based on new pattern of questions included
in CBSE Sample Question Paper 2020)
‘Recap’ — SYNOPSIS/NOTES of each topic
’25 Sample Question Papers ’ based on
CBSE New Question Paper Design

’CBSE Sample Question Paper 2020’ with
Answers through Author’s Pen
‘Top Tips’ helping avoid common errors made
by students in examinations
‘Key Terms’ at the end of each topic

— which are most likely to be used in CBSE
Economics XII examination questions
‘Glossary of Key Terms’ at the end of the

Book
‘Self-Assessment Tests 1-3’ based on the
current chapter – at the end of each chapter
‘Self-Assessment Tests 4-5’ based on current

as well as previous chapters – at the end of
each chapter

Preparing for Examination
Exam Tips — for Attempting CBSE Economics
XII Board Examination
Formulae — National Income Accounting and

Determination of Income and Employment
Diagrams and Schedules — Determination of

Income and Employment
Project Work
CBSE Guidelines on Project Work
Sample Project on Money and Banking
Edition
2020
Completely based on Latest CBSE Syllabus and NCERT Book
Introductory
MACROECONOMICS
A Textbook for Economics Class XII
A Wealth of Objective Type Questions, MCQs
< NUMERICAL QUESTIONS (with solutions) and ‘Do it yourself’ exercises

< ‘Analysing, Evaluating and Creating’ type questions (with answers)
< ‘5 Self-Assessment Tests’ at the end of each unit
< ‘Recap’ at the end of each topic to review its essential understanding
< ‘Preparing for Examinations’ chapter on study skills and exam tips
< CBSE Sample Question Paper 2020 with answers through Author’s pen
< Project Work and Sample Project
< ‘Glossary of Key Terms’
25 Sample Question Papers (based on CBSE New Question Paper Design)
Subhash Dey
Shree Radhey Publications

UNIT 1: National Income and Related Aggregates 7
10 Marks
Unit
National Income and Related
Aggregates
CBSE Syllabus Content
 What is Macroeconomics? 1.1 Some Basic Concepts of National Income Accounting
 Some basic concepts: consumption goods, capital
1.2 Domestic Territory and Resident: Implications
goods, final goods, intermediate goods; stocks and
flows; gross investment and depreciation 1.3 Circular Flow of Income (Two-Sector Model)
 Circular flow of income (two sector model)
1.4 Production Method (or Value Added Method) of
 Methods of calculating national income–Value Added Calculating National Income
or Product method, Expenditure method and Income
method 1.5 Income Method of Calculating National Income
 Aggregates related to national income: Gross National 1.6 Expenditure Method of Calculating National Income
Product (GNP), Net National Product (NNP), Gross
and Net Domestic Product (GDP and NDP)–at market 1.7 Real and Nominal GDP
price, at factor cost 1.8 GDP and Welfare
 Real and Nominal GDP; GDP and welfare
 "There is one rule for the industrialist and that is: make the best quality goods possible at the lowest cost possible, paying the
highest wages possible." —Henry Ford
 “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to
their respective abilities.” —Adam Smith
8 Macroeconomics XII – by Subhash Dey
Introduction National Income and Related Aggregates
National income accounting is a branch of macroeconomics of which estimation of national income

and related aggregates is a part. National income or any aggregate related to it, is a measure of the
value of production activity of a country. There are three methods of estimation of national income–
value added or product method, income method and expenditure method. To understand these, we
must know how the macroeconomy (it refers to the economy that we study in macroeconomics)
works in a circular way? It begins with the question—‘how does the flow of production arise?’
In a closed economy, without a government or external trade, there are only two sectors, namely firms
and households. The production units are called firms. In a firm the entrepreneur (or entrepreneurs)
is at the helm of affairs. He hires wage labour from the market, he employs the services of capital and
land as well. After hiring these inputs he undertakes the task of production. His motive for producing
goods and services (referred to as output) is to sell them in the market and earn profits. In the process
he undertakes risks and uncertainties. For example, he may not get a high enough price for the goods
he is producing; this may lead to fall in the profits that he earns. The households, on the other hand,
consist of people who work in firms as workers and earn wages or they are the owners of firms and
earn profits. Moreover, they can also earn rent by leasing land or earn interest by lending capital.
Thus, goods and services are produced by firms with the combined efforts of factors of production
(labour, land, capital and entrepreneurship). The output produced is sold to the consumers, who may
be an individual or an enterprise and the good or service purchased by that entity may be for final
use (e.g., bread purchased by households) or for use in further production. When it is used in further
production, it loses its characteristics as that specific good and is transformed through a productive
process into another good. For example, a farmer producing cotton sells it to a spinning mill where
the raw cotton undergoes transformation to yarn; the yarn is, in turn, sold to a textile mill where it
is transformed into cloth; the cloth is, in turn, transformed into an article of clothing which is then
ready to be sold to the ultimate consumers for final use. Why do we call this a final good? Because
once it has been sold, it will not undergo any further transformation at the hands of any producer.
It may, however, undergo transformation by the action of the ultimate consumer, e.g. the tea leaves
purchased by the consumer are not consumed in that form – they are used to make drinkable tea,
which is consumed. Similarly, most of the items that enter our kitchen are transformed through the
process of cooking. But cooking at home is not an economic activity because home cooked food is
not sold to the market. However, if the same cooking or tea brewing was done in a restaurant where
the cooked product would be sold to customers, then the same items, such as tea leaves, would cease
to be final goods and would be counted as raw materials or inputs to which economic value addition
can take place. Thus, it is not in the nature of the good but in the economic nature of its use that a
good becomes a final good.
The above discussion is the basis for estimation of national income and the related aggregates.
What is Macroeconomics?
In macroeconomics, we study the economic behaviour of the economy as a whole by focusing our attention on
aggregate measures such as total output, employment and aggregate price level.
Here, we are interested in finding out how the levels of these aggregate measures are determined and how the
levels of these aggregate measures change over time.
Some of the important questions that are studied in macroeconomics are as follows:
• What is the level of total output in the economy?
• How is the total output determined?
• How does the total output grow over time?
• Are the resources of the economy (e.g. labour) fully employed?
• What are the reasons behind the unemployment of resources?
• Why do prices rise?
Thus, instead of studying the different markets as is done in microeconomics, in macroeconomics, we try to
study the behaviour of aggregate or macro measures of the performance of the economy.
1.1 Some Basic Concepts of National Income Accounting

Final Goods and Intermediate Goods
Goods are classified as final goods and intermediate goods on the basis of the end use of the goods.
Final Goods
If goods are purchased for consumption, i.e., for satisfaction of wants, or for investment, these are called final
goods (or final products). Expenditure on them is called final expenditure.
Examples:
(i) Machine purchased by a firm for installation in factory is a final good because it is purchased for investment.
(ii) Milk purchased by households is a final good as it is purchased for consumption.
(iii) Furniture purchased by a school is a final product because it is purchased for investment.
(iv) Computers installed in an office is a final product because it is purchased for investment.
(v) Printer purchased by a lawyer for office use is a final product because it is purchased for investment.
(vi) Blackboard used in a school is a final good because it is for investment. It is not used up completely in a
year but remains for production of educational services.
(vii) Second hand car purchased by a house hold is a final good because it is purchased for consumption.
Intermediate Goods
Goods and services purchased by a production unit from other production units with the purpose of reselling or with
the purpose of using them completely during the same year are called intermediate goods (or intermediate products).
Top Tips
• Raw materials or non-factor inputs purchased for producing goods are intermediate goods.
• Intermediate goods are also called ‘single use producer goods’.
• The expenditure on the intermediate goods is called intermediate cost or intermediate consumption.
Examples:
(i) Steel sheets used for making automobiles and copper used for making utensils are intermediate goods
since they are purchased with the purpose of using them completely during the same year for production
of steel gates/utensils.
(ii) Mobile sets purchased by a mobile dealer are intermediate products because these are purchased for resale.
(iii) Chalks, dusters, etc. purchased by a school are intermediate products because these are used up completely
during the same year in the production of educational services.
(iv) Paper purchased by a publisher is an intermediate product because it is used as raw material for production
of books in the same year.
(v) Purchase of rice by a grocery shop is an intermediate product because it is purchased for resale.
(vi) Coal used by a manufacturing firm is an intermediate product because it is used as a non-factor input for
production of other commodities during the same year.
(vii) Fertilisers used by the farmers are intermediate products because these are used up completely for
producing grains during the same year.
(viii) Cotton used by a spinning mill is an intermediate product because it is used for further production of
clothes during the same year.
Top Tip
National income includes the value of final goods only. The value of intermediate goods is not included in the national
income estimates because it is already included in the value of the final goods. Including intermediate goods separately
will inflate or overestimate the national income.
Consumption Goods and Capital Goods

Final goods produced in an economy in a given period of time are either in the form of consumption goods (both
durable and non-durable) or capital goods. As final goods they do not undergo any further transformation at the
hands of any producer. Thus, of the final goods, we can distinguish between consumption goods and capital goods.
Consumption Goods
The final goods which are consumed (or used) for satisfaction of wants by the consumers are called consumption
goods or consumer goods*, e.g., food, clothing, television sets, etc.
 Those consumer goods like television sets, automobiles, home computers, etc. which are of durable
character are called consumer durables.
 Those consumer goods like food, clothing, etc. which are extinguished by immediate or short period
consumption are known as consumer non-durable goods.
Capital Goods
The final goods of durable character which are used in the production of other goods and services are called
capital goods or investment goods, e.g., machines, tools and equipments.
Capital goods are also called durable use producer goods having a long span of life, say 5 years or 10 years.
Top Tip
Basis of classification of final goods into consumption goods and capital goods
The same good can be consumption good and also capital good. It depends on the economic nature of its use. For
example, a machine purchased by a household is a consumption good whereas, if it is purchased by a firm for use in
the business, then it is a capital good. Similarly, a car purchased by a household is a consumption good whereas if it is
purchased by a firm for use in business, then it is a capital good.
Stocks and Flows

Stocks
Stocks are economic variables measured at a given point of time.
For example, Capital, Wealth, Money supply, Population, Inventories, Foreign debts, Buildings and machines
in a factory, Balance in a bank account, etc. are stock variables since they are measured at a particular point
of time.
* This also includes services like recreation which are consumed but for convenience we may refer to them as consumer goods.
Flows
Flows are economic variables measured over a period of time.
National income or Gross domestic product (GDP) or Production or Output, Sales, Savings, Expenditure, Profits,
Losses, Exports, Imports, Net capital formation or net investment, Depreciation, Interest, Change in inventories,
Change in money supply, Value added, etc. are flow variables since they are measured over a period of time.
Top Tip
An example to understand the difference between stock variables and flow variables
Suppose a tank is being filled with water coming from a tap. The amount of water which is flowing into the tank from the
tap per minute is a flow. But how much water there is in the tank at a particular point of time is a stock concept.
Gross Investment and Depreciation

Investment
In economics, the term ‘investment*’ is defined as addition to the stock of fixed capital (such as machines) and
change in inventories during a year.
That part of final output which comprises of capital goods constitutes gross investment of an economy. For
example, machines, tools and implements, buildings, office spaces, store houses or infrastructure like roads,
bridges, airports or jetties, etc.
Depreciation
A part of the capital goods produced this year goes for maintenance or replacement of existing capital goods
because the existing capital stock suffers wear and tear and needs maintenance and replacement. This portion of
the capital goods produced is not an addition to the stock of capital goods and its value needs to be subtracted
from gross investment to arrive at net investment. This deletion made from the value of gross investment in
order to accommodate regular wear and tear of capital, is called depreciation.
Depreciation is an annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset.
New addition to capital stock in an economy is called net investment (or net capital formation).
Net Investment = Gross investment – Depreciation
Thus, investment is defined as capital formation, a gross or net addition to capital stock.
Let us examine the concept of depreciation a little more in detail:
Cost of the capital asset − Scrap value
Depreciation on capital =
Estimated life of the capital asset (in years)
Example: Suppose a new machine is purchased for `20 lakh having useful life of service 10 years, after which it
falls into disrepair and needs to be replaced.
Suppose, the scrap value of the machine will be nil after 10 years.
` 20 lakhs − 0
Therefore, Depreciation on the machine = = `2 lakh per year.
10 years
Thus, the machine is gradually used up in each year’s production process and each year 1/10th of its original
value, i.e. `2 lakh gets depreciated. So, instead of considering a bulk investment for replacement after 10 years,
we consider an annual depreciation cost every year.
Note that depreciation does not take into account unexpected/unforeseen obsolescence or sudden destruction or
disuse of capital as can happen with accidents, natural calamities or other such extraneous circumstances. This is
called ‘capital loss’.
* The term ‘investment’ must not be confused with the commonplace notion of investment which implies using money to buy physical or financial
assets. Thus, use of the term investment to denote purchase of shares or property or even having an insurance policy has nothing to do with how
economists define investment.
RECAP
Macroeconomics
In macroeconomics, we study the economic behaviour of the economy as a whole, e.g. aggregate demand, aggregate supply,
levels of income, employment and price in the economy.
Final Goods and Intermediate Goods
Goods are classified as final goods and intermediate goods on the basis of the end use.
Final goods are the goods which are used for final consumption (i.e., for satisfaction of wants) or for investment.
Examples: (i) Machine purchased by a firm for installation in factory, (ii) Milk or bread purchased by households, (iii) Printer
purchased by a lawyer for office use, etc.
Intermediate goods (or single use producer goods) are the goods which are purchased during the year by a firm from another
for the purpose of further production or resale.
Examples: (i) Raw materials such as steel sheets used for making automobiles and copper used for making utensils, (ii) Mobile
sets purchased by a mobile dealer, (iii) Chalks, dusters, etc. purchased by a school, (iv) Paper purchased by a publisher, (v)
Purchase of rice by a grocery shop, (vi) Fertilisers used by the farmers, etc.
Consumption Goods and Capital Goods
Consumption goods (or consumer goods) are that part of the final goods which are consumed (or used) for satisfaction of
wants by the consumers, e.g., food, clothing, TV sets, refrigerators, etc.
Capital goods (or investment goods or durable use producer goods) are that part of the final goods which are bought not for
meeting immediate needs of the consumers but are for producing other goods, e.g., machines and equipments. They are of
durable character.
Stocks and Flows
Stocks are economic variables which can be measured at a given point of time, e.g. Capital, Wealth, Money supply, Inventories,
Buildings and machines in a factory, Balance in a bank account, etc.
Flows are economic variables which can be measured over a period of time, e.g, National income or GDP or Production or
Output, Sales, Savings, Expenditure, Profits, Losses, Exports, Imports, Gross/Net capital formation or Gross/Net Investment,
Depreciation, Interest, Change in inventories, Change in money supply or money creation, Value addition, etc.
Gross Investment and Depreciation
Gross investment (or gross capital formation) refers to the addition to capital stock of an economy during an accounting year.
Depreciation is an annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset. Depreciation
is also defined as value of consumption of fixed capital or annual maintenance and replacement cost of fixed capital assets.
Cost of fixed capital asset - Scrap value after its useful life
Depreciation on fixed capital asset =
Estimated useful life of the fixed capital asset (in years)
Note: Unexpected/unforeseen obsolescence or sudden destruction of capital assets is not depreciation. It is called capital loss.
Net investment (or net capital formation) is the new addition to capital stock in an economy. A part of the capital goods produced
goes for maintenance or replacement of existing capital goods. Thus, Net Investment = Gross investment – Depreciation.
Indirect Tax and Subsidy
Indirect tax is a tax imposed by government on production and sale of goods and services. Examples: Goods and services tax
(GST), excise tax, etc. Indirect taxes increase market prices of goods and services.
Subsidy is a form of financial/economic assistance given by the government to the firms and households, with a motive of
general welfare. Examples: Cash grants, interest-free loan to the firms, subsidy on price of cooking gas to the households, etc.
Subsidies reduce the market prices of goods and services.
Net indirect tax = Indirect taxes – Subsidies
Market Price and Factor Cost
Market price is what the buyers pay. It includes indirect taxes but excludes subsidies.
Factor cost is what is actually available to production units. Factor cost = Market price – Indirect taxes + Subsidies
Factor Income and Transfer Income
The payment for the services rendered to the production units by the owners of factors of production is called factor payment
or factor income, e.g. wages and salary, rent, interest profit, etc.
Any payment for which no service is rendered is called a transfer payment or transfer income. It does not involve any production
of goods and services. Examples: Gifts, donations, charity, etc.
Inventory and Change in Inventories
The stock of unsold finished goods, or semi-finished goods, or raw materials which a firm carries from one year to the next is
called inventory.
Net change (or increase) in inventories = Closing inventory – Opening inventory
Numerical 1
Calculate ‘Depreciation on Capital Asset’ from the following data:

(CBSE Sample Question Paper 2020) (4 marks)
S. No Particulars Amount (in `crore)
i. Capital value of the asset 1,000
ii. Estimated life of the asset 20 years
iii. Scrap Value Nil
Cost of the capital asset - Scrap value 1, 000 - 0

Solution: Depreciation on capital asset = = = `50 crore
Estimated life of the capital asset 20
Do it yourself 1
If a machine costing `2,00,000 has a useful life of 5 years with no scrap value, calculate the value of the machine which
is being gradually used up in each year’s production process. (3 marks)
[Ans. `40,000]
Additional NCERT Content Extracted from latest NCERT Book

 Consumer durables are not extinguished by immediate or even short period consumption; they have a relatively long life as compared to
articles such as food or even clothing. They undergo wear and tear with gradual use and often need repairs and replacements of parts.
 Capital goods purchased by business enterprises such as machines make production of other goods feasible, however, they themselves
don’t get transformed in the production process.
 Capital goods gradually undergo wear and tear, and thus are repaired or gradually replaced over time.
 Capital goods are used either for maintenance or replacement of the existing capital stock because there are wear and tear of it, or they are
used for addition to their capital stock.
 Total final output produced in an economy includes output of consumer goods and services and output of capital goods. The consumer
goods sustain the consumption of the entire population of the economy. Purchase of consumer goods depends on the capacity of the
people to spend on these goods which, in turn, depends on their income. The other part of the final goods, the capital goods, are
purchased by business enterprises. They are used either for maintenance of the capital stock because there are wear and tear of it, or
they are used for addition to their capital stock. In a specific time period, say in a year, the total production of final goods can thus be
either in the form of consumption or investment. This implies that there is a trade-off. If an economy, produces more of capital goods, it is
producing less of consumer goods and vice-versa.
 At a particular period, given a level of total output of the economy, it is true if more capital goods are produced less of consumer goods would be
produced. But production of more capital goods would mean that in future the labourers would have more capital equipments to work with.
 Depreciation is an accounting concept. No real expenditure may have actually been incurred each year yet depreciation is annually
accounted for.
 Unplanned Accumulation and Decumulation of Inventories: In case of an unexpected fall in sales, the firm will have unsold stock of goods
which it had not anticipated. Hence, there will be unplanned accumulation of inventories. In the opposite case, where there is unexpected
rise in the sales there will be unplanned decumulation of inventories.
This can be illustrated with the help of the following example. Suppose a firm produces shirts. It starts the year with an inventory of 100
shirts. During the coming year it expects to sell 1000 shirts. Hence, it produces 1000 shirts, expecting to keep an inventory of 100 at the end
of the year. However, during the year, the sales of shirts turn out to be unexpectedly low. The firm is able to sell only 600 shirts. This means
that the firm is left with 400 unsold shirts. The firm ends the year with 400 + 100 = 500 shirts. The unexpected rise of inventories by 400 is an
example of unplanned accumulation of inventories.
If, on the other hand, the sales had been more than 1000 we would have unplanned decumulation of inventories. For example, if the sales
had been 1050, then not only the production of 1000 shirts will be sold, the firm will have to sell 50 shirts out of the inventory. This 50
unexpected reduction in inventories is an example of unexpected decumulation of inventories.
 Planned Accumulation and Decumulation of Inventories: Suppose the firm wants to raise the inventories from 100 shirts to 200 shirts during
the year. Expecting sales of 1000 shirts during the year (as before), the firm produces 1000 + 100 = 1100 shirts. If the sales are actually 1000
shirts, then the firm indeed ends up with a rise of inventories. The new stock of inventories is 200 shirts, which was indeed planned by the
firm. This rise is an example of planned accumulation of inventories.
On the other hand, if the firm had wanted to reduce the inventories from 100 to 25 (say), then it would produce 1000 – 75 = 925 shirts. This
is because it plans to sell 75 shirts out of the inventory of 100 shirts it started with (so that the inventory at the end of the year becomes 100
– 75 = 25 shirts, which the firm wants). If the sales indeed turn out to be 1000 as expected by the firm, the firm will be left with the planned
decumulation of inventory of 25 shirts.
Objective Type Questions 1.1
1. The good or service purchased by an individual or an enterprise is for : (Choose the correct alternative)
(a) Final use (b) Use in further production
(c) Both (a) and (b) (d) Consumption
2. A good that is meant for final use and will not pass through any more stages of production or transformations at the hands
of any producer is called __________ . (Fill in the blank)
3. A final good may also undergo transformations. True/False? Give reason.
4. It is not in the nature of the good but in the _______ that a good becomes a final good. (Fill in the blank)
5. If tea leaves are used in a restaurant for tea brewing , and the drinkable tea is sold to the customers, then the tea leaves
will be________________. (Choose the correct alternative)
(a) Final goods (b) Intermediate good
(c) Consumption goods (d) Capital goods
6. Final goods are: (Choose the correct alternative)
(a) Consumption goods (b) Capital goods
(c) Both (a) and (b) (d) Intermediate goods
7. Goods like food and clothing and services like recreation that are consumed when purchased by their ultimate consumers
are called ________________. (Fill in the blank)
8. Goods of durable character which make production of other commodities feasible but they themselves don’t get
transformed in the production process, are called ________________. (Fill in the blank)
9. The durable goods which undergo wear and tear with gradual use, and thus are repaired or gradually replaced over time
are : (Choose the correct alternative)
(a) Intermediate goods (b) Capital goods
(c) Consumer durables (d) Both (b) and (c)
10. All the final goods and services produced in an economy in a given period of time are either in the form of ________________
or __________ . (Fill in the blanks)
11. Of the total production taking place in the economy, a large number of products don’t end up in final consumption and are
not capital goods either. These are ________________. (Fill in the blank)
12. Raw materials or non-factor inputs used for production of other commodities are: (Choose the correct alternative)
(a) Capital goods (b) Final goods
(c) Intermediate goods (d) Consumer durables
13. Income, or output, or profits are concepts that make sense only when a time period is specified. These are called
___________. (Fill in the blank)
14. (i) ______________ (Stock / Flows) are defined over a period of time, whereas (ii) ______________ (Stock / Flows) are
defined at a particular point of time. (Choose the correct option)
15. Capital goods (e.g. buildings or machines in a factory) or consumer durables (e.g. television sets, home computers, etc)
once produced do not wear out or get consumed in a delineated time period. In fact, capital goods continue to serve us
through different cycles of production. There can be addition to, or deduction from, these if a new machine is added or a
machine falls in disuse and is not replaced. These are called ____________ . (Stock / Flows) (Choose the correct option)
16. Change in stocks are _____________. (Stocks / Flows). (Choose the correct option)
17. Suppose a tank is being filled with water coming from a tap. The amount of water which is flowing into the tank from
the tap per minute is a (i) _________________ (Stock concept / Flow concept). But how much water is in the tank is a
(ii) _________________ (Stock concept / Flow concept). (Choose the correct option)
18. The part of final goods that comprises of capital goods constitutes ______________ of an economy. (Fill in the blank)
19. All the capital goods produced in a year do not constitute net addition to the capital stock already existing.
True / False? Give reason.
20. A part of the capital goods produced this year goes for replacement of existing capital goods and is not an addition to
the stock of capital goods already existing and its value needs to be subtracted from gross investment for arriving at the
measure of net investment. This deletion, which is made from the value of gross investment in order to accommodate
regular wear and tear of capital is called __________ . (Fill in the blank)
21. New addition to capital stock in an economy is ________________.

22. Which of the following does not explain the concept of depreciation? (Choose the correct alternative)
(a) An annual allowance for wear and tear of a capital good.
(b) Cost of the capital good (minus scrap value) divided by number of years of its useful life.
(c) Unexpected or sudden destruction or disuse of capital as can happen with accidents, natural calamities etc.
(d) Maintenance and replacement cost of existing capital goods.
23. Depreciation is an accounting concept. True/False? Give reason.
24. Which of the following define ‘investment’ in Economics ? (Choose the correct alternative)
(a) Purchase of share or property.
(b) Having an insurance policy.
(c) Using money to buy physical or financial assets.
(d) Capital formation ,i.e. a gross or net addition to capital stock.
25. In economics, investment implies using money to buy physical or financial assets. True/False? Give reason.
26. Total final output produced in an economy in a given year are used : (Choose the correct alternative)
(a) To substain the consumption of the entire population of the economy.
(b) For maintenance and replacement of the existing capital stock.
(c) For new addition to the capital stock.
(d) All of the above
27. More capital goods would always mean more consumer goods. True/False?
28. _________ add to, or maintain, the capital stock of an economy and thus make production of other commodities
possible. (Fill in the blank)
29. Match the following:
(i) Fertilisers or pesticides used by (a) Intermediate goods
a farmer to produce wheat
(ii) Bread produced by a baker for (b) Final goods
selling it to consumers or restaurants
30. Depreciation is also known as: (Choose the correct alternative)
(a) Consumption of fixed capital
(b) Annual replacement cost
(c) Value of capital consumption
31. Inventory is a stock variable. True/False? Give reason.
32. Change in inventories is a stock variable . True/False? Give reason.
33. ‘Exports’ is a flow variable. True/False? Give reason.
34. Which of the following is a flow concept? (Choose the correct alternative)
(a) Foreign exchange reserves (b) Inventory
(c) Capital (d) Exports
35. Which of the following is a stock variable? (Choose the correct alternative)
(a) Money supply (b) Depreciation
(c) Interest (d) Output
36. Losses are classified as: (Choose the correct alternative)
(a) Stock variable (b) Flow variable
(c) Either (a) or (b) (d) Neither (a) nor (b)
37. Which of the following is not a flow? (Choose the correct alternative)
(a) Capital (b) Income
(c) Investment (d) Depreciation
38. Which of the following is a stock? (Choose the correct alternative)
(a) Wealth (b) Saving
(c) Exports (d) Profits
39. Which of the following is a flow? (Choose the correct alternative)

(a) Deposits in a bank (b) Capital
(c) Depreciation (d) Wealth
40. Which one of the following is an intermediate product? (Choose the correct alternative)
(a) Purchase of pulses by consumers (b) Machine purchased by a firm
(c) Wheat used by a flour mill (d) Wheat used by households
41. Which of the following is an example of an intermediate good? (Choose the correct alternative)
(a) Copper purchased for making utensils (b) Steel and cement used to construct a flyover
(c) Fertilizers purchased by a farmer (d) All of these
42. Depreciation of fixed capital assets refers to: (Choose the correct alternative)
(a) Normal wear and tear
(b) Foreseen obsolescence
(c) Normal wear and tear and foreseen obsolescence
(d) Unforeseen obsolescence
43. Unforeseen obsolescence of fixed capital assets during production is: (Choose the correct alternative)
(a) Consumption of fixed capital (b) Capital loss
(c) Income loss (d) None of the above
44. Refrigerator purchased by a confectionery shop is an example of: (Choose the correct alternative)
(a) Final good (b) Intermediate good
(c) Capital good (d) Both (a) and (c)
45. Which of the following is an example of consumer non-durable good? (Choose the correct alternative)
(a) Milk (b) Bread
(c) Both (a) and (b) (d) Clothes
46. Addition to the capital stock of an economy is termed as: (Choose the correct alternative)
(a) Investment (b) Capital loss
(c) Consumption of fixed capital (d) All of these
47. Goods purchased for the following purpose are final goods : (Choose the correct alternative)
(a) For satisfaction of wants (b) For investment in firm
(c) Both (a) and (b) (d) None of these
48. Match the following: (Choose the correct alternative)
(i) Profits (a) Stock variable
(ii) Savings (b) Flow variable
(iii) Balance in a bank account
(iv) Gross Domestic Product (GDP)
49. State giving reason whether the following statement is True or False:
Capital formation is a flow concept.
Bread is always a consumer good.
Savings are a stock.
Butter is only a final product.
National income of a country is a stock variable.
Capital goods are used up to produce other goods.
1.4 Production Method of Calculating National Income

In product method or value added method, we calculate the aggregate annual value of goods and services
produced during a year. How to go about doing this? Do we add up the value of all goods and services produced
by all the firms in an economy? The following example will help us to understand.
Let us suppose that there are only two kinds of producers in the economy – wheat producers (or the farmers)
and the bread makers (the bakers). The wheat producers grow wheat and they do not need any input other
than human labour. They sell a part of the wheat to the bakers. The bakers do not need any other raw materials
besides wheat to produce bread. Let us suppose that in a year the total value of wheat that the farmers have
produced is `100. Out of this they have sold `50 worth of wheat to the bakers. The bakers have used this
amount of wheat completely during the year and have produced `200 worth of bread.
What is the value of total production in the economy? If we follow the simple way of aggregating the values of
production of the sectors, we would add `200 (value of production of the bakers) to `100 (value of production
of farmers). The result will be `300.
A little reflection will tell us that the value of aggregate production is not `300. The farmers had produced `100
worth of wheat for which it did not need assistance of any inputs. Therefore, the entire `100 is rightfully the
contribution of the farmers. But the same is not true for the bakers. The bakers had to buy `50 worth of wheat
to produce their bread. The `200 worth of bread that they have produced is not entirely their own contribution.
To calculate the net contribution of the bakers, we need to subtract the value of the wheat that they have bought
from the farmers. If we do not do this we shall commit the mistake of ‘double counting’. This is because `50
worth of wheat will be counted twice. First, it will be counted as part of the output produced by the farmers.
Second time, it will be counted as the imputed value of wheat in the bread produced by the bakers.
Therefore, the net contribution made by the bakers is, `200 – `50 = `150.
Hence, aggregate value of goods produced by this simple economy is `100 (net contribution by the farmers) +
`150 (net contribution by the bakers) = `250.
The term that is used to denote the net contribution made by a firm is called its 'value added'. We know that
the raw materials that a firm buys from another firm which are completely used up in the process of production
are called ‘intermediate goods’. Therefore:
Value added of a firm = Value of output produced by the firm – Cost of intermediate goods used
The value added of a firm is distributed among its four factors of production, namely, labour, capital,
entrepreneurship and land. Therefore wages, interest, profits and rents paid out by the firm must add up to the
value added of the firm. Value added is a flow variable.
We can represent the example given above in terms of the following Table.
Farmer Baker
Value of output 100 200
Intermediate consumption 0 50
Value added 100 200 – 50 =150
Problem of Double Counting

The problem of double counting arises when the value of same goods and services are counted more than once
while estimating national income.
There are two approaches/methods to avoid the problem of double counting:
(i) Take the value of final goods and services only ignoring all intermediate products.
(ii) Take value added at different stages in production process instead of total output.
Steps for calculation of national income by product method

Step 1: Estimation of value of output produced by each firm in all the sectors of the
economy during the year.
Value of output is the market value of goods and services produced by a firm during an accounting year.
Value of output = Output produced (in units) × Market price
(a) If a firm had no initial unsold stock in the beginning of the year:
Value of output produced = Sales + Value of unsold stock
Note: Sales = Output sold (in units) × Market price

Sales = Sale of goods and services to domestic buyers + Exports of goods and services.
(b) If a firm had some unsold stock in the beginning of the year:
Value of output = Sales + Net change in stock
or, Value of output = Sales + Closing stock – Opening stock

Example: Suppose that a firm had an unsold stock worth `100 at the beginning of the year. During
the year it produced `1000 worth of goods by using raw materials and other inputs worth `400 and
managed to sell `800 worth of goods.
(i) Value of closing stock = Opening stock + Value of output produced – Sales
= 100 + 1000 – 800 = `300
(ii) Change in stock = Closing stock – Opening stock = 300 – 100 = `200
or, Change in stock = Value of output produced – Sales = 1000 – 800 = `200
(iii) Value of output produced = Sales + Change in stock = 800 + 200 = `1000
Step 2: Calculation of Value Added/Value Addition (VA) and Gross Domestic Product at
market price (GDPmp)
Value added/value addition is the difference between value of output and intermediate consumption.
Value added = Value of output – Intermediate consumption
Top Tip
Intermediate consumption = Purchase of raw materials etc. + Imports of raw materials etc.
In our example of farmers and bakers, the Value Added by farmers and bakers are their Gross Value Added at
market price (GVAmp).
GVAmp of a firm = Value of output – Intermediate consumption
Now, if we sum the GVAmp of all the firms in all the sectors of the economy, we get Gross Domestic Product
at market price (GDPmp).
GDPmp = Value of output of all the firms in the economy – Intermediate costs
GDPmp is the money value of all final goods and services produced within the domestic territory of a country
during an accounting year. All production done by the national residents or the non-residents in the domestic
territory of the country gets included, regardless of whether that production is owned by a local company or a
foreign entity. Everything is valued at market prices.
Why is GDPmp called gross?

GDPmp is final products valued at market price. This is what buyers pay. But this is not what production units
actually receive. Out of what buyers pay, the production units have to make provision for depreciation and
payment of indirect tax like excise, sales tax, etc. This explains why GDPmp is called 'gross'. It is called gross
because no provision has been made for depreciation. However, if depreciation is deducted from the GDP, it
becomes Net Domestic Product (NDP). Naturally, depreciation does not become part of anybody’s income.
Why is GDPmp called ‘at market price’ ?
Out of what buyers pay, the production units have to make payments of indirect taxes, if any. Indirect taxes
accrue to the government, and not to the production units. Payment of indirect taxes to the government is a
transfer payment as no good or service is provided in return. Hence, indirect taxes are deducted from GDPmp
to calculate what production units actually receive.
Sometimes production units receive subsidy on production. This is in addition to the market price which
production units receive from the buyers. Therefore, what production units actually receive is not the 'market-
price' but "market price – indirect tax + subsidies".
Step 3: Calculation of Net Domestic Product at factor cost (NDPfc)
If we make adjustment of depreciation, indirect taxes and subsidies in GDPmp, we get Net Domestic
Product at Factor Cost (NDPfc).
NDPfc = GDPmp – Depreciation – Indirect taxes + Subsidies
or, NDPfc = GDPmp – Depreciation – Net indirect taxes

or, NDPfc = GDPmp – Depreciation – Net product taxes – Net production taxes
NDPfc is the income earned by the factors of production in the form of wages, profits, rent, interest, etc., within
the domestic territory of a country. This is also called domestic income because this is the income generated in
the production process within the domestic territory of the country.
Step 4: Calculation of Net National Product at factor cost (NNPfc) or National Income (NI)
Net National Product at factor cost (NNPfc) is the net domestic factor income added with the net
factor income from abroad. In other words:
National income (NNPfc) = NDPfc + NFIA
or, NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA

or, NNPfc = GDPmp – Depreciation – Net product taxes – Net production taxes + NFIA
NNP at factor cost is the sum of income earned by all factors in the production in the form of wages, profits,
rent and interest, etc., belonging to a country during a year. It is the National Product and is not bound by
production in the national boundaries.
Top Tip
Other Basic National Income Aggregates

1. Net Domestic Product at Market Price (NDPmp)
NDPmp = GDPmp – Depreciation
This measure allows policy-makers to estimate how much the country has to spend just to maintain their current
GDP. If the country is not able to replace the capital stock lost through depreciation, then GDP will fall.
2. Gross National Product at Market Price (GNPmp)
GNPmp = GDPmp + Net factor income from abroad (NFIA)
GNPmp is the value of all the final goods and services that are produced by the normal residents of India and is
measured at the market prices, in a year. GNP refers to all the economic output produced by a nation’s normal
residents, whether they are located within the national boundary or abroad. Everything is valued at the market prices.
3. Net National Product at Market Price (NNPmp)
NNPmp = GDPmp – Depreciation + NFIA
This is a measure of how much a country can consume in a given period of time. NNP measures output
regardless of where that production has taken place (in domestic territory or abroad).
4. Gross Domestic Product at Factor Cost (GDPfc)
GDP at factor cost is gross domestic product at market prices less net indirect taxes.
GDPfc = GDPmp – Net indirect taxes
or GDPfc = GDPmp – Net Product Taxes – Net Production Taxes
GDP at factor cost measures money value of output produced within the domestic boundaries of a country in a
year, as received by the factors of production.
5. Gross National Product at Factor Cost (GNPfc)
GNP at factor cost is gross domestic product at market prices less net indirect taxes plus NFIA.
GNPfc = GDPmp – Net Indirect taxes + NFIA
or GNPfc = GDPmp – Net Product Taxes – Net Production Taxes + NFIA
GNP at factor cost measures value of output received by the factors of production belonging to a country in a year.
Precautions in calculating national income by value added method
1. Avoid double counting.
Value of intermediate goods is not included in the estimation of value added because value of intermediate
goods is reflected in the value of final goods. So, avoid double counting of goods and services as these tend to
inflate national income estimates.
2. Do not include sale of second hand goods.
Value of second hand goods (or used goods) being sold should not be included in national income as their value
was accounted for at the time of first production. Sale of the second hand goods is not a production activity. The
second hand good should not be treated as fresh production, and therefore is not included in national income.
However, any brokerage or commission paid to facilitate the sale of second hand goods is a fresh production
activity. It should be included in production but to the extent of brokerage or commission only.
3. Self-consumed output must be included.
Output produced but retained for self-consumption, rather than selling in market, is output and must be included
in estimates. Services of owner-occupied buildings, farmer consuming its own produce, etc. are some examples.
Key Terms
Value of output — It is the market value of goods and services produced by a firm during an accounting year.
Double counting — The problem of double counting arises when the value of same goods and services are counted
more than once while estimating national income.
Value added/value addition — It is the difference between value of output and intermediate consumption.
Gross Domestic Product (GDP) — It is the money value of all final goods and services produced within the domestic
territory of a country during an accounting year.
NDP at factor cost — It is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the
domestic territory of a country. It is also called net domestic factor income or domestic income.
National Income (NI)/NNP at factor cost — It is the sum of factor incomes earned by the normal residents in the form
of wages, profits, rent and interest, etc., during an accounting year within the domestic territory or abroad.
RECAP
Steps for calculation of national income by product method

Step 1: Estimation of value of output produced by each firm in all the sectors of the economy during the year.
Value of output is the market value of goods and services produced by a firm during an accounting year.
Value of output = Sales + Change in stock
Step 2: Calculation of Value Added (VA) and Gross Domestic Product at market price (GDPmp)
Value added/Value addition is the excess of value of output over the value of intermediate consumption.
Sum of Value added of all firms in the economy is Gross Domestic Product (GDP), which refers to the money value of all final
goods and services produced in an economy during an accounting year.
GDPmp = Value of output of all the sectors – Intermediate consumption
Step 3: Calculation of Net Domestic Product at factor cost (NDPfc)
NDPfc (net domestic factor income) = GDPmp – Depreciation – Indirect taxes + Subsidies
NDPfc is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the domestic territory of a
country.
Step 4: Calculation of Net National Product at factor cost (NNPfc) or National Income (NI)
National income or NNPfc = NDPfc + NFIA
Precautions in calculating national income by production method (or value added method)
1. Avoid double counting. Value of intermediate goods is not included in the estimation of value added because it is reflected in
the value of final goods. So, avoid double counting of goods and services as these tend to inflate national income estimates.
2. Do not include sale of second hand goods. Their value was accounted for at the time of first production. However, any
brokerage or commission paid to sell the second hand goods is a fresh production activity, so included.
3. Self-consumed output must be included. Output produced but retained for self-consumption rather than selling in the
market should be included since output has been produced during the year. E.g. Farmer consuming its own produce,
services of owner occupied buildings etc.
1. Though intermediate goods are crucial inputs to any production process, yet we measure final goods only. This is because
_________________. (Complete the sentence)
(a) Inventories (i) Investment
(b) Change in inventories (ii) Capital
3. __________ is what production units actually receive for distribution of income among the owners of factors of
production. (Choose the correct alternative)
(a) GDPmp (b) NDPfc
(c) NNPfc (d) NNPmp
4. The problem of ‘Double counting’ can be avoided by __________. (Choose the correct alternative)
(a) counting only value added (b) counting only value of final products
(c) not counting value of intermediate products (d) All of these
5. Market price and factor cost will be equal when there is: (Choose the correct alternative)
(a) No direct tax (b) No indirect tax
(c) No subsidy (d) No indirect tax and no subsidy
6. Market price is always more than factor cost. True/False? Give reason.
7. Goods produced for self-consumption will be included in national income. True/False? Give reason.
8. Counting intermediate goods separately will lead to the error of ____________ , which will highly exaggerate the
____________ . (Fill in the blanks)
9. In a simple economy, suppose there are only two producers/firms — the farmers who produce wheat and the bakers, i.e.
the bread makers. The total value of wheat produced by the farmers is `100, for which they do not need any input other
than human labour. Out of this, the farmers have sold `50 worth of wheat to the bakers, who have used it completely
during the year and have produced `200 worth of bread. The aggregate value of final goods produced by this simple
economy will be : (Choose the correct alternative)
(a) `300 (b) `250
(c) `350 (d) `200
(a) Net contribution made by a firm (i) Value of output
(b) Raw materials that a firm buys from (ii) Intermediate goods
another which are completely used up (iii) Value added
in the process of production.
11. Value of production of a firm – value of intermediate goods used by the firm = ____________. (Fill in the blank)
12. Value added is a flow variable. True/False? Give reason.
13. To calculate the net contribution made by a firm, we need to deduct (i) ___________ from the value of production. If we
do not do this, we shall commit the mistake or error of (ii) __________. (Fill in the blanks)
14. A firm produces `100 worth of goods per year, `20 is the value of intermediate goods used by it during the year and `10
is the value of capital consumption. The net value added will be: (Choose the correct alternative)
(a) `100 (b) `80
(c) `70 (d) `130
A firm buys raw materials from other firms.
(a) The part of raw materials which gets (i) Intermediate good.
used up in the same year. (ii) Final good
(b) The part of raw material which (iii) Inventory
does not get used up. (iv) Value added
16. In economics, ‘inventory’ includes the stock of unsold finished goods only. True/False? Give reason.
(i) If the value of inventories at the end of the (a) Inventories have increased
year is higher than that at the beginning of the year. (or accumulated)
(ii) If the value of inventories is less at the end (b) Inventories have decreased
of the year compared to the beginning of the year (or decumulated)
18. Production of a firm during a year – Sales of the firm during the year = ___________ ? (Fill in the blank)
19. In case of an unexpected fall in sales, there will be _________________ of inventories.
(unplanned accumulation / unplanned decumulation) (Fill in the blank with correct option)
20. In case, there is unexpected rise in sales, there will be ___________________ of inventories.
(unplanned accumulation / unplanned decumulation) (Fill in the blank with correct option)
21. Suppose a firm produces shirts. It starts the year with an inventory of 100 shirts. During the coming year it expects to sell
1,000 shirts. Hence, it produces 1,000 shirts, expecting to keep an inventory of 100 shirts at the end of the year. However,
during the year, the firm could sell only 600 shirts. The unexpected rise of inventories by ________ units is an example of
_________ inventories. (Fill in the blank)
22. A firm produces computers. It has opening inventory of 100 computers. During the coming year it expects to sell 1,000
computers. Hence, it produces 1,000 computers expecting to keep an inventory of 100 at the end of the year. But the sales
during the year is 1,050 computers. The reduction in inventory by ____________ computers is called ______________ of
inventories. (Fill in the blanks)
23. A firm wants to raise the inventories from 100 to 200 shoes during the year. Expecting sales of 1,000 shoes during the
year, the firm produces 1,100 shoes. The sales are actually 1,000 shoes and the firm ends up with an inventory of 200
shoes. This rise in inventories is called _____________ (Planned accumulation of inventories/ unplanned accumulation of
inventories). (Fill in the blank with correct option)
24. A firm wants to reduce the inventories from 100 to 25 mobile phones. Expecting sales of 1,000 mobile phones during the
year, the firm produces 925 mobile phones. The sales turn out to be 1,000 as expected by the firm and the firm ends up
with an inventory of 25 mobile phones. This reduction in inventories is called ____________________.
(Planned decumulation of inventories / Unplanned decumulation of inventories). (Fill in the blank with correct option)
25. The sum total of gross value added of all the firms in the economy is called ______________. (Fill in the blank)
26. Sales by a firm includes sales to domestic buyers only. True/False? Give reason.
27. To calculate GVA at factor cost from GVA at market prices, which of the following is deducted : (Choose the correct alternative)
(a) Net product taxes (product taxes – product subsidies)
(b) Net production taxes (production taxes – production subsides)
(c) Both (a) and (b)
(d) Net factor income from abroad.
28. Production taxes are paid per unit of production. True/False? Give reason.
29. Excise tax, service tax, export and import duties, etc are product taxes. True/False? Give reason.
30. Basic prices include both product taxes (less product subsidies) and production taxes (less production subsidies).
True/False? Give reason.
31. __________ measures the aggregate production of final goods and services taking place within the domestic territory of
the country during a year. (Fill in the blank)
32. A part of the capital which gets consumed during the year due to wear and tear is called _________. If we deduct it from
GNP the measure of aggregate income we obtain is called __________. (Fill in the blanks)
33. Depreciation is deducted from GDP while calculating national income because ______________. (Fill in the blank)
34. Market prices include: (Choose the correct alternative)
(a) Subsidies (b) Indirect taxes
(c) Intermediate consumption (d) Depreciation
35. _____________ are deducted and ______________ are added from NNP at market prices in order to calculate that part
of NNP which actually accrues to the factors of production. (Fill in the blanks)
36. Indirect taxes are deducted from NNP at market prices to calculate national income because _________.
(Complete the sentence)
37. That part of NNP which actually accrues to the owners of factors of production is called ___________ . (Fill in the blank)
38. GDPmp includes market value of all final goods and services produced by the normal residents or the non-residents in a
country. True/False? Give reason.
39. The prices of products as received by the owners of factors of production is called _____________ . (Fill in the blank)
40. ______________ is the value of all the final goods and services that are produced by the normal residents of India and
is measured at the market prices, in a year, regardless of whatever they are located within the economic territory or
abroad. (Fill in the blank)
41. _______________ measures value of output received by the factors of production belonging to a country in a year of (in
domestic territory or abroad). (Choose the correct alternative)
(a) GNP at market price (b) GNP at factor cost
(c) GDP at market price (d) GDP at factor cost
42. This is a measure of how much a country can consume in a given period of time. It measures output regardless of where
that production has taken place (in domestic territory or abroad). (Choose the correct alternative)
(a) GNP at market price (b) GDP at market price
(c) NNP at market price (d) NDP at market price
43. It is the net domestic factor income added with the net factor income from abroad. (Choose the correct alternative)
(a) GNP at market price (b) GNP at factor cost
(c) NNP at market price (d) NNP at factor cost
44. ______________ is the sum of income earned by all factors of production in the form of wages, profits, rent and interest,
etc, belonging to a country during a year (in the domestic territory or abroad). (Fill in the blank)
HOTS Analysing, Evaluating & Creating Type Questions

1. What is the difference between planned and unplanned inventory accumulation? Write down the relation
between change in inventories and value added of a firm. (NCERT) (4 marks)
Ans. In case of an unexpected fall in sales, a firm will have unsold stock of goods which it had not anticipated.
Hence, there will be unplanned inventory accumulation.
On the other hand, if the firm wants to raise the inventory during the year and produces goods accordingly;
and the sales also happen to be the same as expected, then there will be planned accumulation of inventories.
Relation between change in inventories and value added of a firm:
Value added of a firm = Sales during the year + Change in inventories – Value of intermediate goods used
2. Explain why subsidy is added to and indirect tax is deducted from domestic product at market price to
arrive at domestic product at factor cost. (3 marks)
Ans. Domestic product at market price is what buyers pay. But this is not what production units actually receive.
Out of what buyers pay the production units have to make payment of indirect tax, e.g., Goods and Services
Tax (GST). Therefore, indirect tax is deducted. Sometimes, production units get subsidy on production from
the government. Therefore, subsidy is added.
What production units actually receive is not the ‘Market Price’ but ‘Market Price – Indirect tax + Subsidies’.
This is what is actually available to production units for distribution of income among the owners of factors of
production. Therefore, Market Price (mp) – Indirect Tax (IT) + Subsidies = Factor Cost (fc) or factor payments
3. State, giving reason, whether the following will be included in the estimation of national income: (3 marks)
(i) Services of owner-occupied building
(ii) Payment of indirect taxes by a firm
(iii) Wheat grown by a farmer but used entirely for his family’s consumption.
Ans. (i) Yes, imputed value of free services provided by the owners of production units must be included in national income.
(ii) No, it is not included in national income because an indirect tax paid to the government is a transfer
payment as no good or service is provided in return.
(iii) Yes, its imputed value is included in national income because it adds to the current flow of goods and services.
Numerical 2
Suppose in an imaginary economy GDP at market price in a particular fiscal year was `4000 crore, National Income
was `2500 crore, Net Factor Income paid by the economy to Rest of the World was `400 crore and the value of Net
Indirect Taxes is `450 crore. Estimate the value of consumption of fixed capital for the economy from the given data.
(NCERT) (3 marks)
Solution: National Income (NNPfc) = GDPmp – Consumption of fixed capital – Net indirect taxes + NFIA
2500 = 4000 – Consumption of fixed capital – 450 + (–)400
Consumption of fixed capital = 4000 – 450 – 400 – 2500 = `650 crore
Note: Net factor income paid by the economy to rest of the world = `400 crore. Therefore, NFIA = (–) `400 crore
Do it yourself 2
GNPmp of an imaginary economy is `120000 crore and its capital stock is worth `300000 crore. If capital stock
depreciates @ 20% per annum, indirect taxes amount to `30000 crore and subsidies are put at `15000 crore. What
is national income? (3 marks)
[Ans. `45000 crore]
Numerical 3
In an economy, the following transactions took place.

(i) Firm A sold to firm B goods of `80 crore; to firm C `50 crore; to households `30 crore and goods of value `10
crore remains unsold.
(ii) Firm B sold to firm C goods of `70 crore; to firm D `40 crore; goods of value `30 crore were exported and
goods of value `5 crore was sold to government.
Calculate: (i) Value of output of Firm A and Firm B.
(ii) Value added by Firm B (CBSE Sample Question Paper 2019) (3 marks)
Solution: (i) Value of output of Firm A = Total sales + Value of unsold stock
= (Sales to Firm B + Sales to Firm C + Sales to Households) + Value of unsold stock
= (80 + 50 + 30) + 10 = `170 crore
Value of output of Firm B = Sales to Firm C + Sales to Firm D + Exports + Sales to Government
= 70 + 40 + 30 + 5 = `145 crore
(ii) Value added by Firm B = Value of output of Firm B – Purchases by Firm B from Firm A
= 145 – 80 = `65 crore
Do it yourself 3
From the following data, calculate the value added by firm A and firm B. (3 marks)
S. No. Items (` in lakh)
(i) Closing stock of firm A 20
(ii) Closing stock of firm B 15
(iii) Opening stock of firm A 5
(iv) Opening stock of firm B 10
(v) Sales by firm A 300
(vi) Purchases by firm A from firm B 100
(vii) Purchases by firm B from firm A 80
(viii) Domestic sales by firm B 250
(ix) Import of raw material by firm A 50
(x) Exports by firm B 30
[Ans. (a) `165 lakh (b) `205 lakh ]
Numerical 4
In a single day, Raju, a barber, collects `500 from haircuts. Over this day, his equipment depreciates in value by `50.
Of the remaining `450, Raju pays sales tax `30, takes home `200 and retains `220 for improvement and buying of
new equipment. He further pays `20 as income tax.
Based on this information, calculate Raju's contribution to GDP, NDP and National Income. (3 marks)
Solution: Raju's contribution to:
(i) GDP = Value of haircuts service produced by him = `500
(ii) NDP = GDP – Depreciation of equipment
= 500 – 50 = `450
(iii) National Income (NNP at factor cost) = NDP – Sales Tax
= 450 – 30 = `420
Do it yourself 4
From the following data about a firm, calculate the firm’s net value added at factor cost. 3 marks

(i) Subsidy 40
(ii) Sales 800
(iii) Depreciation 30
(iv) Exports 100
(v) Closing stock 20
(vi) Opening stock 50
(vii) Intermediate purchases 500
(viii) Purchase of machinery for own use 200
(ix) Import of raw material 60
[Ans. `280 lakh]
Numerical 5
Calculate GVA at factor cost of a firm: (3 marks)

S. No. Items (`)
(i) Net production taxes 600
(ii) Product taxes 400
(iii) Price per unit of output 10
(iv) Net change in stocks (–)50
(v) Purchases of raw materials 10,000
(vi) Import of raw materials 3,000
(vii) Import of machines 20,000
(viii) Product subsidies 100
Additional information: Output sold is 2000 units.
Solution:
Particulars (`)
Sales (note 1) 20,000
(+) Net change in stocks (–) 50
Value of output 19,950
(–) Intermediate consumption (Purchases of raw materials) (–)10,000
GVA at market prices 9,950
(–) Net product taxes (note 3) (–) 300
GVA at basic prices 9,650
(–) Net production taxes (–) 600
GVA at factor cost 9,050
Note:
1. Sales = Output sold × Price per unit = 2,000 units × `10 = `20,000
2. Import of raw materials is already included in Purchase of raw materials. Import of machines is not included in
intermediate consumption.
3. Net product taxes = Product taxes – Product subsidies = 400 – 100 = `300
Do it yourself 5
Find net value added at factor cost: 3 marks

(i) Sales 100
(ii) Closing stock 20
(iii) Excise 15
(iv) Opening stock 10
(v) Current replacement cost 12
(vi) Intermediate consumption 50
[Ans. `33 lakh]
Numerical 6
Find NVA at factor cost of a firm. (3 marks)

S. No. Items (`)
(i) Durable use producer goods with a life span of 10 years 10
(ii) Single use producer goods 5
(iii) Sales 20
(iv) Unsold output produced during the year 2
(v) Net indirect taxes 1
Solution:
Particulars (` in lakh)
Sales 20
(+) Unsold output 2
Value of output 22
(–) Intermediate consumption (Single use producer goods) (–) 5
GVA at market prices 17
(–) Depreciation (note) (–) 1
(–) Net indirect taxes (–) 1
GVA at factor cost 15
cost of fixed capital good - scrap value 10 - 0

Note: Depreciation = = = `1 Lakh
life (in years) 10
Do it yourself 6
Find Net Value Added at market price of a firm: 3 marks

(i) ixed capital good with a life span of 5 years
F 15
(ii) Raw materials 6
(iii) Sales 25
(iv) Net change in stock (–)2
(v) Taxes on production 1
[Ans. `14 lakh]

Numerical 7
Calculate ‘Sales’ from the following: (3 marks)

S. No. Items (`)
(i) Subsidies 200
(ii) Opening stock 100
(iii) Closing stock 600
(iv) Intermediate consumption 3000
(v) Consumption of fixed capital 700
(vi) Profit 750
(vii) Net value added at factor cost 2000
(viii) Exports 100
Solution: Net value added at factor cost
= Sales + Closing stock – Opening stock – Intermediate consumption – Consumption of fixed capital + Subsidies
2,000 = Sales + 600 – 100 – 3,000 – 700 + 200
Sales = 2,000 – 600 + 100 + 3,000 + 700 – 200
Sales = `5,000 lakh
Do it yourself 7
Calculate ‘Value of output’ from the following: 3 marks

(i) Net value added at factor cost 100
(ii) Intermediate costs 75
(iii) Excise duty 20
(iv) Subsidy 5
(v) Depreciation 10
[Ans. `200 lakh]
Numerical 8
Calculate (a) Gross Domestic Product at Market Price and (b) National Income. (6 marks)
S. No. Items (` in crore)
(i) Value of output
(a) Primary sector 800
(b) Secondary sector 200
(c) Tertiary sector 300
(ii) Cost of intermediate inputs
(a) Primary sector 400
(b) Secondary sector 100
(c) Tertiary sector 50
(iii) Indirect taxes paid by all sectors 50
(iv) Consumption of fixed capital of all sectors 80
(v) Factor income received by the residents from rest of the world 10
(vi) actor income paid to non-residents 20
(vii) Subsidies received by all sectors 20
Solution:
Particulars (` in crore)
Value of output of all sectors (note 1) 1300
(–) Cost of intermediate inputs purchased by all sectors (note 2) (–)550
(a) Gross Domestic Product at Market Price (GDPmp) 750
Adjustments:
(–) Consumption of fixed capital of all sectors (–)80
(–) Indirect taxes paid by all sectors (–)50
(+) Subsidies received by all sectors 20
(+) Net factor income from abroad (NFIA) (note 3) (–)10
(b) National Income (NNPfc) 630
Note: 1. Value of output of all sectors = Value of output of primary, secondary and tertiary sectors
= 800 +200 + 300 = `1300 crore
2. Cost of intermediate inputs purchased by all sectors = 400 +100 + 50 = `550 crore
3. NFIA = Factor income received by the residents from rest of the world – Factor income paid to non-residents
= 10 – 20 = (–) `10 crore
Do it yourself 8
From the following data calculate the (a) Gross National Product at Market Price (b) National Income. 3 marks

(i) Value of output in primary sector 1,000
(ii) Net factor income from abroad (–)20
(iii) Value of output in tertiary sector 700
(iv) Intermediate consumption in secondary sector 400
(v) Value of output in secondary sector 900
(vi) Intermediate consumption in primary sector 500
(vii) Intermediate consumption in tertiary sector 300
(viii) Net Indirect Taxes 300
(ix) Consumption of fixed Capital 100
[Ans. (a) `1,380 crore (b) `980 crore]
1.5 Income Method of Calculating National Income

Steps for calculating national income by income method
Step 1: Estimate the factor payments by each firm in all the sectors of the economy during
the year.
The sum of factor payments equals Net Value Added at Factor Cost (NVAfc) of a firm.
Step 2: Take the sum total of NVAfc by all firms in all the sectors of the economy to arrive
at NDPfc.
The components of NDPfc are compensation of employees, operating surplus and mixed income.
1. Compensation of employees: It is defined as the total remuneration in cash or in kind, payable
by the employers to employees in return for work done by them during an accounting year.
The main components of compensation of employees are:

(a) Wages and salaries in cash and in kind. For example,
• Payment of bonus by a firm to its employees
• Free medical facilities, free meals and rent-free house given by the employer
• House rent allowance or leave travel allowance paid by the employer
• Medical treatment of employee’s family
(b) Social security contributions by the employers. For example,
• Contribution to provident fund by the employer
• Insurance premium paid by the employer
Top Tip
ontribution to provident fund or insurance premium paid by employees is not included in national income because it is
C
paid out of compensation of employees, which is already included.
Similarly, compensation given by insurance company to an injured worker is not included as compensation is given by
insurance company to the employee, and not by employer.
Also, gifts received from employer, e.g. festival gift, gifts on independence day, etc. is not included in national income as
it is a transfer payment.
2. Operating surplus: Operating surplus is defined as the sum of rent, royalty, interest and profits.
Operating surplus can also be termed as 'Income from property and entrepreneurship', i.e.
incomes earned by property owners. It includes rent and royalty, profit and interest.
(a) Rent is defined as the amount receivable by a landlord from a tenant for the use of land.
(b) Royalty is defined as the amount receivable by the owner for granting the leasing rights of
sub-soil assets, e.g., royalty income received by an author of a book from the publisher.
(c) Interest is defined as the amount payable to the owners of financial assets in the production
unit. The production unit uses these assets for production and in turn makes interest
payment, imputed or actual.
Top Tip
Payment of interest by banks to its depositors or Payment of interest by a firm (government firm or a private firm) to
households or Payment of interest by a firm to a bank is included in national income because it is factor payment. The
borrowed money is used for carrying out production of goods and services.
However, payment of interest on a loan taken by an employee from the employer or payment of interest by an individual
to a bank on a loan to buy a car or interest received on loans given to a friend for purchasing a car will not be included in
national income because the individual is a consumer, and the loan is taken to meet consumption expenditure. There is
no contribution to production of goods and services. Therefore, it is not a factor payment.
(d)
Profit is a residual factor payment by the production unit to the owners of the production
unit. The production unit uses profit for (i) payment of corporation tax to the government,
(ii) dividend payments to the owners of the production unit, and (iii) undistributed profits/
retained earnings for investment in new projects and ventures.
Profits = Corporation tax
+ Dividend
+ Undistributed profits/Retained earnings/savings of private corporate sector
or, Profits = Corporate profit tax + After-tax profit
(Note: After-tax profit = Dividend + Retained earnings)
Top Tip
Payment of corporate tax by a firm is also not included in national income as it is a transfer payment. Corporate tax
is already included in profits. Corporate tax accrues to the government. It is not received by the owners of factors of
production. Hence, it is not a factor income.
3. Mixed income of self-employed: The income of self employed people like doctors, chartered
accountants, consultants, etc. has two or more factor incomes. For example, a doctor’s income
may consist of salary from a hospital, fees earned by him from the patients in his own clinic, rental
income from his property, and profits of a business owned by him. In such cases, total income is
estimable, but not its different components. So, mixed income of self-employed is another factor
payment, which is added to the national income.
NDPfc = Compensation of employees + Operating surplus + Mixed income
Top Tip
The main source of factor payments are the accounts of production units. Since accounts of most production units are not
available to the estimators, and also since the accounting practices differ, it is not possible for the estimators to clearly identify
the components. Therefore, in cases where total factors payment is estimable but not its different components, an additional
factor payment item called 'mixed income' is added. Since this problem arises mainly in case of self employed people like
doctors, chartered accountants, consultants, etc, this factor payment is popularly called "mixed income of the self-employed".
Step 3: Once we estimate NDPfc, we can find NNPfc (national income) by adding NFIA to it.
National income (NNPfc) = NDPfc + NFIA
Top Tip
Components of National Income by Income Method are:
(i) Compensation of employees (ii) Operating surplus
(iii) Mixed income of self-employed (iv) Net factor income from abroad (NFIA)
National income (NNPfc) = Compensation of employees + Operating surplus + Mixed income + NFIA
Precautions in making estimates of national income by income method

1. Avoid transfers.
National income includes only factor payments, i.e. payment for the services rendered to the production units
by the owners of factors of production.
Any payment for which no service is rendered is called a transfer (e.g. gifts, donations, charity, etc.), and not a
production activity. Hence, transfer payment is not included in national income.
2. Avoid capital gain.
Capital gain refers to the income from the sale of second hand goods and financial assets.
Income from the sale of old cars, old house, bonds, debentures, etc are some examples.
These transactions are not production transactions. So, any income arising to the owners of such things is not a
factor income.
3. Include income from self-consumed output.
When a house owner lives in that house, he does not pay any rent. But in fact he pays rent to himself. Since
rent is a payment for services rendered,even though rendered to the owner itself,it must be counted as a factor
payment.
4. Include free services provided by the owners of the production units.
Owners work in their own unit but do not charge salary. Owners provide finance but do not charge any interest.
Owners do production in their own buildings but do not charge rent.
Although they do not charge, yet the services have been performed. The imputed value of these must be included
in national income.
Treatment of Items in the Estimation of National Income by Income Method

S. No. Items Treatment Reason
1. Value of bonus shares received by No, it will not be included As bonus shares are financial assets and
shareholders of a company in the national income. do not contribute to the production of
goods and services.
2. Payment of interest on a loan taken by an No, it is not included in Because the individual is a consumer, and
employee from the employer/Payment of national income. the loan is taken to meet consumption
interest by an individual to a bank on a expenditure. There is no contribution
loan to buy a car/Interest received on loans to production of goods and services.
given to a friend for purchasing a car. Therefore, it is not a factor payment.
3. Payment of interest by banks to its Yes, it is included in national Because it is a factor income paid by
depositors/Payment of interest by a firm income. a production unit (bank or firm).
to households. Banks borrow for carrying out banking
services./The firms borrow money for
carrying out production.
4. Payment of interest by a firm Yes, it is included in national Because it is a factor payment by the
(government firm or a private firm) to income. firm. The firm borrows money for
a bank carrying out production of goods and
services.
5. Interest received on loan given to a Yes, it will be included in the As it is a factor income from abroad.
foreign company in India. national income.
6. Interest received on debentures. Yes, it will be included in the Because interest received on debentures
national income. is a factor income because debenture
is a sort of loan taken by a production
unit, which uses the money in producing
goods and services.
7. Payment of interest on borrowings by No, it will not be included Because it is a transfer payment as
general government (National debt in the national income. general government borrows only for
interest) consumption purpose.
8. Money received by a family in India No, it will not be included As it is a transfer payment, which is
from relatives working abroad, i.e., in national income. received without any contribution to
remittances from abroad/Scholarship production of goods and services. It is
given to Indian students studying in not a factor income.
India by a foreign company/Financial
help received by flood victims/
Expenditure on old age pensions
by government/Gift received from
employer, e.g. festival gift, gifts on
independence day, etc.
9. Free medical facilities or free meals or house Yes, it will be included in the As it is a part of the compensation of
rent allowance or leave travel allowance national income. employees.
paid by the employer/Rent-free house
given to an employee by an employer/
Expenditure on medical treatment of
employee’s family/Payment of bonus by
a firm to its employees/Contribution to
provident fund by employer
10. Payment of corporate tax by a firm No, it is not included in As it is a transfer payment. Corporate tax
national income. accrues to the government. It is not received
by the owners of factors of production.
Hence, it is not a factor income.
11. Contribution to provident fund or No, it is not included in Because it is paid out of compensation of
insurance premium paid by employees national income. employees, which is already included.
12. Compensation given by insurance No, it is not included in As compensation is given to the employee
company to an injured worker. national income. by insurance company, not by employer.
13. Salaries paid to Russians working in It will be included in As it is a factor income paid to abroad.
Indian Embassy in Russia. domestic income of India It is subtracted from domestic income to
(since the factor income is get national income.
earned within the domestic
territory). But it will not be
included in national income
of India.
14. Imputed rent of self occupied houses. Yes, it will be included in the Because self-occupied houses provide
national income. housing services similar to those as
rented houses.
15. Earnings of shareholders from the sale No, it will not be included Because financial assets (shares, bonds,
of shares. in the national income. etc.) are neither goods nor services, and
do not contribute to any production of
goods and services.
16. Capital gains to Indian residents from No, capital gains from sale of As they do not add to the current flow of
sale of shares of a foreign company. shares will not be included in goods and services in the economy.
national income.
17. Money received from sale of second- No, it will not be included Because sale of second hand goods is
hand goods/ Money received from sale in national income. not a fresh production transaction. So
of old house or old car. any income arising to the owners of
such goods is not a factor income, but a
capital gain.
18. Commission received by a dealer from Yes, it will be included in As it is a factor income because any
the buyer and seller of a house. national income. commission paid to facilitate the sale of
house is a fresh production activity.
19. Prize won in a lottery No, it will not be included Because it is a windfall gain, not a factor
in national income. income.
20. Receipts from sale of land No, it will not be included As land is a free gift of nature and cannot
in national income. be produced.
21. Profit earned by foreign banks in India. It will be included in domestic As it is a factor income paid to abroad.
income of India (since the It is subtracted from domestic factor
factor income is earned within income to get national income.
the domestic territory). But
it will not be included in
national income of India.
22. Profits earned by an Indian bank from Yes, it will be included in As it is a factor income from abroad.
its branches abroad. national income.
23. Dividend received by a foreigner from No, it will not be included As it is a factor income paid to abroad.
investment in shares of an Indian company. in national income.
24. Dividend received by shareholders. Yes, it will be included in As it is a part of the profits of production
national income. units, which is distributed to the owners.
Hence, it is a factor income.
25. Rent received by Indian residents on Yes, it will be included in This factor income is earned by the
their buildings rented out to foreigners national income. residents.
in India.
26. Royalty Yes, it will be included in As royalty is a productive income.
national income.
UNIT 3: Determination of Income and Employment 119
12 Marks
Unit
Determination of Income and
Employment
CBSE Syllabus Content

 Aggregate demand and its components 3.1 Consumption Function: Propensity to Consume
 Propensity to consume and propensity to save (average
3.2 Savings and Investment Functions
and marginal)
 Short-run equilibrium output 3.3 Aggregate Demand and Aggregate Supply
 Investment multiplier and its mechanism 3.4 Short-Run Equilibrium Level of Income/Output
 Meaning of full employment and involuntary
unemployment 3.5 Investment Multiplier and its Mechanism
 Problems of excess demand and deficient demand; 3.6 Problems of Deficient Demand and Excess Demand
measures to correct them–change in government
spending, taxes and money supply
 “The political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty."
—John Maynard Keynes
 “The difficulty lies not so much in developing new ideas as in escaping from old ones.” —John Maynard Keynes
Introduction Determination of Income and Employment
Macroeconomics, as a separate branch of economics, emerged after the British economist John Maynard Keynes
published his celebrated book ‘The General Theory of Employment, Interest and Money’ in 1936. This book is
regarded as one of the most influential economics books of the twentieth century. John Maynard Keynes, British
economist, was born in 1883. He was educated in King’s College, Cambridge, United Kingdom and later appointed
its Dean. Being a sharp intellectual he prophesied the break down of the peace agreement of the War in the book
‘The Economic Consequences of the Peace (1919)’. He was also a shrewd foreign currency speculator.
The Great Depression of 1929 and the subsequent years saw the output and employment levels in the countries
of Europe and North America fall by huge amounts. It affected other countries of the world as well. Demand for
goods in the market was low, many factories were lying idle, workers were thrown out of jobs. In USA, from 1929
to 1933, unemployment rate rose from 3 per cent to 25 per cent (unemployment rate may be defined as the number
of people who are not working and are looking for jobs divided by the total number of people who are working
or looking for jobs). Over the same period aggregate output in USA fell by about 33 per cent. These events made
economists think about the functioning of the economy in a new way. The fact that the economy may have long
lasting unemployment had to be theorised about and explained. Keynes’ book was an attempt in this direction.
The dominant thinking in economics before Keynes was that all the labourers who are ready to work will find
employment and all the factories will be working at their full capacity. Unlike his predecessors, his approach was
to examine the working of the economy in its entirety and examine the interdependence of the different sectors.
Thus, the subject of macroeconomics was born.
In this unit, we deal with the determination of National Income under the assumption of fixed price of final goods
and constant rate of interest in the economy. The theoretical model used in this chapter is based on the theory
given by John Maynard Keynes. In unit 1 on ‘National Income and Related Aggregates’, we had come across
terms like consumption, investment, or the total output of final goods and services in an economy (GDP). These
terms have dual connotations. In unit 1 they were used in the accounting sense– denoting actual values of these
items as measured by the activities within the economy in a certain year. We call the actual or accounting values
of the variables–consumption, investment or output of final goods– their ex-post measures. These terms, however,
can be used with a different connotation. Consumption may denote not what people have actually consumed in a
given year, but what they had planned to consume during the same period, called planned consumption. Similarly,
investment can mean the amount a producer plans to add to his inventory, called planned investment. We call
the planned values of the variables–consumption, investment or output of final goods–their ex-ante measures.
Suppose the producer plans to add `300 worth goods to his stock by the end of the year. His planned investment
is, therefore, `300 in that year. However, due to an unforeseen upsurge of demand for his goods in the market
the volume of his sales exceeds what he had planned to sell and, to meet this extra demand, he has to sell goods
worth `100 from his stock. Therefore, at the end of the year, his inventory goes up by `(300 – 100) = `200 only.
His planned investment is `300 whereas his actual, or realised investment is `200 only. In a theoretical model of
the economy the ex-ante values of these variables should be our primary concern. If we want to predict what the
equilibrium value of the final goods, output or GDP will be, it is important to know what quantities of the final
goods people plan to demand or supply. We must, therefore, learn about the determinants of the ex-ante values of
consumption, investment or aggregate output of the economy. When, at a particular price level, aggregate demand
for final goods equals aggregate supply of final goods, the final goods or product market reaches its equilibrium.
Aggregate demand for final goods consists of ex-ante consumption, ex-ante investment, government spending, etc.
We also assume that the aggregate supply is fixed at this price level. Under such circumstances, aggregate output is
determined solely by the level of aggregate demand. An increase (decrease) in investment causes aggregate output
of final goods to increase (decrease) by a larger amount through the investment multiplier process.
Ex-ante and Ex-post Measures

Ex-ante measures
The planned values of the variables are called their ex-ante measures. For example, ex-ante consumption, ex-ante
savings and ex-ante investment.
 Ex-ante consumption: It refers to planned consumption expenditure on final goods in the economy.
 Ex-ante investment: It refers to planned investment expenditure on final goods in the economy.
 Ex-ante savings: It refers to the planned savings at different levels of income in an economy.
Ex-post measures
The actual (or realised or accounting) values of the variables is called their ex-post measures. For example, ex-
post savings, ex-post investment, etc.
 Ex-post savings: Ex-post savings are the actual amount of savings made in the economy during a period.
 Ex-post investment: Ex-post investments are the actual amount of investments made in the economy
during a period.
Top Tip
Ex-ante savings and ex-post savings may or may not be equal because ex-ante savings are those which all the households
plan to make at different levels of income during a period, whereas ex-post savings are the actual amount of savings made
in the economy during a period.
The ex-ante variables (e.g. ex-ante consumption, ex‑ante investment, etc.) are the basis of determination of
national income.
3.1 Consumption Function: Propensity to Consume

Consumption Function
The most important determinant of consumption demand is household income.
A consumption function describes the relation between consumption and income.
The simplest consumption function assumes that consumption changes at a constant rate as income changes. Of
course, even if income is zero, some consumption still takes place. If your income is zero in a certain period, you
use your past savings or borrow money to buy certain minimum consumption items in order to survive. Hence,
it is not possible to think of a situation where there is no consumption at all. Since this level of consumption is
independent of income, it is called autonomous consumption.
We can describe consumption function as:
C = C + bY
Here, C = Consumption expenditure by households
Y = Level of income in the economy
C = Autonomous consumption (i.e. consumption expenditure at zero income)
b = Slope of the consumption function (It measures rate of change in consumption per unit change in income.)
Top Tip
Note that the equation of a straight line is y = mx + c, where y is the dependent variable, x is the independent variable, m
is the slope of the straight line (i.e. Dy/Dx) and c is the intercept, i.e. value of y when x is zero.
Therefore, C = C + bY is a linear consumption function, i.e. a straight line consumption function, where:
• Consumption (C) is the dependent variable and income (Y) is the independent variable. Clearly, consumption
expenditure depends on the level of income.
• b = Slope of the consumption function, i.e. DC/DY (slope means change in dependent variable due to a given change in
independent variable)
• The intercept C is the level of consumption (C) when income (Y) is zero, i.e. autonomous consumption
Components of Consumption Function

The consumption function C = C + bY consists of the two components – (i) Autonomous consumption (C) and
(ii) Induced consumption ( bY ).
1. Autonomous consumption: It refers to the minimum level of consumption for survival even at a zero
level of income. It is called autonomous consumption because the consumption expenditure does not
depend upon the level of income.
If consumption takes place even when income is zero, it is because of autonomous consumption. It is
denoted by C and shows the consumption which is independent of income
2. Induced consumption: Induced consumption is directly determined by the level of income. Clearly, bY
shows dependence of consumption on income.
Example: Suppose the consumption function in an economy is C = `100 crore + 0.8Y and the level of income
is `800 crore. Autonomous Consumption ( C ) = `100 crore and Induced Consumption (bY) = 0.8Y = 0.8 ×
`800 crore = `640 crore (since Y = `800 crore)
Marginal Propensity to Consume
In the consumption function equation C = C + bY, 'b' represents the slope of the consumption function. It is
called Marginal Propensity to Consume (MPC).
MPC may be defined as change in consumption due to a given change in income.
∆C
MPC =
∆Y
Top Tip
MPC represents the slope of the consumption function as it represents change in consumption due to a given change in
income (MPC = DC/DY). In Keynesian analysis, MPC is assumed to be constant. Therefore, the consumption function will
be a straight line (linear) consumption curve. However, in reality, MPC has a tendency to decline.
What can be the value of MPC?

Generally, MPC lies between 0 and 1 (inclusive of both values).
 As income increases, consumers may choose not to change consumption at all (i.e. DC = 0). In this case
MPC = 0 (since MPC = DC/DY = 0/ DY = 0)
 On the other hand, as income increases, consumers may use entire increase in income on consumption,
i.e. DC = DY. Thus, MPC = DC/DY = DC/ DC = 1.
 Also, as income increases, consumers may use a part of the increase in income for increasing consumption,
i.e. DC < DY. Thus, MPC < 1. However, MPC is greater than 0 because consumption cannot be zero
even at zero income. There has to be a minimum or subsistence level of consumption even at zero
income, called autonomous consumption. Thus, when consumers use a part of the increase in income for
increasing consumption, 0< MPC < 1.
Top Tip
When income changes, change in consumption (DC) can never exceed the change in income (DY). Therefore, value of MPC
cannot exceed 1. In other words, the maximum value of MPC can be 1.
Average Propensity to Consume

Average Propensity to Consume (APC) is the consumption per unit of income. In other words, APC is the ratio
of consumption and income at a given level of income.
C
APC =
Y
Consumption Schedule
Imagine a country Imagenia which has a consumption function described by: C = 100 + 0.8Y
This indicates that even when Imagenia does not have any income, its citizens still consume `100 crore worth
of goods. Thus, Imagenia’s autonomous consumption is `100 crore. Its marginal propensity to consume is 0.8.
This means that if income goes up by `100 in Imagenia, consumption will go up by `80. In other words, people
spend 80% of rise in income on consumption.
TABLE 3.1: Consumption Schedule
Income (Y) DY Consumption (C) DC MPC (DC/DY) APC (C/Y)
0 – 100 – – –
100 100 180 80 0.8 1.80
200 100 260 80 0.8 1.30
300 100 340 80 0.8 1.13
400 100 420 80 0.8 1.05
500 100 500 80 0.8 1
600 100 580 80 0.8 0.97
700 100 660 80 0.8 0.94
800 100 740 80 0.8 0.93
900 100 820 80 0.8 0.91
1000 100 900 80 0.8 0.90
 Column (3) shows the consumption expenditure at various levels of income. The values in column (3)
are obtained from the consumption function equation C = 100 + 0.8Y. For example:
When income (Y) = `100 crore, consumption (C) = 100 + 0.8 × 100 = 100 + 80 = `180 crore.
When Y = `200 crore, C = 100 + 0.8 × 200 = 100 + 160 = `260 crore.
 Column (5) shows MPC, which is equal to DC/DY. For example, as income increases from `100
crore to `200 crore (DY = `100 crore), the consumption increases from `180 crore to `260 crore
(DC = `80 crore) and thus MPC = 80/100 = 0.8.
Consumption Curve
Figure 3.1 shows the graph of the consumption function
given by the equation: C = 100 + 0.8Y
The consumption curve does not start from origin
because of the assumption that there is some minimum
level of consumption even at zero level of income, called
autonomous consumption.
Thus, the consumption curve starts from the Y-axis at
a distance equal to autonomous consumption from the
origin.
The 45° line from origin has the feature that every point
on it has the same horizontal and vertical coordinates.
Since income is shown on the horizontal axis (i.e.
X-axis) and consumption on the vertical axis (i.e. Y-axis),
therefore at every point on the 45° line, consumption is
equal to income.
Thus, the 45° line tells us whether consumption is equal
to, greater than, or less than income.
 The consumption curve crosses the 45° line at point B. This point is known as the break-even point
(B.E.P.).
Break-even point is the point at which the level of consumption is equal to the income.
In Figure 3.1, point B is the B.E.P. because consumption (C) = income (Y) = `500 crore.
Since C = Y, therefore APC = C/Y = C/C = 1. (Thus, at break even point APC = 1)
 When the consumption curve lies above the 45° line, consumption is greater than income (C > Y). For
example, at an income level (Y) = `200 crore, the consumption (C) is `260 crore. The households must
find funds (`60 crore) to meet this consumption expenditure. They will either sell the assets acquired in
the past, or will borrow. This act of the households is called dis-saving.
Since C > Y, APC > 1. (Thus, before break even point APC > 1)
 When the consumption curve lies below the 45° line, consumption is less than income (C < Y). For
example, at an income level (Y) = `900 crore, consumption (C) is `820 crore.
Since C < Y, APC < 1. (Thus, after break even point APC < 1)
Top Tip
The value of APC can be greater than one when total consumption is greater than total income (i.e., C > Y) before break
even point, due to the existence of autonomous consumption.
RECAP
Ex-ante and Ex-post Measures

The planned values of the variables–consumption, savings, investment etc.–are called their ex-ante measures whereas the
actual or realised value of the variables is called their ex-post measures. The ex-ante variables (ex-ante consumption and
ex‑ante investment) are the basis of determination of national income.
• Ex-ante consumption refers to planned consumption expenditure on final goods in the economy.
• Ex-ante investment refers to planned investment expenditure on final goods in the economy.
• Ex-ante savings refers to the planned savings at different levels of income in an economy.
Consumption Function
Consumption function describes the relation between consumption and income. Consumption function: C = C + bY.
Consumption function has two components:
(i) Autonomous consumption (C): It refers to to the minimum level of consumption for survival even at a zero level of income.
It is called autonomous consumption because the consumption expenditure does not depend upon the level of income.
(ii) Induced consumption (bY): It is directly determined by the level of income. Clearly, bY shows dependence of consumption
on income.
For example, if the consumption function equation is C = 100 + 0.8Y, C = 100 and MPC = 0.8, so when income rises by `100,
induced consumption rises by `80 (0.8 × 100).
Marginal propensity to consume (MPC)
MPC is the change in consumption due to a given change in income. It is denoted by ‘b’ and is equal to DC/DY.
MPC represents the slope of the consumption function as it represents change in consumption due to a given change in
income (MPC = DC/DY).
• When income changes, change in consumption (DC) can never exceed the change in income (DY). Therefore, the maximum
value of MPC can be 1.
• Generally, MPC lies between 0 and 1 (inclusive of both values). This means that as income increases either the consumers
do not increase consumption at all (MPC = 0) or use entire change in income on consumption (MPC = 1) or use part of the
change in income for changing consumption (0< MPC<1).
Average propensity to consume (APC)
APC is the consumption per unit of income, i.e. C/Y. In other words, APC is the ratio of consumption and income at a given
level of income.
Key Terms
Ex-ante and ex-post — Ex-ante variable is the planned or expected value of the variable whereas, ex-post variable is the
actual or realised value of the variable.
Ex-ante consumption — It refers to planned consumption expenditure on final goods in the economy.
Ex-ante investment — It refers to planned investment expenditure on final goods in the economy.
Ex-ante savings — It refers to the planned savings at different levels of income in an economy.
Ex-post investment — Ex-post investments are the actual amount of investments made in the economy during a period.
Consumption function — It describes the relation between consumption and income.
Break-even point — The point at which the level of consumption is equal to the income.
Autonomous consumption — Consumption at zero level of income i.e., consumption which is independent of income.
It is the subsistence level of consumption.
Induced consumption — The consumption expenditure which is dependent on the level of income.
Marginal propensity to consume (MPC) — Change in consumption per unit change in income, i.e. DC/DY.
Average propensity to consume (APC) — APC is the consumption per unit of income, i.e. C/Y.

In the chapter on National Income Accounting, we have come across terms like consumption, investment, or the total output of final goods and
services in an economy (GDP). These terms have dual connotations. In National Income Accounting they were used in the accounting sense –
denoting actual values of these items as measured by the activities within the economy in a certain year. We call these actual or accounting values
ex post measures of these items. These terms, however, can be used with a different connotation. Consumption may denote not what people have
actually consumed in a given year, but what they had planned to consume during the same period. Similarly, investment can mean the amount a
producer plans to add to her inventory. It may be different from what she ends up doing. Suppose the producer plans to add `100 worth goods to
her stock by the end of the year. Her planned investment is, therefore, `100 in that year. However, due to an unforeseen upsurge of demand for
her goods in the market the volume of her sales exceeds what she had planned to sell and, to meet this extra demand, she has to sell goods worth
`30 from her stock. Therefore, at the end of the year, her inventory goes up by `(100 – 30) = `70 only. Her planned investment is `100 whereas her
actual, or ex post, investment is `70 only. We call the planned values of the variables – consumption, investment or output of final goods – their ex
ante measures. In simple words, ex-ante depicts what has been planned, and ex-post depicts what has actually happened. In order to understand
the determination of income, we need to know the planned values of different components of aggregate demand.
1. The ratio of change in consumption to change in income is called _________. (Choose the correct alternative)
(a) Marginal propensity to consume (b) Marginal propensity to save
(c) Average propensity to consume (d) Average propensity to save
2. Average propensity to consume can never be zero. (True/False)
3. Average propensity to consume can be greater than one. (True/False)
4. The minimum level of consumption for survival even if income is zero is called ________ because ______ . (Fill in the blanks)
5. The value of MPC can exceed one. True/False? Give valid reason.
6. Which of the following is not true for MPC in an economy? (Choose the correct alternative)
(a) MPC can be zero. (b) MPC lies between zero and one.
(c) MPC can exceed one (d) None of these
7. The consumption function of an imaginary country is: C = `80 crore + 0.7Y. Which of the following is true for his
economy? (Choose the correct alternative)
(a) Even if the country does not have any income, its citizens still consume `80 crore.
(b) People spend 70% of rise in income on consumption.
(c) Both (a) and (b)
(d) Autonomous consumption is `80 crore and people spend 70% of income on consumption.
8. When the consumption curve in an economy lies above the 45° line from origin, the value of APC is :
(Choose the correct alternative)
(a) Greater than one (b) Zero
(c) One (d) Less than one
9. APC can be zero at a particular level of income. True/False? Give reason.

10. The planned values of the variables are their ___________ (ex‑ante/ex-post) measures. (Fill in the blank with correct option)
11. In order to understand the determination of national income, we need to know the ________ (ex-ante/ex-post) values of
the components of aggregate demand. (Fill in the blank with correct option)
12. ___________ describes the relation between consumption and income. (Fill in the blank)
13. Even if income is zero, some consumption still takes place. Since this level of consumption is independent of income, it is
called __________ . (Fill in the blank)
14. If consumption takes place even when income is zero, it is because of __________ . (Fill in the blank)
15. Given the consumption function of an economy: C = a + bY
The autonomous consumption and induced consumption are respectively denoted by _________. (Fill in the blank)
16. The maximum value of MPC can be _________ when ___________ . (Fill in the blanks)
17. The minimum value of MPC can be ______ when _______ . (Fill in the blanks)
18. The range of MPC is: (Choose the correct alternative)
(a) between 0 and 1 (b) from 0 to 1
(c) between 1 and ∞ (d) from 1 to ∞
19. When consumers consume part of change in income, which of the following is true? (Choose the correct alternative)
(a) MPC > 1 (b) MPC = 1
(c) MPC = 0 (d) 0 < MPC < 1
20. At zero level of income, consumption is (Choose the correct alternative)
(a) zero (b) positive
(c) negative (d) zero or negative
21. In consumption function C = a + bY, b represents (Choose the correct alternative)
(a) autonomous consumption (b) savings
(c) MPC (d) MPS
22. If MPC is 0.5, what will be change in consumption, if income increases by `100 crore? (Choose the correct alternative)
(a) `60 crore (b) `50 crore
(c) `40 crore (d) `70 crore
23. APC can never be equal to 1. True/False? Give reason.

1. State which of the following statements are true or false. Give valid reasons. (CBSE 2019) (3 marks)
(a) According to Keynesian theory of employment, Ex-ante savings and Ex-post savings are always equal.
(b) In a two-sector economy if income is zero, consumption will also be zero.
Ans. (a) The given statement is false, as ex-ante savings are those which all the households plan to make at different
level of income during a period, whereas ex-post savings are the actual amount of savings made in the
economy during a period. So, the two may or may not be equal.
(b) The given statement is false, even at zero level of income there is still some minimum consumption
(autonomous consumption) in the economy, as it is essential for survival.
2. Why does consumption curve not start from the origin ? (CBSE 2018) (1 mark)
Ans. Consumption curve does not start from origin because of the assumption that there is some minimum level of
consumption even at zero level of income.
3. Value of which of the following can be greater than one and why? (1 mark)
(a) Marginal Propensity to Consume (MPC) (b) Average Propensity to Consume (APC)
Ans. (b) The value of Average Propensity to Consume (APC) can be greater that one. This is because total
consumption can be greater than total income, due to the existence of autonomous consumption.
4. Giving valid reason, state whether the following statement is true or false: (1 mark)
Marginal propensity to consume represents the slope of the consumption function.
Ans. The given statement is true, as MPC represents change in consumption due to a given change in income.
(MPC = ΔC/ΔY)
Numerical 1
Given the consumption function of an economy:

C = `100 crore + 0.75Y
The equilibrium level of income is `900 crore.
Calculate the values of the two components of the consumption function when the economy is in equilibrium. (3 marks)
Solution: The values of the two components of the consumption function are:
Autonomous Consumption (a) = `100 crore
Induced consumption (bY)= 0.75 × `900 crore = `675 crore
Do it yourself 1
Calculate autonomous consumption and induced consumption from the following:

National income = `1,000 crore, MPC = 0.75 and Consumption expenditure = `850 crore (3 marks)
[Ans. (i) Autonomous consumption, a = `100 crore; (ii) Induced consumption, bY = `750 crore]
Numerical 2
Given the consumption function of an economy C = `100 crore + 0.8Y.

(a) What are the values of autonomous consumption and the slope of consumption function?
(b) What is the level of income at Break-Even Point? (3 marks)
Solution: (a) From the consumption function C = 100 + 0.8Y, autonomous consumption = `100 crore
Slope of consumption function = MPC = 0.8
(b) At Break even point, C = Y
100 + 0.8Y = Y
Y – 0.8 Y = 100
0.2Y = 100
Y = 100/0.2 = 500
Therefore, break even level of income = `500 crore
Do it yourself 2
Given the consumption function of an economy C = `100 crore + 0.75Y, calculate:

(a) Values of autonomous consumption and slope of consumption function.
(b) The level of income corresponding to the Break-Even Point. (3 marks)
[Ans. Autonomous consumption = `100 crore; Slope of consumption function = 0.75; Level of income corresponding
to the Break-Even Point = `400 crore]
Numerical 3
Given that National Income is `80 crore and consumption expenditure `64 crore, find out average propensity to consume.
When income rises to `100 crore and consumption expenditure to `78 crore, what will be the APC and MPC? (3 marks)
Solution:
Income (Y) DY Consumption (C) DC APC (C/Y) MPC (DC/DY)
80 – 64 – 0.8 –
100 20 78 14 0.78 0.7
Do it yourself 3
If national income is `50 crore and consumption `45 crore, find out average propensity to consume. When income
rises to `60 crore and consumption by `6 crore, what will be the APC and MPC? (3 marks)
[Ans. APC 0.9, 0.85 and MPC 0.6]
3.2 Savings and Investment Functions

Savings Function
The relationship between savings and income is called the savings function. There is a direct (positive) relation
between income and savings. Higher the income, higher is the level of savings and vice-versa.
Derivation of savings function from consumption function
Savings is that part of income which is not consumed, that is
S=Y– C
This equation tells us that by definition, saving is equal to income minus consumption.
Substituting the consumption function equation C = C + bY into the above equation, we can get the savings
function equation.
S = Y – (C + bY)
S = Y – C – bY
S = – C + (1 – b)Y
S = – C + sY
This is the savings function, where Y is the level of income in the economy, i.e. national income and S is the
desired or planned savings at that income level.
 The intercept term C is the amount of savings done when there is zero level of income. It is already
shown that C is positive. Therefore, C savings is negative. Thus, there is negative savings C at zero level
of income. Since negative savings is nothing but dissaving, this means that at zero level of income, there
is a dissaving of amount C. Note that the amount of autonomous consumption is exactly equal to the
amount of dissaving at zero level of income. This is because of the fact that Y = C + S (whether S is
positive or negative).
 s = (1 – b) is the slope of the savings function. The slope of the savings function gives the change in
savings due to a given change in income. This is known as the Marginal Propensity to Save (MPS).
Top Tip
MPS represents the slope of the savings function as it represents change in savings due to a given change in income
(MPS = DS/DY).
Marginal propensity to save (MPS) is defined as the change in savings per unit change in income.
or, MPS refers to the change in savings due to a given change in income, i.e. MPS = DS/DY.
Relationship between MPC and MPS

MPC + MPS = 1
Explanation: MPS

∆(Y − C)
Since S = Y – C, therefore MPS =
∆Y
∆Y ∆C
⇒ =
MPS −
∆Y ∆Y
⇒ MPS = 1 – MPC
⇒ MPS + MPC = 1 or MPC + MPS = 1
Numerical Example:
Given the consumption function C = 100 + 0.8Y, we can derive the corresponding savings function.
S=Y– C
Substituting the consumption function equation C = 100 + 0.8Y into the above equation, we can get the savings
function equation.
S = Y – (100 + 0.8Y)
S = Y – 100 – 0.8Y
S = – 100 + 0.2Y
Here, MPS = 0.2, which means that in the economy 20% of total additional income is put into additional
savings by the people; and dissaving at zero income = `100 crore (which is equal to autonomous consumption)
Top Tip
Derivation of consumption function from savings function
Given the savings function, we can derive the corresponding consumption function. The two functions are closely related,
since income always equals consumption plus saving (Y = C + S).
C=Y– S
Substituting the savings function equation S = – C + sY into the above equation, we can get the consumption function
equation.
C = Y – (– C + sY) ⇒ C = Y + C – sY ⇒ C = C + (1 – s)Y ⇒ C = C + bY
Example: Given the savings function S = –100 + 0.2Y, we can derive the corresponding consumption function.
C = Y – S
Substituting the savings function S = –100 + 0.2Y into the above equation, we can get the consumption function.
C = Y – (–100 + 0.2Y) ⇒ C = Y + 100 – 0.2Y ⇒ C = 100 + 0.8Y
Derivation of savings curve from

consumption curve
Figure 3.2 shows the derivation of savings curve from
consumption curve.
Step 1: Draw a 45° line from origin. Given consumption
curve CC intersects it at B (Break-even point).
Corresponding to the Break-even point is the level of
income at which consumption equals income (C = Y).
Therefore, savings is zero (S = 0).
Step 2: Take OS1 equal to OC because at zero income,
negative savings is exactly equal to the autonomous
consumption.
Step 3: From the break-even point B, we draw a
perpendicular on X-axis which cuts the X-axis at B1. At
OB1 level of income, savings must be zero because at
this level of income consumption equals income.
Step 4: Join S1 and B1 and extend it by a straight line
to get the savings curve S1S.
Top Tip
Derivation of consumption curve from savings curve
Since income equals consumption plus savings, therefore, consumption and savings curves can be called complementary
curves. Consumption curve can be derived from savings curve.
Fig. 3.2 shows the derivation of consumption curve from savings curve.
Step 1: Draw a 45° line from origin.
Step 2: Given the savings curve S1S, take OC equal to OS1 because in the economy the autonomous consumption is
exactly equal to negative savings at zero income.
Step 3: At point B1, savings = 0. We draw a perpendicular from B1 till it intersects the 45° line at B. B is the break-even
point where consumption equals income.
Step 4: Join C and B and extend it by a straight line to get the consumption curve CC.
Average propensity to save (APS)

Average propensity to save (APS) is the savings per unit of income, i.e. S/Y. In other words, APS is the ratio of
savings and income at a given level of income.
Relationship between APC and APS: The sum of APC and APS is equal to one.
Explanation: Income is either consumed or saved.
Y=C+S
Y C S
Dividing both sides of the equation by Y, we have = +
Y Y Y
⇒ 1 = APC + APS
Therefore, APS = 1 – APC and APC = 1 – APS
TABLE 3.2: Consumption and Savings Schedule
Income DY Consumption DC Savings DS APC APS MPC MPS
(Y) (C) (S = Y–C) (C/Y) (S/Y) (DC/DY) (DS/DY)
0 — 100 — –100 — — — — —
100 100 180 80 –80 20 1.80 –0.80 0.8 0.2
200 100 260 80 –60 20 1.30 –0.30 0.8 0.2
300 100 340 80 –40 20 1.13 –0.13 0.8 0.2
400 100 420 80 –20 20 1.05 –0.05 0.8 0.2
500 100 500 80 0 20 1 0 0.8 0.2
600 100 580 80 20 20 0.97 0.03 0.8 0.2
700 100 660 80 40 20 0.94 0.06 0.8 0.2
800 100 740 80 60 20 0.93 0.07 0.8 0.2
900 100 820 80 80 20 0.91 0.09 0.8 0.2
1000 100 900 80 100 20 0.90 0.10 0.8 0.2
Important observations from Figure 3.2 and Table 3.2
1. APC is continuously declining as income increases; and APS is continuously increasing as income
increases. This means that as income increases, the proportion of income saved increases and the
proportion of income consumed decreases.
2. APC can never be zero because consumption expenditure in the economy cannot be zero. Even at zero
income, there has to be a minimum or subsistence level of consumption expenditure, called autonomous
consumption (C = `100 crore).
3. APC (= C/Y) can be greater than one, equal to one or less than one.
• APC can be greater than one, when total consumption is greater than national income before Break-
even point, due to the existence of autonomous consumption. (Since C > Y, therefore, APC > 1)
• APC can be equal to one, when consumption is equal to income (at Break-even point). (Since C = Y,
therefore, APC = 1)
• APC can be less than one, when consumption is less than income. (Since C < Y, therefore, APC < 1)
4. APS can be negative, zero or positive.
• APS can be negative because of negative savings at a low level of income(before break even point)
when total consumption is greater than national income, due to the existence of autonomous
consumption. (Since C > Y, therefore, S is negative and APS is also negative.)
• APS can be zero when savings is zero at a level of income when consumption is equal to income, i.e.
at break even point. (Since C = Y, therefore, S = Y – C = C –C = 0. So, APS = S/Y = 0/Y = 0)
• APS is positive because of positive savings at a level, when consumption is less than income.
(Since C < Y, therefore, S is positive and APS is also positive.)
5. Both MPC and MPS range from 0 to 1, i.e. MPC or MPS can be 0 or 1 or between 0 and 1.
6. MPC represents the slope of the consumption function as it represents change in consumption due to
a given change in income (MPC = DC/DY). In Keynesian analysis, MPC is assumed to be constant.
Therefore, MPC is 0.8 at all levels of income. Similarly, MPS, i.e. the slope of the savings function is the
same at all levels of income because of a linear curve with constant slope we used in our example.
7. MPC cannot be negative because as income increases, consumption cannot decrease. Similarly, MPS
cannot be negative because as income increases, savings cannot decrease.
8. The sum of MPC and MPS is equal to one. This means that the part of the increase in income, which is
not consumed, is saved. This is because income is either consumed or saved.
9. The APC gives the average consumption- income relationship at different levels of income. Similarly,
from the savings function,we can find out the average savings-income ratio. The sum of the APC and
APS is always equal to one. This is because income is either consumed or saved.
Investment Function
Investment expenditure refers to the addition to the stock of physical capital and change in inventories of a firm
in an economy.
Investment decisions by firms, such as whether to buy a new machine, depend, to a large extent, on the market
rate of interest. However, for simplicity, we assume here that firms plan to invest the same amount every year.
We can write the ex-ante investment demand as:
I=I
where, I is a positive constant which represents the
autonomous investment (or ex-ante investment) in the
economy in a given year.
Autonomous investment refers to the investment
expenditure which is independent of income. The
investment expenditure is the same, no matter whatever is
the level of income.
Since firms plan to invest the same amount I regardless of
the level of income or output, the investment function/
schedule/curve will be a horizontal line (i.e., parallel to
X-axis). This is because every point on the investment curve
lies at the same height above the X-axis. That is, the level of
investment demand is the same at every level of income.
Top Tip
Autonomous investment refers to the investment expenditure which is independent of income whereas, Induced
investment refers to the investment expenditure which is dependent on the level of income.
Key Terms
Savings Function — The relationship between savings and income is called the savings function.
Marginal propensity to save (MPS) — It refers to the change in savings due to a given change in income, i.e. MPS = DS/DY.
Average propensity to save (APS) — It is the savings per unit of income, i.e. S/Y.
Investment expenditure — It refers to the addition to the stock of physical capital and change in inventories of a firm
in an economy.
Autonomous investment — It refers to the investment expenditure which is independent of income.
Induced investment — It refers to the investment expenditure which is dependent on the level of income.
RECAP
Savings Function
Savings is that part of income which is not consumed. In other words, S = Y – C.
Substituting C = C + bY, we get S = Y – (C + bY) ⇒ S = – C + (1 – b)Y ⇒ S = – C + sY
where – C is the dissavings at zero level of income. Since even at zero level of income, there will be some minimum amount of
consumption (i.e. autonomous consumption) for survival, therefore at zero level of income, there will be dissavings.
‘s’ is Marginal propensity to save (MPS), which refers to the change in savings due to a given change in income, i.e. DS/DY. It
is equal to 1 – MPC.
It implies that the sum of MPC and MPS is equal to 1. Explanation: Since S = Y – C, therefore
MPS = DS/DY = D(Y – C)/DY = DY/DY – DC/DY = 1 – MPC.
MPS represents the slope of the savings function as it represents change in savings due to a given change in income (MPS = DS/DY).
Average propensity to save (APS) is the savings per unit of income, i.e. S/Y. In other words, APS is the ratio of savings and
income at a given level of income.
The sum of APC and APS is equal to one. Explanation: Y = C + S. Dividing both sides of the equation by Y,
Y/Y = C/Y + S/Y ⇒ 1 = APC + APS.
Therefore, APS = 1 – APC and APC = 1 – APS.
• When the consumption and income are equal, the savings will be zero. Hence, APS = S/Y = 0/Y = zero.
• When total consumption is greater than total income, Savings will be negative and APS (= S/Y)will also be negative.
• When consumption is less than income, saving is positive. Then, APS (= S/Y) is positive.
Investment Function
Investment refers to the addition to the stock of physical capital and change in inventories of a firm in an economy.
For simplicity, we assume that firms plan to invest the same amount every year. We can write the ex-ante investment demand
as I = I where I is a positive constant which represents the autonomous investment in the economy in a given year. So,
investment curve will be a horizontal straight line parallel to X-axis.
1. If APC = 0.6, APS =‌‌‌‌‌‌‌‌‌‌___________ (Choose the correct alternative)

(a) 0.4 (b) 1
(c) 2.4 (d) None of these
2. Average propensity to save is always greater than zero. (True/False)
3. The value of marginal propensity to save can never be negative. (True/False)
4. Average propensity to save cannot be negative. (True/False)
5. _____________ refers to actual or realised savings in an economy during a year. (Choose the correct alternative)
(a) Ex-ante savings (b) APS
(c) MPS (d) Ex-post savings
6. Which of the following can have a negative value? (Choose the correct alternative)
(a) APC (b) MPC
(c) MPS (d) APS
7. If C = 100 + 0.75 Y, then the corresponding Savings Function will be expressed as: (Choose the correct alternative)
(a) S = 100 + 0.25 Y (b) S = –100 + 0.75 Y
(c) S = –100 + 0.25 Y (d) S = 75 + 0.25 Y
8. If the savings function of an economy is given as: S = –100 + 0.40Y, then MPC is: (Choose the correct alternative)
(a) 1 (b) 0.40
(c) 0.60 (d) None of these
9. Sum of average propensity to consume and marginal propensity to consume is always equal to 1. (True/False)
10. If APC = 1.2, APS will be zero. (True/False)
11. When the consumption function lies below the 45° line, APS will be positive. (True/False)
12. The value of average propensity to save can never be greater than 1. (True/False)
13. The point at which consumption curve intersects the 45 degree line, APS is zero. (True/False)
14. Out of the following, which can have a value more than one? (Choose the correct alternative)
(a) MPC (b) APC
(c) APS (d) MPS
15. The value of MPS ranges from ________ . (Fill in the blank)
16. (i)________is the rate of change in savings per unit change in income, and is equal to (ii)________ . (Fill in the blanks)
17. As income increases, APS ______. (increases/decreases) (Fill in the blank with correct option)
18. As income increases, APC ______. (increases/decreases) (Fill in the blank with correct option)
19. __________ is the savings per unit of income. (Fill in the blank)
20. Investment decisions by producers, such as whether to buy a machine, depend, to a large extent on _________. (Fill in the blank)
21. In the Keynesian analysis, we assume that firms plan to invest the same amount every year. We can write the ex-ante
investment demand as: I = I, where I is a positive constant which represents the ___________ in the economy in a given
year. (Fill in the blank)
22. In the consumption function, C = 200 + 0.6Y, the value of dis-saving will be (Choose the correct alternative)
(a) 200 (b) –200
(c) 0.6 (d) 0.4
23. When consumption function starts from Y-axis, it indicates that: (Choose the correct alternative)
(a) consumption is zero when income is zero (b) saving is negative when income is positive
(c) consumption is positive when income is zero (d) saving is positive when income is zero
24. Break even point occurs when (Choose the correct alternative)
(a) Y = S (b) S = 0
(c) C > Y (d) Y > C
25. Autonomous investment curve (when on X-axis, Income is shown and on Y-axis, Autonomous Investment is shown) is
always (Choose the correct alternative)
(a) a horizontal straight line. (b) negatively related to income
(c) an upward rising straight line (d) always equal to income
26. If the MPS is 1, how much will be MPC? (Choose the correct alternative)
(a) 1 (b) 0.5
(c) 0 (d) 0.4
27. How are both APC and APS associated with National Income? (Choose the correct alternative)
(a) both APC and APS fall with increase in National Income
(b) both APC and APS rise with increase in National Income
(c) APC falls APS rises with increase in national income
(d) APC rises APS falls with increase in national income
28. If MPC = 0.4 and change in income is `1,000 crore, what will be change in savings? (Choose the correct alternative)
29. Ex-post investment means fixed capital with production units during a particular period of time. True/False? Give reason.
Numerical 4
iven the consumption function of an economy C = 100 + 0.8Y.

G
(a) Derive the corresponding savings function.
(b) What is the value of slope of the savings function?
(c) Show that in this economy as income increases, APC declines and APS increases. (6 marks)
Solution:
(a) C = 100 + 0.8Y
Savings is that part of income which is not consumed, i.e. S = Y – C = Y – (100 + 0.8Y) = –100 + 0.2Y
Thus, S = –100 + 0.2Y is the required savings function.
(b) From the savings function S = – 100 + 0.2Y, the slope of savings function (i.e. MPS) = 0.2
(c) At Y = 1000, C = 100 + 0.8 (1000) = 100 + 800 = `900 crore
At Y = 2000, C = 100 + 0.8 (2000) = 100 + 1600 = `1700 crore
At Y = 3000, C = 100 + 0.8(3000) = 100 + 2400 = `2500 crore
Income (Y) Consumption (C) Savings (S = Y – C) APC (C/Y) APS (S/Y)

1000 900 100 0.9 0.1
2000 1700 300 0.85 0.15
3000 2500 500 0.83 0.17
As income increases from 1000 to 3000, APC declines from 0.9 to 0.83 but APS increases from 0.1 to 0.17.
Do it yourself 4
Given the consumption function of an economy C = 200 + 0.75Y.

(a) Derive the corresponding savings function.
(b) What is the value of slope of the savings function?
(c) Show that in this economy as income increases, APC declines and APS increases. (6 marks)
[Ans. (a) S = – 200 + 0.25Y (b) 0.25]
Numerical 5
Complete the following table: (4 marks)

Income Savings MPC APC
0 –20
50 –10 – –
100 0 – –
150 30 – –
200 60 – –
Solution:
Income DY Savings C DC MPC APC (C/Y)
(Y) (S) (Y – S) (DC/DY)
0 – –20 20 – – –
50 50 –10 60 40 0.8 1.2
100 50 0 100 40 0.8 1
150 50 30 120 20 0.4 0.8
200 50 60 140 20 0.4 0.7
As income increases from 1000 to 3000, APC declines from 0.9 to 0.83 but APS increases from 0.1 to 0.17.
Do it yourself 5
Income Savings APC MPC

0 –40
50 –20 – –
100 0 – 0.6
150 30 0.8 –
200 50 – –
[Ans. APC 1.4, 1, 0.75 and MPC = 0.6, 0.4, 0.6]
Numerical 6
Complete the following table:

Income Consumption APS MPS
200 120 0.40
400 220 – –
– 250 0.50 –
Solution:
Income DY Consumption DC Savings DS APS APC MPS
(Y) (C) (S = Y – C) (S/Y) (1– APS) (DS/DY)
200 – 120 – 80 – 0.4 0.6 –
400 200 220 100 180 100 0.45 0.55 0.5
500* 100 250 30 250 70 0.5 0.5 0.7
*Note: APC = C/Y. When APC = 0.50, C = 250.

Therefore, 0.50 = 250/Y
⇒ Y = 250/0.50 = 500

Do it yourself 6
Income Consumption APS MPS

400 240 0.4
800 440 – –
– 520 0.48 –
[Ans. Income = 1,000

APS = 0.45
MPS = 0.5 and 0.6]
Numerical 7
In an economy, the ratio of average propensity to consume and average propensity to save is 5 : 3. The level of income
is `6000. How much is the savings? Calculate. (3 marks)
APC 5 C/Y 5 C 5
Solution: = ⇒ = ⇒ =
APS 3 S/ Y 3 S 3
Y −S 5
= (since C= Y − S)
S 3
6,000 − S 5 18,000
= ⇒ 5S = 18,000 – 3S ⇒ 8S = 18,000 ⇒ S = = 2,250
S 3 8
Thus, savings in the economy are `2,250 crore.
Do it yourself 7
In an economy, total savings are `2000 crore and the ratio of average propensity to save and average propensity to
consume is 2 : 7. Calculate the level of income in the economy. (3 marks)
[Ans. `9,000 crore]
3.3 Aggregate Demand and Aggregate Supply

Aggregate Demand
Aggregate Demand (AD) means the total demand for final goods in an economy during an accounting year.
It also means the aggregate expenditure on final goods in the economy.
Components of aggregate demand
The components of aggregate demand are: (i) Consumption Expenditure(C) (ii) Investment Expenditure(I)
(iii) Government’s final expenditure (G) (iv) Net exports.
However, in a two sector economy, there are only two components of aggregate demand, viz. (i) Consumption
Expenditure(C) (ii) Investment Expenditure(I).
1. Consumption Expenditure(C)– It is that portion of income which is spent on purchase of goods and
services by the consumers in an economy during the accounting period.
2. Investment Expenditure (I)– It refers to the addition to the stock of physical capital and change in
inventories of a firm in an economy.
Thus, in a two sector economy without a government and external trade, ex-ante aggregate demand is sum total
of ex-ante consumption expenditure and ex-ante investment expenditure, viz.
AD = C + I
Substituting the values of C = C + bY and I = I, ex-ante aggregate demand for final goods can be written as:
AD = C + bY + I
⇒ AD = ( C + I ) + bY
or, AD = A + bY
where A = C + I is the total autonomous expenditure.
Top Tip
Note that the slope of aggregate demand function AD = A + bY is given by ‘b’, i.e. MPC.
There are two components of autonomous expenditure (A):

(i) Autonomous consumption (C)
(ii) Autonomous investment (I)
In reality, these two components of autonomous expenditure behave in different ways. C, representing subsistence
consumption level of an economy, remains more or less stable over time. However, I has been observed to
undergo periodic fluctuations. We have assumed that investment is autonomous. However, it just means that it
does not depend on income. There are a number of factors other than income which can affect investment. One
such factor is availability of credit, for example, easy availability of credit encourages investment. Another factor
is market rate of interest, for example, interest rate is the cost of investible funds, and at higher interest rates,
firms tend to lower investment.
Top Tip
AD can change if there is change in consumption or/and change in investment.
1. Change in consumption: This can happen due to (i) change in autonomous consumption (C) or/and (ii) change in MPC.
2. Change in investment: Easy availability of credit encourages investment. Similarly, at lower market rate of interest,
firms tend to increase investment.
Diagrammatic Presentation
The ex-ante aggregate demand curve shows the total demand (ex-
ante consumption + ex-ante investment ) at each level of income.
Graphically, it means the aggregate demand curve can be obtained
by vertically adding the consumption and investment curves.
The aggregate demand curve is parallel to the consumption
curve since they have the same slope, i.e. MPC. This is because
AD = C + I, where I remains constant irrespective of the level of
income. So, AD rises only with the rise in consumption, C. So,
the slope of the aggregate demand curve remains the same as that
of the consumption curve.
Aggregate Supply
Aggregate Supply (AS) is the value of total quantity of final goods
and services produced in the economic teritory of a country.
In Keynesian analysis, aggregate supply refers to the ex-ante, i.e.
planned aggregate output produced in the economy in a given year.
In a two sector economy, in the absence of indirect taxes or subsidies,
the value of total final goods and services is distributed among the
factors of production (wages to labour, interest to capital and rent to
land). Whatever is left over is appropriated by the entrepreneur and
is called profit. Thus, the sum total of aggregate factor payments in
the economy, i.e. National Income, is equal to the aggregate value of
the output of final goods, i.e. Aggregate Supply.
Aggregate Supply (AS) = National Income (Y)
Therefore, aggregate supply curve is represented by a 45° line
from the origin because the 45° line from the origin establishes
the relation of Y = C + S.
Also, since the 45° line from the origin has the feature that every
point on it has the same horizontal and vertical coordinates,
therefore, corresponding to every point on the 45° line, AS = Y.
Key Terms
Aggregate Demand (AD) – It means the total demand for final goods in an economy during an accounting year.
Autonomous expenditure (A) – It is the sum of autonomous consumption (C) and Autonomous investment (I)
Aggregate Supply (AS) – It is the value of total quantity of final goods and services produced in the economic teritory
of a country.
RECAP
Aggregate Demand (AD)

It means total expenditure planned to be incurred on final goods and services. Its components are: (i) Consumption
Expenditure(C) (ii) Investment Expenditure(I) (iii) Government’s final expenditure (G) (iv) Net exports.
In a two sector economy, there are only two components of aggregate demand, viz. (i) Consumption Expenditure(C)
(ii) Investment Expenditure(I).
Consumption Expenditure(C)– It is that portion of income which is spent on purchase of goods and services by the
consumers in an economy during the accounting period.
Investment Expenditure (I)– It refers to the addition to the stock of physical capital and change in inventories of a firm in an
economy.
Thus, in a two sector economy, AD = C + I ⇒ AD = C + bY + I ⇒ AD = ( C + I ) + bY ⇒ AD = A + bY
where A = C + I = Autonomous expenditure.
Note that the slope of aggregate demand function is given by ‘b’, i.e. MPC. Thus, the aggregate demand curve is parallel to the
consumption curve since they have the same slope.
Aggregate Supply (AS)
It is the value of total quantity of final goods and services produced in the economic teritory of a country. It refers to the ex-
ante, i.e. planned aggregate output in the economy. It is equal to the National Income and is represented by a 45 degree line
from origin because at every point on it, AS = Y.
1. Which of the following is not a component of aggregate demand in a two-sector economy? (Choose the correct alternative)
(a) Net Exports (b) Government Expenditure (c) Consumption expenditure (d) Both (a) and (b)
2. In a two sector economy and without any indirect tax and subsidy, aggregate supply and ______ are always equal.
(Choose the correct alternative)
(a) National Income (b) Aggregate Demand (c) Marginal Propensity to save (d) Average Propensity to Consume
3. What causes the Aggregate Demand Curve swing downwards from AD1 to AD2?
4. Aggregate demand curve is parallel to ________ because they have the same _________ . (Fill in the blanks)
5. In a two sector economy, the aggregate demand curve shifts in parallel upwards. In which of the following case the above
situation is possible? (Choose the correct alternative)
(a) Change in autonomous consumption, MPC and autonomous investment.
(b) Change in autonomous investment only, while autonomous consumption and MPC remain the same.
(c) Change in both the autonomous consumption and autonomous investment; but MPC remains the same.
(d) Both (b) and (c)

1. Why is aggregate demand curve parallel to the consumption curve? (3 marks)
Ans. The aggregate demand curve is parallel to the consumption curve since they have the same slope, i.e. MPC.
This is because AD = C + I, where I remains constant irrespective of the level of income. So, AD rises only
with the rise in consumption, C. So, the slope of the aggregate demand curve remains the same as that of the
consumption curve.
2. State the two components of autonomous expenditure. How do they behave in general? (3 marks)
Ans. There are two components of autonomous expenditure (A):
(ii) Autonomous investment (I)
In reality, the two components of autonomous expenditure behave in different ways. C remains more or less
stable over time. However, I undergoes periodic fluctuations. We have assumed that investment is autonomous,
which means that it does not depend on income. But, investment may increase at lower interest rates.
Numerical 8
Estimate the value of Aggregate Demand in an economy if:

(a) Autonomous Investment = `100 crore
(b) Marginal Propensity to Save = 0.2
(c) Level of Income = `4,000 crore
(d) Autonomous Consumption Expenditure = `50 crore (3 marks)
Solution: MPC = b = 1 – MPS = 1 – 0.2 = 0.8, C = 50, Y = 4,000 and I = 100
Aggregate demand, AD = C + I
AD = C + bY + I
AD = 50 + 0.8 × 4,000 + 100
AD = 50 + 3,200 + 100 = `3,350 crore
Do it yourself 8
stimate the value of ex-ante AD, when autonomous investment and consumption expenditure (A) is `50 crore,
E
and MPS is 0.2 and level of income is `300 crore. (3 marks)
[Ans. `290 crore]
3.4 Short-Run Equilibrium Level of Income/Output

We shall confine our analysis of the determination of the equilibrium level of income or output in an economy
with only two sectors, households and firms. Hence, the only components of aggregate demand will be
consumption and investment.
Top Tip
The level of output, income and employment in an economy move together in the same direction till full employment
is reached. In other words, increase in output means increase in level of employment and increase in level of income.
Decrease in output means less employment and lower level of income.
Consumption plus investment approach (or AD-AS approach)

Meaning of equilibrium level of income/output
Equilibrium level of income or output is that level of income or output at which ex-ante aggregate demand
becomes equal to ex-ante aggregate supply.
AD = AS
It is also called ‘effective demand principle’.
Since AS = Y, therefore the economy is in equilibrium if Y = AD
or, Y = C + I
The Adjustment Mechanism
When ex-ante aggregate demand (i.e. planned demand or planned expenditure) is not equal to ex-ante aggregate
supply (i.e. planned output) of final goods and services, then output will tend to adjust up or down until the
two are equal again.
 If planned demand falls short of planned output (AD < Y)
It means buyers are planning to buy less goods and services than producers are planning to produce.
Thus, inventories of unsold goods will be piling up in the warehouses (i.e. unplanned accumulation of
inventories). As a result, producers will plan to cut down production. This will decrease planned output
and income. The process continues till the planned output produced in the economy becomes equal to
planned demand, i.e. Y = AD.
 If planned demand exceeds planned output (AD > Y)
It means buyers are planning to buy more goods and
services than producers are planning to produce.
Thus, the inventories in hand with the producers
will start falling (i.e. unplanned decumulation of
inventories). As a result, producers will plan to raise
the production. This will increase planned output
and income. The process continues till planned
output produced in the economy becomes equal to
the planned demand, i.e. Y = AD.
Thus, Y = AD is a necessary condition for equilibrium
level of income or output.
Equilibrium is shown graphically by putting ex-ante
aggregate demand and supply together in a diagram. The
point where ex-ante aggregate demand is equal to ex-ante
aggregate supply will be equilibrium. Thus, equilibrium
point is E and equilibrium level of income is OM.
Savings and Investment Approach
Derivation of S-I approach from C + I approach
Under C + I approach, the equilibrium level of income or output is determined at that level of income or output
at which planned aggregate demand is equal to ex-ante aggregate supply, i.e. AD = Y or Y = C + I
Planned output or income is either consumed or saved, i.e. Y = C + S
Substituting Y = C + S in the equilibrium condition equation, we have
C + S = C + I
⇒ S=I
Equilibrium level of income or output is that level of income or output at which ex-ante savings and ex-ante
investment are equal.
The Adjustment Mechanism
When planned savings and planned investment are not equal, output will tend to adjust up or down till they are
equal again.
 If planned saving is greater than planned investment (S > I)
It implies buyers are planning to buy less goods than producers are planning to produce. In other words,
planned demand is less than planned output (i.e. AD < Y). Thus, inventories of unsold goods will be
piling up in the warehouses (i.e. unplanned accumulation of inventories). As a result, producers will plan
to cut down production. This will decrease planned output and income. The process continues till the
planned output produced in the economy becomes equal to planned demand, i.e. planned investment
becomes equal to planned savings and the economy achieves the equilibrium level of national income.
 If planned saving is less than planned investment (S < I)
It implies buyers are planning to buy more goods than producers are planning to produce (i.e. AD > Y).
Thus, the inventories in hand with the producers will start falling (i.e. unplanned decumulation of
inventories). As a result, producers will plan to raise the production. This will increase planned output
and income. The process continues till planned output produced in the economy becomes equal to the
planned demand, i.e. planned investment becomes
equal to planned savings and the economy achieves
the equilibrium level of national income.
Thus, S = I is a necessary condition for equilibrium level of
income or output.
Fig. 3.7 shows that the economy is in equilibrium at point
E, where OM is equilibrium level of income or output.
At this level of income or output, planned savings of
households is equal to the planned investment of firms.
'Effective Demand' Principle
Effective Demand refers to that level of income/output
where ex-ante aggregate demand is equal to the ex-ante
aggregate supply, i.e. AD = AS.
TABLE 3.3: Determination of Equilibrium Income or Output (C = 100, MPC = 0.8 and I = 300)
Income Consumption Savings Investments Aggregate Demand Aggregate Supply
(Y) (C) (S = Y –C) (I) (AD = C + I) (AS = Y)
0 100 –100 < 300 400 > 0
1000 900 100 < 300 1200 > 1000
2000 1700 300 = 300 2000 = 2000
3000 2500 500 > 300 2800 < 3000
4000 3300 700 > 300 3600 < 4000
 At Y = 0, and Y = 1,000; AD > AS. This causes unplanned decrease in inventories inducing producers to
produce more output.
 At Y = 2,000; AD = AS. This keeps the inventory level unchanged. Thus, Effective Demand (AD = AS)
is obtained at `2,000 crore level of income/output which is the equilibrium level of income/output.
 At Y = 3,000 and Y = 4,000; AD < AS. This causes unplanned increase in inventory of unsold goods
inducing producers to produce less.
Key Terms
Equilibrium level of income or output – It is that level of income or output at which ex-ante aggregate demand becomes
equal to ex-ante aggregate supply or ex-ante savings and ex-ante investment are equal.
Effective Demand – It refers to that level of income/output where ex-ante aggregate demand is equal to the ex-ante
aggregate supply, i.e. AD = AS.
RECAP
C + I approach or AD-AS approach

Equilibrium income/output (or effective demand) refers to that level of income/output where ex-ante aggregate demand is
equal to the ex-ante aggregate supply, i.e. AD = AS.
Since AS = Y, therefore the economy is in equilibrium if Y = AD ⇒ Y = C + I (the equilibrium condition in a two sector economy)
• When AD < Y, it means buyers are planning to buy less goods and services than producers are planning to produce. Thus,
there will be unplanned accumulation of inventories. As a result, producers will plan to cut down production. This reduces
output and income till Y = AD.
• When AD > Y, it means buyers are planning to buy more goods and services than producers are planning to produce. Thus,
inventories in hand with the producers will start falling. As a result, producers will plan to raise the production. This will
increase the level of output and income till Y = AD.
Savings-Investment Approach: Derivation from C+I Approach
Under C + I approach that equilibrium level of income is determined where AD = Y, or Y = C + I ...(i)
Also, Y = C + S ...(ii)
From (i) and (ii), we have C + S = C + I ⇒ S = I
Thus, equilibrium level of income/output is that level of income at which planned savings and planned investment are equal.
• When S > I, it implies AD < Y. There is unplanned accumulation of inventories. Producers plan to cut down production. This
reduces output and income till Y = AD and hence, S = I.
• When S < I, it implies AD > Y. Inventories start falling. Producers plan to raise the production. This raises output and income
till Y = AD and hence, S = I.

DETERMINATION OF INCOME IN TWO-SECTOR MODEL
Equilibrium requires that the plans of suppliers are matched by plans of those who provide final demands in the economy. Thus, in this situation,
Equilibrium level of income is that level where ex-ante aggregate demand (AD) is equal to ex-ante aggregate supply (AS).
Ex-ante aggregate demand, AD = C + I and Ex-ante aggregate supply = Y
Thus, the equilibrium condition is: Y = C + I....... (1)
C+ I
Substituting C = C + bY and I = C, we get Y = C + bY + I ⇒ Y – bY = C + I ⇒ Y (1 – b) = C + I ⇒ Y =
1− b
The term Y on the left hand side of equation (1) represents the ex-ante output or the planned supply of final goods. On the other hand, the
expression on the right hand side denotes ex-ante or planned aggregate demand for final goods in the economy. Ex-ante supply is equal to ex
ante demand only when the final goods market, and hence the economy, is in equilibrium. Equation (1) should not, therefore, be confused with
the accounting identity of national income accounting, which states that the ex-post value of total output must always be equal to the sum total
of ex-post consumption and ex-post investment in the economy. If ex ante demand for final goods falls short of the output of final goods that the
producers have planned to produce in a given year, equation (1) will not hold. Stocks will be piling up in the warehouses which we may consider
as unintended accumulation of inventories. It should be noted that inventories or stocks refers to that part of output produced which is not sold
and therefore remains with the firm. Change in inventory is called inventory investment. It can be negative as well as positive: if there is a rise
in inventory, it is positive inventory investment, while a depletion of inventory is negative inventory investment. The inventory investment can
take place due to two reasons: (i) the firm decides to keep some stocks for various reasons (this is called planned inventory investment) (ii) the
sales differ from the planned level of sales, in which case the firm has to add to/run down existing inventories (this is called unplanned inventory
investment). Thus, even though planned Y is greater than planned C + I, actual Y will be equal to actual C + I, with the extra output showing up
as unintended accumulation of inventories in the ex post I on the right hand side of the accounting identity.
In the short-run, we assume that an economy has unused resources – machineries, buildings and labours. In such a situation, the law
of diminishing returns will not apply; hence additional output can be produced without increasing marginal cost. Accordingly, price
level does not change even if the quantity produced changes.
1. AD curve starts: (Choose the correct alternative)

(a) From the origin (b) Point below to the origin
(c) Point above the origin (d) None of these
2. In determination of equilibrium level of income by AD–AS approach, AD is represented by: (Choose the correct alternative)
(a) C + S (b) C + I
(c) S + I (d) C +Y
3. Which of the following is the equilibrium condition in a two sector economy? (Choose the correct alternative)
C C
(a) Y = (b) Y =
MPS 1 – MPS
C+I C −I
(c) Y = (d) Y =
1 − MPC MPS
4. When Aggregate Demand is more than Aggregate Supply, this will lead to _________. (Choose the correct alternative)
(a) a planned inventories accumulation
(b) a planned inventories decumulation
(c) an unplanned inventories accumulation
(d) an unplanned inventories decumulation
5. When Planned Savings is more than Planned Investment, then _________. (Choose the correct alternative)
(a) National income is likely to fall
(b) There will be no change in national income
(c) National income is likely to rise
(d) None of these
6. When aggregate demand is greater than aggregate supply, inventories _________. (Choose the correct alternative)
(a) fall (b) rise
(c) do not change (d) first fall, then rise
7. The equilibrium level of income changes if there is _________. (Choose the correct alternative)
(a) change in autonomous consumption
(b) change in MPC
(c) change in autonomous investment
8. In the Keynesian analysis of determination of equilibrium income in the short run, the justification for taking the price level
as fixed is: (Choose the correct alternative)
(a) We are assuming an economy with unused resources: machineries, buildings and labours.
(b) In such a situation, the law of diminishing returns will not apply.
(c) Additional output can be produced without increasing marginal cost.

1. Ex-post value of total output is always equal to the ex-post aggregate expenditure in the economy. True/
False? Give reason. (3 marks)
Ans. True; ex-post value of total output (Y) must always be equal to the sum total of ex-post consumption
expenditure (C) and ex-post investment expenditure (I) in the economy.
However, ex-ante aggregate supply is equal to ex-ante aggregate demand only when the final goods market and
hence the economy, is in equilibrium.
Thus, even though planned Y is greater than planned C + I, actual Y will be equal to actual C + I, with the
extra output showing up as unplanned accumulation of inventories in the ex-post I on the right hand side of
the accounting identity.
2. “Inventories accumulate when planned investment is less than planned saving.” Is the statement true or
false? Give reason in support of your answer. (3 marks)
Ans. True: When planned investment is less than planned saving, AD < Y. It implies that consumers are not planning
to buy as much goods and services as the firms are planning to produce. This will lead to an unplanned
accumulation of inventories.
3. Explain how the level of effective demand is attained in an economy if, Aggregate Demand is more than
the Aggregate Supply. (CBSE Sample Question Paper 2019) (3 marks)
Ans. Effective demand refers to that level of output where Aggregate demand is equal to the Aggregate supply. If
Aggregate Demand exceeds Aggregate Supply, it means buyers are planning to buy more goods and services
than producers are planning to produce. Thus, the inventories in hand with the producers will start falling.
As a result, producers will plan to raise the production. This will increase the level of income upto the level
Aggregate Demand is equal to Aggregate Supply.
4. How is ‘saving and investment’ approach derived from the ‘aggregate demand and supply’ approach of
income determination? Explain using diagram. (6 marks)
Ans. Equilibrium level of income/output is that level at which
aggregate planned expenditure is equal to aggregate
planned output, i.e. AD = AS. In other words, C + I = Y
We know that planned income/output is either consumed
or saved, viz. Y=C+S
Therefore, equality of aggregate planned expenditure and
aggregate planned output at equilibrium implies that
C + I = C + S
⇒ S = I
Equilibrium level of income/output is that level at which
planned savings and planned investment are equal.
Thus, the two alternative approaches of national income
determination are:
(i) AD = Y which is on E in the upper part of diagram
when AD curve intersects the 45˚ line with
equilibrium income OM.
(ii) S = I which is on E1 in the lower part of the diagram
when saving curve intersects the investment curve at
E1 with OM as the equilibrium income level.
5. Discuss the significance of 45-degree line in Keynesian Economics. (3 marks)
Ans. • The straight line obtained which will originate from point of origin O forming a 45° angle establishes the
relation of: Income = Consumption + Savings (Y = C + S). Therefore, the 45° line from origin represents
the aggregate supply curve.
• At any point on the 45° line, consumption expenditure is exactly equal to income. Thus, the 45° line from
origin tells us whether consumption is equal to, greater than, or less than income.
• The 45° line also helps to identify the equilibrium level of income/output in the economy. At all points
on the 45° line, the aggregate demand equals the level of income/output in the economy. Thus, the
point where the aggregate demand curve (C + I curve) will intersect the 45° line must be the equilibrium
point because at that point on the 45° line aggregate demand must be equal to the income/output in the
economy.
Numerical 9
I f in an economy consumption function is given by C = 100 + 0.75 Y, and autonomous investment is `150 crore.
Estimate (i) Equilibrium level of income by C + I approach and (ii) Consumption and Savings at the equilibrium level
of income. (6 marks)
Solution: C = 100 + 0.75Y; I = `150 crore
(i) At equilibrium level of income:
Y = C + I
Y = 100 + 0.75Y + 150
Y – 0.75Y = 250
0.25Y = 250
Y = 250/0.25 = 1,000
The equilibrium level of income in the economy Y = `1,000 crore
(ii) Consumption at the equilibrium level of income:
C = 100 + 0.75Y
Do it yourself 9 C = 100 + 0.75 (1,000)
C = 100 + 750 = `850 crore
Find equilibrium level of national income from the following: 3 marks
Savings at the equilibrium level of income:
S. No. Items S = Y – C = 1,000 – 850 = `150 crore (`crore)
(i) Autonomous consumption 100
(ii) Marginal propensity to consume 0.8
(iii) Investment 50
[Ans. `750 crore]
Numerical 10
I n an economy, C = 100 + 0.4Y is the consumption function, where C is consumption and Y is National Income.
If investment expenditure is `1,100 crore, calculate:
(i) Equilibrium level of National Income using savings and investment approach.
(ii) Consumption expenditure at equilibrium level of National Income. (6 marks)
Solution: Consumption function C = 100 + 0.4Y. Therefore, savings function
S = Y – C
S = Y – (100 + 0.4Y)
S = –100 + 0.6Y
Investment expenditure I = `1,100 crore
At equilibrium level of national income, S = I
–100 + 0.6Y = 1,100
0.6Y = 1,100 + 100 = 1,200
Y = 1,200/0.6 = 2,000
(i) Equilibrium level of national income = `2,000 crore
(ii) At equilibrium level of national income, Savings (S) = Investment (I) = `1,100 crore
Consumption expenditure at equilibrium level of national income, C = Y – S = 2,000 – 1,100 = `900 crore
Do it yourself 10
In an economy, S = –100 + 0.6Y is the saving function, where S is Saving and Y is National Income. If investment
expenditure is 1,100, calculate:
(i) Equilibrium level of National Income
(ii) Consumption expenditure at equilibrium level of National Income. (6 marks)
[Ans. (i) 2,000 (ii) 900]
Numerical 11
he savings function of an economy is S = –200 + 0.25Y. The economy is in equilibrium when income is equal to `2,000
T
crore. Calculate: (i) Investment expenditure at equilibrium level of income and (ii) Autonomous consumption. (3 marks)
Solution:
(i) Equilibrium level of income Y = `2,000 crore, Savings function S = –200 + 0.25Y
Savings at equilibrium level of income S = –200 + 0.25(2,000)
S = –200 + 500 = `300 crore
At equilibrium, planned savings and planned investment expenditure are equal. Therefore, investment
expenditure at equilibrium level of income I = `300 crore
(ii) From the Savings function S = –200 + 0.25Y, we get dissavings at zero income = `200 crore, which is equal to
autonomous consumption.
Therefore, autonomous consumption = `200 crore
Do it yourself 11
If in an economy Consumption function is given by C = 100 + 0.75 Y, and Autonomous investment is `150 crore.
Estimate (i) Equilibrium level of income and (ii) Consumption and Savings at the equilibrium level of income.
(3 marks)
[Ans. (i) `1,000 crore (ii) `150 crore]
Numerical 12
Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure (A) is
`50 crore, and MPC is 0.8 and level of income (Y) is `4000 crore. State whether the economy is in equilibrium or not
(cite reasons). (3 marks)
Solution: Sum of autonomous investment (I) and autonomous consumption (C) = A = `50 crore, MPC = b = 0.8 and
national income (Y) = `4,000 crore
Ex-ante aggregate demand, AD = C + I
AD = C + bY + I
AD = (C + I) + bY = A + bY
AD = 50 + 0.8 × 4,000 = `3,250 crore
Since AD (`3,250 crore) is less than National Income (Y = `4,000 crore), therefore, the economy is not equilibrium.
The economy is in equilibrium when AD = Y.
Do it yourself 12
In an economy the autonomous investment is `100 crore and the consumption is C = 80 + 0.4Y. Is the economy
in equilibrium at an income level `400 crore ? Justify your answer.
[Ans. No, equilibrium level of income = `300 crore]
Numerical 13
I n an economy the autonomous investment is `60 crore and the marginal propensity to consume is 0.8. If the
equilibrium level of income is `400 crore, then the autonomous consumption is `30 crore. True or False? Justify your
answer. (3 marks)
Solution: At equilibrium, Y = C + I (since at equilibrium AD = Y ⇒ C + I = Y)
Y = C + bY + I
400 = C + 0.8 × 400 + 60 (since Y = 400, MPC = b= 0.8 and I = 60)
400 = C + 320 + 60
C = 400 – 320 – 60 = 20
Autonomous consumption C = `20 crore
The given value of autonomous consumption (`30 crore) is incorrect.
Do it yourself 13
In an economy, C = 50 + 0.5Y is the consumption function, where C is consumption expenditure and Y is National
Income. If investment expenditure is 2,000, calculate:
(i) Equilibrium level of National Income
(ii) Consumption expenditure at equilibrium level of National Income.
(iii) Savings at equilibrium level of income (6 marks)
[Ans. (i) 4,100 (ii) 2,100 (iii) 2,000]
Numerical 14
From the data given below about an economy, calculate investment expenditure and consumption expenditure:
Equilibrium level of income = `5,000 crore
Autonomous consumption = `500 crore
Marginal propensity to consume = 0.4 (3 marks)
Solution: Equilibrium income Y = `5,000 crore, Autonomous consumption C = `500 crore, MPC = b = 0.4
Consumption expenditure C = C + bY
C = 500 + 0.4(5,000)
C = 500 + 2,000
C = `2,500 crore
At equilibrium income Y = C + I (since at equilibrium AD = Y ⇒ C + I = Y)
5000 = 2,500 + I
I = 5,000 – 2,500
I = 2,500
\ Investment expenditure I = `2,500 crore
Do it yourself 14
Calculate Investment expenditure from the following data about an economy which is in equilibrium:
National income = `1,000 crore
Marginal propensity to save = 0.25
Autonomous consumption expenditure = `200 crore (3 marks)
[Ans. `50 crore]
Numerical 15
n economy is in equilibrium. Calculate Marginal Propensity to Save from the following:

A
National Income = `1,000
Autonomous Consumption = `100
Investment Expenditure = `200 (4 marks)
Solution: At equilibrium, Y = C + I
Y = C + bY + I
1,000 = 100 + b(1,000) + 200
b (1,000) = 1,000 – 100 – 200 = 700
b = 700/1,000 = 0.7 = MPC
Therefore, MPS = 1 – MPC = 1 – 0.7 = 0.3
Do it yourself 15
An economy is in equilibrium. From the following data, calculate the marginal propensity to save:
(a) Income = 10,000
(b) Autonomous consumption = 500
(c) Consumption expenditure = 8,000 (4 marks)
[Ans. 0.25]
Numerical 16
Calculate Autonomous consumption expenditure from the following data about an economy which is in equilibrium:
National income = `1,200 crore
Marginal propensity to save = 0.20
Investment expenditure = `100 crore (3 marks)
Solution: Since MPS = 0.20, therefore, MPC = b = 1 – MPS = 1 – 0.20 = 0.80
Consumption function equation C = C + bY = C + 0.80Y
At equilibrium level of national income Y = C + I (since at equilibrium AD = Y ⇒ C + I = Y)
Y = C + 0.80Y + I
1,200 = C + 0.80 × 1,200 + 100 (since Y = 1200, I = 100)
1,200 = C + 960 + 100
C = 1,200 – 960 – 100 = 140
Autonomous consumption expenditure = `140 crore
Do it yourself 16
Calculate Marginal Propensity to Consume from the following:

Equilibrium income = `350 crore
Consumption expenditure at zero income = `20 crore
Investment = `50 crore (3 marks)
[ Ans. 0.8]
Numerical 17
I f in an economy savings function is given by S = (–) 50 + 0.2 Y and Y = `2,000 crore; consumption expenditure for
the economy would be `1650 crore and the autonomous investment is `350 crore and the marginal propensity to
consume is 0.8. True or False? Justify your answer with proper calculations. (3 marks)
Solution: Level of income Y = `2,000 crore
Savings S = –50 + 0.2Y
S = –50 + 0.2(2,000) = –50 + 400 = `350 crore
Consumption expenditure C = Y – S = 2,000 – 350 = `1,650 crore (Which is true.)
From the savings function equation S = (–) 50 + 0.2 Y, we have MPS = 0.2
Since MPC + MPS = 1, therefore, MPC = 1 – MPS = 1 – 0.2 = 0.8 (Which is true.)
At equilibrium level of income, Savings = Investment = `350 crore (Which is also true.)
Thus, all the given values are correct.
Do it yourself 17
I n an economy C = 200 + 0.5 Y is the consumption function where C is the consumption expenditure and Y is the
national income. Investment expenditure is `400 crore. Is the economy in equilibrium at an income level `1,500
crore? Justify your answer. (3 marks)
[Ans. No, the equilibrium level of income is `1,200 crore]
Numerical 18
The saving function of an economy is given as: S = – 250 + 0.25Y

If the planned investment is `2,000 crore, calculate the following:
(a) Equilibrium level of income in the economy.
(b) Aggregate demand at income of `5,000 crore. (CBSE 2019) (6 marks)
Solution: S = –250+ 0.25Y (Given)
(a) Equilibrium level of income in the economy exist when S = I
Substitute the values of saving and investment, we get
–250 + 0.25Y = 2,000
0.25Y = 2,000 + 250
0.25Y = 2,250
Y = 2,250/0.25
Equilibrium level of income Y = `9,000 crore
(b) C = Y – S = Y – (– 250 + 0.25Y)
C = 250 + 0.75Y
Given that Y = 5,000
C = 250 + 0.75 (5,000) = 250 + 3,750 = 4,000
AD = C + I = 4,000 + 2,000 = 6,000
Aggregate demand at income of `5,000 crore = `6,000 crore
Do it yourself 18
The saving function of an economy is given as: S = – 10 + 0.20Y

If the planned investment is `100 crore, calculate the following:
(a) Equilibrium level of income in the economy.
(b) Aggregate demand at income of `300 crore.
[Ans. (a) `550 crore (b) `350 crore]
Self Assessment Test 1
Determination and Income and Employment

Time allowed : 1 hour Maximum Marks : 25
Q.1 Average Propensity to Consume can never be ………………………... (choose the correct alternative) (1 mark)
(a) positive (b) zero
(c) more than one (d) less than one
Q.2 The monetary policy generally targets to ensure………….…… (Choose the correct alternative) (1 mark)
(a) price stability in the economy
(b) employment generation in the country.
(c) stable foreign relations.
(d) greater tax collections for the government.
Q.3 In an economy, break-even point and equilibrium point may lie at the same level of income, if ex-ante investments
are ………………… (Fill up the blank with correct answer) (1 mark)
Q.4 In an economy, MPC = 0.75. As a result of multiplier mechanism, national income increased by `300 crore
caused by an additional investment of .............. (1 mark)
Q.5 Calculate the value of Marginal Propensity to Consume (MPC), if in an economy, autonomous consumption
is `500 crore, ex-ante investments are `4000crore and equilibrium level of Income of the economy is
`18,000 crore. (3 marks)
Q.6 Suppose in a hypothetical economy, the savings increase by `20 crore when national income increases by `100
crore. Compute the additional investments needed to attain an increase in national income by `6,000 crore?
(3 marks)
Q.7 Giving valid reasons, state whether the following statements are true or false: (3 marks)
(a) Ex-post investment means fixed capital with production units during a particular period of time.
(b) Marginal propensity to consume represents the slope of the consumption function.
Q.8 Define inflationary gap. Show inflationary gap using a well-labelled diagram. Explain any one fiscal measure and
one monetary measure to correct the situation of inflationary gap. (6 marks)
Q.9 What is Effective Demand Principle? Discuss with the help of an imaginary numerical example. (6 marks)

Q.1 According to Keynesian Theory of employment, ex-ante savings and ex-post savings are always equal.
True/False? Give reason. (1 mark)
Q.2 In the Keynesian theory of employment, it is assumed that consumption changes at a constant rate as income
changes. It implies: (1 mark)
(a) Both MPC and MPS are constant
(b) Both the consumption and savings curves have constant slopes, and are linear curves.
(c) Aggregate demand curve is parallel to the consumption curve, i.e. they have the same slope (i.e., MPC).
Q.3 If change in investment is `1,000 crore and MPC is 0.8 then national income will change by (1 mark)
(a) `1,250 crore (b) `2,500 crore
(c) `5,000 crore (d) `10,000 crore
Q.4 An excess of aggregate demand over full employment level of aggregate supply represents a situation of inflationary
gap. (True/False) (1 mark)
Q.5 “An economy facing unintended accumulation of inventories would try to reduce aggregate demand.” Do you
agree with the given statement? Support your answer with valid reasons. (3 marks)
Q.6 Estimate the change in final income, if Marginal Propensity to Consume (MPC) is 0.75 and change in initial
investment is `2,000 crore. (3 marks)
Q.7 Giving valid reasons, state whether the following statements are true or false: (3 marks)
(a) An excess of aggregate demand over full employment level of aggregate supply represents a situation of
inflationary gap.
(b) If the ratio of Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) is 4 : 1, the
value of investment multiplier will be 4.
Q.8 Discuss the working of the adjustment mechanism in the following situation : (6 marks)
(a) Ex-Ante Aggregate demand is greater than Ex-Ante Aggregate supply.
(b) Ex-Ante/Planned Investments are lesser than Ex-Ante/Planned Savings.
Q.9 Draw a straight line consumption curve. From it derive a savings curve explaining the process. Show on this
diagram:
(a) the level of income at which average propensity to consume is equal to one.
(b) a level of income at which average propensity to save is negative.
(CBSE Sample Question Paper 2015) (6 marks)

Q.1 If MPS = 0.20 and investment is increased by `100 crore, then total increase in income will be: (1 mark)
Q.2 An economy is at full employment and AD is greater than AS, what will be the impact on price level in such an
economy? (1 mark)
(a) Rise (b) Fall
(c) no change (d) both rise and fall
Q.3 Which of the following is not true? (1 mark)
(a) APC can be more than 1 (b) APC can be equal to 1
(c) APC rises with increase in income (d) APC can never be 0
Q.4 Ex-post investment means fixed capital with production units during a particular period of time. True/False?
Give reason. (1 mark)
Q.5 Value of which of the following can be greater than one and why? (3 marks)
(a) Marginal Propensity to Consume (MPC)
(b) Average Propensity to Consume (APC)
Q.6 The consumption function of an economy is : C = 40 + 0.8Y (amount in `crore). Determine that level of
income where average propensity to consume will be one. (3 marks)
Q.7 State and discuss the components of Aggregate Demand in a two sector economy. (3 marks)
Q.8 The saving function of an economy is given as:
S = (–) 10 + 0.20Y
If the ex-ante investments are `240 crore, calculate the following:
(i) Equilibrium level of income in the economy.
(ii) Additional investments which will be needed to double the present level of equilibrium income. (6 marks)
Q.9 (a) Give the meaning of: (3 marks)
(i) Involuntary unemployment
(ii) Inflationary gap
(iii) Autonomous consumption
(b) Explain the role of margin requirements in dealing with the problem of excess demand. (3 marks)
National Income and Related Aggregates, Money and Banking

Time allowed : 1 hour 30 minutes Maximum Marks : 40
Q.1 If MPS = 0.30, Autonomous Consumption = `50 crore and Investment = `100 crore, then Equilibrium level of
Income will be: (1 mark)
(a) `500 crore (b) `150 crore (c) `300 crore (d) `45 crore
Q.2 Value of MPC can be greater than one. True/False? Give reason. (1 mark)
Q.3 ________ refers to that level of output where ex-ante aggregate demand is equal to ex-ante aggregate supply.
(Aggregate demand/Effective demand) (1 mark)
Q.4 For a bank, the main liability is ___________. (1 mark)
Q.5 What will be the value of money multiplier if LRR is 10%? (1 mark)
Q.6 Wages received by an Indian working in the British Embassy in India will be included in Gross Domestic Product
(GDP) of India. True/False? Give reason. (1 mark)
Q.7 Net value added at factor cost (NVAfc) = `100 crore, Depreciation = `30 crore, Subsidies = `15 crore and
Intermediate Consumption = `185 crore, then “Gross value of output” is: (1 mark)
Q.8 National income and money creation are examples of stock concept. True/False? (1 mark)
Q.9 In an economy planned saving is greater than planned investment. Explain how the economy achieves equilibrium
level of national income. (3 marks)
Q.10 How will you treat the following in the calculation of Gross Domestic Product of India? Give reasons for your answer.
(i) Profits earned by a branch of foreign bank in India. (3 marks)
(ii) Salaries of Indian employees working in embassy of Japan in India.
(iii) Salary of resident of Japan working in Indian embassy in Japan.
Q.11 Explain ‘Government’s Bank’ function of central bank. (4 marks)
Q.12 Explain any two quantitative methods of credit control used by Central bank. (4 marks)
Q.13 From the following data relating to a firm: (a) Estimate the net value added at market prices (b) Show that net
value added at factor cost is equal to the sum of factor incomes. (6 marks)
(i) Purchase of raw materials and other inputs from the domestic market 600
(ii) Increase in stocks 200
(iii) Domestic sales 1800
(iv) Imports of raw materials 100
(v) Exports 200
(vi) Depreciation 75
(vii) Salaries and wages 600
(viii) Interest payments 450
(ix) Rent 75
(x) Dividends 150
(xi) Undistributed profits 80
(xii) Corporate profit tax 20
(xiii) Indirect taxes 50
Q.14 What is meant by inflationary gap? Show it on a diagram. Explain three measures to reduce this gap. (6 marks)
Q.15 The saving function of an economy is given as: S = (–) 50 + 0.10 Y
If the ex-ante Investments are `450 crore, calculate the following : (i) Equilibrium level of income in the economy.
(ii) Additional investments which will be needed to gain an additional income level of `3,000 crore. (6 marks)
National Income and Related Aggregates, Money and Banking

Time allowed : 1 hour 30 minutes Maximum Marks : 40
Q.1 If consumption function of an economy is given by C = 100 + 0.80Y and autonomous investment expenditure is
`300 crore, then equilibrium level of income will be: (1 mark)
Q.2 Value of APC can be greater than one. True/ False? Give reason. (1 mark)
Q.3 __________ refers to a situation when a person who is willing and able to work at the prevailing wage rate, does
not work. (1 mark)
Q.4 Assets of a commercial bank include loans advanced by them to be public and ___________. (1 mark)
Q.5 An increase in Legal Reserve Deposit Ratio increases the credit creation power of the commercial banks (banking
system). True/False? Give reason. (1 mark)
Q.6 Financial aids received from abroad after “Fani cyclone” is not included in National Income. True/False? Give
reason. (1 mark)
Q.7 Goods which are not bought for meeting immediate needs of the consumers but are producing other goods are
called _____________. (1 mark)
Q.8 Match the following : (1 mark)
(a) Value addition (i) Value of all final goods and services produced in an economy during
(b) Income from property and an accounting year
entrepreneurship intermediate (ii) Excess of value of output over the value of consumption
(iii) Operating surplus
(iv) Wages, profits and rent
Q.9 State the meaning of: (a) Ex-Ante Savings (b) Full employment (c) Autonomous Consumption (3 marks)
Q.10 Explain how “non-monetary exchanges” are a limitation of the Gross Domestic Product (GDP) as an indicator
of welfare. (3 marks)
Q.11 How will ‘Reverse Repo Rate’ and ‘Open Market Operations’ control excess money supply in an economy? (4 marks)
Q.12 Explain the following functions of the Central Bank: (4 marks)
(i) Bank of issue (ii) Bankers’ bank
Q.13 (a) Distinguish between stocks and flows. Give an example of each. (2 marks)
(b) Calculate Gross National Product at factor cost from the following data. (4 marks)
S. No. Items (`in crore)
(i) Net domestic fixed capital formation 310
(ii) Closing stock 100
(iii) Government final consumption expenditure 200
(iv) Net indirect taxes 50
(v) Opening stock 60
(vi) Consumption of fixed capital 50
(vii) Net exports (–)10
(viii) Private final consumption expenditure 1500
(ix) Imports 20
(x) Net factor income from abroad (–)10
Q.14 How an initial increase in investment affects the level of final income of the economy. Show its working with a
suitable numerical example. (6 marks)
Q.15 (a) If marginal propensity to consume is 80% and is constant at all levels of income, and the autonomous
consumption is `400 crore, construct consumption function of the given hypothetical economy. (3 marks)
(b) Estimate the change in initial investment, if Marginal Propensity to Save (MPS) is 0.10 and change in final
income is `15,000 crore. (3 marks)
Check List to Objective Type Questions
Objective Type Questions 3.1 is positive. Also, when income decreases (DY is negative),
1. (a) savings also decreases (DS is negative); so MPS is positive.
2. True: APC = C/Y and APC will be zero if consumption 4. False: Average propensity to save can be negative at a level
(C) is zero which is not possible. Even if income is zero, when there is dissavings, i.e. when total consumption is
there is some consumption expenditure to survive (called greater than national income, due to the existence of
autonomous consumption). autonomous consumption.
3. True, average propensity to consume can be greater than one, 5. (d) Ex-post savings
when total consumption in an economy is greater than national 6. (d) APS
income due to the existence of autonomous consumption. 7. (c) S = –100 + 0.25 Y
Households will either sell the assets acquired in the past or will 8. (c) 0.60
borrow to meet extra consumption expenditure. 9. False: Sum of APC and APS is equal to 1 and Sum of
4. Autonomous consumption; this level of consumption is MPC and MPS is equal to 1.
independent of income. 10. False: Since APC + APS = 1, therefore, APS = 1 – APC =
5. False: MPC = DC/DY. When income changes, change in 1 – 1.2 = –0.2. Thus, APS will be negative.
consumption (DC) can never exceed the change in income 11. True: When the consumption function lies below the
(DY). 45° lines, the level of consumption is less than the level
The maximum value of MPC can be one (MPC = 1) of income. This means that there is positive savings.
when the consumers use entire change in income on Since APS = S/Y and S is positive, therefore, APS will be
consumption (i.e. DC = DY). positive.
6. (c) 12. True: Average propensity to save (APS = S/Y) can never
7. (c) Both (a) and (b) be greater than 1 as savings (S) can never be more than
8. (a) Greater than one income (Y).
9. False: APC can never be zero because even at zero income, 13. True: Because at this point (called Break-even point),
some consumption still takes place, called autonomous consumption is equal to income and hence, saving is zero.
consumption. Therefore, APS = S/Y = 0/Y = 0
10. ex-ante 14. (b) APC
11. ex-ante 15. 0 to 1
12. A consumption function 16. (i) MPS (ii) 1 – MPC or DS/DY
13. autonomous consumption 17. increases
14. autonomous consumption 18. decreases
15. a ; bY 19. Average Propensity to Save (APS)
16. 1 (one); the consumers use entire change in income on 20. the market rate of interest
consumption. 21. Autonomous (or exogenous) investment (which means, it
17. 0 (zero) ; consumers do not increase consumption as is the same no matter whatever is the level of income)
income increases. 22. (b) –200
18. (b) from 0 to 1 23. (c) consumption is positive when income is zero
19. (d) 0 < MPC < 1 24. (b) S = 0
20. (b) positive 25. (a) a horizontal straight line.
21. (c) MPC 26. (c) 0
22. (b) `50 crore 27. (c) APC falls APS rises with increase in national income
23. False: APC is equal to 1 when total consumption (C) is 28. (c) `600 crore
equal to total income (Y) corresponding to the break even 29. False: As ex-post investment includes both fixed as well as
point. inventory investment with the production units during a
period of time.
1. (a) 0.4
2. False: APS = S/Y. At low levels of income, consumption 1. (d) Both (a) and (b)
(C) exceeds income (Y). So, saving (S) is negative. 2. (a) National Income
Therefore, APS is negative. Also, when C = Y, S = 0. Then 3. Decline in MPC, i.e. slope of the AD curves decreases.
APS = 0. Thus, APS can be zero or negative. 4. consumption curve; slope, i.e. MPC
3. True: MPS = DS/DY. When income increases (DY is 5. (d) Both (b) and (c)
positive), savings also increases (DS is positive); so MPS
Objective Type Questions 3.4 Objective Type Questions 3.6

1. (c) Point above the origin 1. (d) none of the above
2. (b) C + I 2. (a) Decrease in bank rate
3. (c) 3. (b) Increase in government expenditure
4. (d) an unplanned inventories decumulation 4. (a) Fall in Aggregate Demand
5. (a) National income is likely to fall 5. (c) Inflationary gap
6. (a) fall 6. (a) Deficient Demand
7. (d) All of the above 7. (c) No change in the level of employment
8. (d) All of the above 8. (d) Both (a) and (b)
9. (b) Central Bank
Objective Type Questions 3.5 10. (b) Increases
1. (d) Infinity 11. True: The bank rate is the rate of interest at which the
2. (b) 1 Central Bank lends money to the commercial banks.
3. (b) Infinity, one During inflation, the Central bank increases the bank
4. True: Since production capacity will increase with rise rate, which increases the cost of borrowings from the
investment, therefore national income will rise multiplier Central bank. Therefore, commercial banks also increase
times the initial rise in investment. their lending rates. This will discourage people to take
5. 4 loans. This will reduce the money supply and the level of
6. False: Investment multiplier, k = 1/(1–MPC) aggregate demand in the economy to combat inflation.
Since 0 < MPC < 1, therefore, value of multiplier ranges 12. False: In situation of deficient demand, the Central bank
between 1 and ∞. decreases the cash reserve ratio (CRR). As a result,banks
7. False: Value of investment multiplier, k = 1/(1–MPC) are required to hold smaller fraction of their deposits as
When MPC = 0, k = 1/(1 – 0) = 1/1 = 1 cash reserves with the central bank. Therefore, the lending
8. Investment multiplier capacity of the banks increases. It leads to an increase in
9. (c) 2.5 money supply. This will raise the level of aggregate demand
10. True: Investment multiplier, k = 1/(1 – MPC) Since 0 < and correct the situation of deficient demand.
MPC < 1, the value of multiplier will be greater than 1 (k > 13. (b) Decrease in output, income, employment and price
1). Therefore, a change in investment will cause a multiple level.
change in income. Hence, a decrease in investment will 14. excess demand
cause national income to decrease at least by an amount 15. False: The equilibrium level of output determined by the
equal to decrease in investment. equality of Y and AD does not necessarily signify the full
11. True: When MPS = 1, k = 1/MPS = 1/1 = 1 employment level of output. The equilibrium level of
k = DY/DI = 1 output may be greater than the full employment level of
DY = DI output (the situation of excess demand) or less than the
Thus, change in national income will be exactly equal to full employment level of output (the situation of deficient
change in investment. demand).
12. False: MPC = 2MPS ; 16. (c) Rise in the price level and the nominal income but no
MPC + MPS = 1 ⇒ 2MPS + MPS =1 change in the output and employment.
⇒ 3MPS = 1 ⇒ MPS = 1/3 Reason: Since the economy is already working at the
Value of investment multiplier, k = 1/MPS = 3 full employment, there is no further scope of creation of
13. True: Equality between MPC and MPS signifies that both employment. So there is no change in the employment
of them are equal to 0.5 (as MPC + MPS = 1). Therefore, and hence, the output (real income).
value of investment multiplier (k) = 1/MPS = 1/0.5 = 2. However, excess demand gives rise to an inflationary gap;
It means that increase in income in the economy will be which causes a rise in the price level or inflation (demand
twice the initial increase in investment. pull inflation—an aggregate demand induced rise in the
14. True: k = 1/(1 – MPC) price level).
Since k = 1, therefore, 1 = 1/(1 – MPC) Nominal income increases due to rise in the price level.
1 – MPC = 1 17. Full employment level of income
MPC = 0 18. involuntary unemployment
15. MPC; since k = 1/(1 – MPC) 19. deficient demand
16. True: Because the size of the multiplier (k) depends on the 20. decreased
value of MPC as k = 1/(1 – MPC).
There is a direct/positive relation between MPC and value
of multiplier. Thus, as MPC rises, the value of multiplier
increases.
Preparing for Examinations and Sample Papers 253
Preparing for Examinations

The aim of this guide is to help you prepare for your examinations by:
 informing you about the various skills and abilities that are assessed in the CBSE Economics XII examinations.
 helping you with a few tips on how to plan your preparation for examinations in an effective way.
 telling you why some students do not succeed or perform to their true ability in the CBSE examinations.
 making you feel confident in tackling CBSE examination questions and knowing what examiners expect when
marking your script.
FORMULAE – National Income Accounting and Keynesian Theory of Income and Employment
DIAGRAMS AND SCHEDULES – Keynesian Theory of Income and Employment
Important tips for attempting CBSE Economics XII Examination
CBSE Sample Question Paper 2020 with Solutions through Author’s Pen
25 Sample Question Papers (based on new sample question paper design of CBSE)
You can help yourself greatly in preparing for the final CBSE Economics XII Examination by following some important
steps. No one likes examinations but there is no need to be afraid of them if you prepare yourself well. The seeds for
success are sown long before you enter the examination room. The key thing is to be prepared. It is worth remembering:
‘If you fail to prepare, you are preparing to fail.’
Why not put this on your wall? But if you do, remember to practice what it says.
A few hints on how to study effectively

 Read through your book on a daily basis and feel confident that you have understood the main subject
content. When reading, underline or highlight the key points. They make notes on what you have read.
Writing and working in this way greatly enhances your understanding of a topic.
Tick off each topic (from the syllabus given at the start of each unit) as you revise and understand it.
When you have completed a chapter, Attempt ‘Self-Assessment Tests’—ideally without referring to the
book—so as to evaluate the understanding of concepts of the chapter.
 Revision is not something that is only confined to the last week or so before an examination. So:
‘make study a habit; make revision a habit.’
 Managing your time in an effective way is crucial. Remember:
‘it is not how much time you have but how you manage it.’
There should be regular periods in the week when you have spare blocks of time that you can devote to
studying Economics. Even if it is only 1 hour, if this is spent effectively, it will be of much value to you.
Remember:
‘it is not so much how long you study but how effective you are in your studying.’
 You should also try to have set places where you can study, ideally free from distractions such as loud
music, talking, television noise and so on. This may not be easy but try to have set times and places for
your study and stick to a routine. Put yourself in a position where you can concentrate on your study.
This is most unlikely to happen if your favourite television programme is on in the same room.
 Short sessions, but lots of them. Psychological studies have shown that our learning abilities decline
sharply after around 50 minutes of intensive study. The attention span of most people is 40-60 minutes.
After such a period, have a drink and a rest, may be do something else before studying for a further
period. Be as detailed as possible in your timetable; for example:
‘Saturday–revise Money and Banking is not detailed enough. Better to lay out your timetable like this:
Saturday: 9.00 am to 9.40 am – Money: its meaning, and supply of money.
Break – 10 minutes
9.50 am to 10.50 am – Money creation by the commercial banking system.
Break – 20 minutes
11.10 am to 12.10 pm – Central bank and its functions (Bank of issue, Government’s bank,
Banker’s bank)
12.10 pm – lunch and rest
1:30 pm to 2:30 pm – Central bank as controller of credit through Bank Rate, CRR, SLR,
Repo Rate and Reverse Repo Rate, Open Market Operations, Margin
requirement.
All of these simple things should help you feel relaxed and confident when you take the examinations.
FORMULAE – National Income Accounting

 Basic Concepts
• Net Investment = Gross investment – Depreciation
Cost of the capital asset − Scrap value
• Depreciation on capital =
Estimated life of the capital asset (in years)
• Net indirect tax = Indirect taxes – Subsidies
• Factor cost = Market price – Indirect taxes + Subsidies
• Net change (or increase) in inventories = Closing inventory – Opening inventory

• Net Factor Income from Abroad (NFIA) = Factor Income from Abroad – Factor Income to Abroad
 National income by product method

• Value added of a firm = Value of output produced by the firm – Cost of intermediate goods used
• Value of output = Output produced (in units) × Market price
• Sales = Output sold (in units) × Market price
Sales = Sale of goods and services to domestic buyers + Exports of goods and services.
• If a firm had no initial unsold stock in the beginning of the year:
Value of output produced = Sales + Value of unsold stock
• If a firm had some unsold stock in the beginning of the year
Value of output = Sales + Net change in stock
• GVAmp of a firm = Value of output – Intermediate consumption
• If we sum the GVAmp of all the firms in all the sectors of the economy, we get Gross Domestic
Product at market price (GDPmp).
GDPmp = Value of output of all the firms in the economy – Intermediate costs
• NDPfc = GDPmp – Depreciation – Indirect taxes + Subsidies
• National income (NNPfc) = NDPfc + NFIA
 Other Basic National Income Aggregates
• NDPmp = GDPmp – Depreciation
• GNPmp = GDPmp + Net factor income from abroad (NFIA)
• NNPmp = GDPmp – Depreciation + NFIA
• GDPfc = GDPmp – Net indirect taxes
• GNPfc = GDPmp – Net Indirect taxes + NFIA
 National income by income method

• Compensation of employees = Wages and salaries in cash and in kind
+ Social security contributions by the employers
• Profits = Corporation tax + Dividend + Undistributed profits/Retained earnings
or, Profits = Corporate profit tax + After-tax profit
(Note: After-tax profit = Dividend + Retained earnings)
• Operating surplus = Rent and royalty + Profit + Interest
• National Income (NNPfc) = Compensation of employees + Operating surplus + Mixed income + NFIA
 Expenditure Method of Calculating National Income
• GDCF = Gross domestic fixed capital formation + Net change in stocks
or, GDCF = (Net fixed capital formation + Depreciation) + (Closing Stock – Opening Stock)
• GDPmp = Private final consumption expenditure + Government final consumption expenditure
+ Gross domestic capital formation + Net exports
• National Income (NNPfc) = GDPmp – Depreciation – Indirect taxes + Subsidies + NFIA
 Real and Nominal GDP
• Nominal GDP = ΣP1Q1 and Real GDP = ΣP0Q1
Nominal GDP
• GDP Deflator = × 100
Real GDP
No min al GDP
• Real GDP = ¥ 100
Price Index
∆ in real GDP 500
• Percentage Change in Real GDP = × 100 = × 100 = 10%
Base year real GDP 5000
∆ in nominal GDP 1050
• Percentage Change in Nominal GDP = × 100 = × 100 = 21%
Base year nominal GDP 5000
 Real and Nominal National Income
• Nominal National Income = ΣP1Q1 and Real National Income = ΣP0Q1
Nominal national income
• Real national income = × 100
Price Index
FORMULAE – Keynesian Theory of Income and Employment

 Consumption function:
C = C + bY
where, C = Consumption expenditure by households
Y = National Income = C + S (where S = Savings)
C = Autonomous consumption (i.e. consumption expenditure at zero income)
b = Slope of consumption function = Marginal Propensity to Consume (MPC) = DC/DY
• DC + DS = DY
• C = C + bY consists of the two components:
(ii) Induced consumption ( bY )
• Average Propensity to Consume (APC) = C/Y

• At Break-even point: C = Y
 Savings Function
S = Y – C ⇒ S = Y – (C + bY) ⇒ S = Y – C – bY ⇒ S = – C + (1 – b)Y
⇒ S = – C + sY
There is negative savings C at zero level of income. It is equal to autonomous consumption .
s = (1 – b) is the slope of the savings function = Marginal Propensity to Save (MPS) =DS/DY
• Relationship between MPC and MPS: MPC + MPS = 1
• Average propensity to save (APS) = S/Y
• Relationship between APC and APS: APC + APS = 1.
Therefore, APS = 1 – APC and APC = 1 – APS
 Aggregate Demand
AD = C + I
Substituting the values of C = C + bY and I = I, ex-ante aggregate demand for final goods can be written as:
AD = C + bY + I ⇒ AD = ( C + I ) + bY ⇒ AD = A + bY
where, A = C + I is the total autonomous expenditure.
Note that the slope of aggregate demand function AD = A + bY is given by ‘b’, i.e. MPC.
 Aggregate Supply
Aggregate Supply (AS) = National Income (Y) = C + S
 Equilibrium level of income/output Condition (also called ‘effective demand principle’)
AD = AS
Since AS = Y and AD = C + I, therefore equilibrium condition is: Y = C + I
Savings and Investment Approach – Equilibrium condition: S = I
 Investment Multiplier
∆Y
Investment Multiplier, k =
∆I
∆Y ∆Y
Since DA = DI, therefore=
k =
∆I ∆A
1
Investment Multiplier, k =
1 − MPC
1
Since 1 – MPC = MPS, therefore, value of investment multiplier is: k =
MPS
 Deflationary gap and Inflationary gap

Deflationary gap = Full employment level of income – Actual aggregate demand
Inflationary gap = Actual aggregate demand – Full employment level of income
DIAGRAMS – Keynesian Theory of Income and Employment

Diagrams are very important and a relevant means of economic explanation. Many of the topics you come
across in Economics can be illustrated by a diagram or by means of an explanation supported by a diagram. So,
a relevant, correctly drawn diagram, used effectively and referred to in your answer, will impress an examiner
reading your examination script.
Common errors which students often make is in the way they use diagrams in their answers:
 Labeling axis incorrectly or not labeling them at all or making diagrams to small.
 Failure to use a diagram in an answer when asked for one to be included

Suppose a question is: “Explain the determination of equilibrium level of national income with the help of
saving and investment curves.”
Here, a student has to make clear the determination of equilibrium level of national income by saving
and investment approach supported by a diagram.
 Including a diagram when one is not needed
Suppose a question is: “Explain ‘deflationary gap’. Also explain how the bank rate policy of the central
bank helps to correct deflationary gap in an economy.”
Here, a student has to give detailed explanation of the deflationary gap, i.e., its meaning, cause and
effects. Then, an explanation how bank rate policy of the central bank helps to combat deflationary gap.
Diagram is not required.
Include a diagram only when asked for one to be included.
Important Diagrams which are likely to be asked in CBSE Economics XII Examination:
Consumption and savings curves Equilibrium level of income/output

Deficient Demand and Deflationary Gap Excess Demand and Inflationary Gap
Effective Demand Principle – Numerical Example

Determination of Equilibrium Income or Output (C = 100, MPC = 0.8 and I = 300)
Income Consumption Savings Investments Aggregate Demand Aggregate Supply
(Y) (C) (S = Y –C) (I) (AD = C + I) (AS = Y)
0 100 –100 < 300 400 > 0
1000 900 100 < 300 1200 > 1000
2000 1700 300 = 300 2000 = 2000
3000 2500 500 > 300 2800 < 3000
4000 3300 700 > 300 3600 < 4000
Important Tips for Attempting CBSE Economics XII Examination

 During 15 minutes Reading Time, read all questions carefully. Select the Option to be answered in questions
having internal choice. When reading, underline the key lines with pencil which help you to write answers. Do
calculations for all Numerical Questions during the reading time.
 Timing is an essential ingredient of success. Attempting the full paper on time with at least 20 minutes Revision
Time in hand to check calculations is necessary to score 100% marks in Economics Paper. Economics paper is worth
80 marks and must be completed in 180 minutes. Allowing 20 minutes revision time, this leaves 160 minutes or
2 minutes per mark. So, do not spend 10 minutes on a question worth just 3 marks! Do not exceed the time you
have allocated for each question.
The following Time Schedule will help you managing your time when sitting the examination hall.
For Macroeconomics
Types of Questions Marks Word limit Number of Total Marks Estimated
Questions Time
OTQs/MCQs 1 One word to a sentence 10 10 10 min.
SA-I 3 60-80 words 2 6 10 min.
SA-II 4 80-100 words 3 12 30 min.
LA 6 100-150 words 2 12 30 min.
20 Minutes – Revision
Total 17 40 90 min.
 The following table shows a list of key directive words which are most likely to occur in CBSE Economics
examination questions. You should read these carefully and understand what each means.
Directive Words The examine is supposed to:

Name/Identify/Which Write the name of the concept/term only
Define Give the exact meaning
State Make clear
Explain Give clear reasons
Describe Give a description of
Illustrate Give example/diagram
Discuss Give the important arguments, for and against
Comment Give your reasoned opinions on
Calculate/Compute Work out using the information provided
Defend/Refute Write whether given statement is correct/incorrect
 To score 100% marks, the presentation of answers is as much important as their content.
 Don’t forget to write Question Number you are answering.
 Answer each question from new page (except 1 mark questions)
 Give answer in points, as far as possible, rather than in paragraphs.
 Leave one line space between two headings
 Leave at least 2-3 lines space between two answers of 1 mark questions.
 Step by Step Calculation is always appreciable by the examiner.
 Write the main heading in capital letters. (Use dark and bold pen like Pilot V10)
 Underline the headings with pencil.
 Explanation/description from next line of heading.
 Use bullets while giving explanation.
 Attempt all parts of a question together.
 Write impersonally. In other words, do not use ‘I’ or ‘We’ in your answers. For example, do not write — “I
don’t agree with the statement.” Rather you must write — “The given statement is not correct.”
 Take care with sentences and punctuation. In general, try to write short sentences.
 During last 25 minutes of revision, first of all make sure that you have attempted all the questions and written
Question Number for each answer. If any question(s) left, attempt it first. Don’t leave it even if you don’t know the
proper answer. Remember that writing something is always better than leaving it at all. Then check the calculations
in Numerical Questions one by one. Then, read your answers one by one underlining the key lines using pencil.
 Economics Paper requires a relaxed mind to attempt the Numerical Questions/Applying or Creating or Analysing
based Questions. ‘Study the whole night before the exam.’ is the major cause of under-performance in Economics
Paper. Successful students always have given proper rest to their mental faculty so as to do all calculations correctly
and to attempt Numerical Questions/Applying or Creating or Analysing based Questions when sitting the
Examination Hall.
In my teaching career, I’ve seen even good students making calculations as 2 × 3 = 5 or 1/0.2 = 2 who ultimately
score 70 or 80 per cent only, just because they had spent the whole night revising the whole syllabus and solving
numerical questions.
To conclude, it is very important for you to be well-organised and to be able to plan ahead if you are to score 100% marks
in CBSE Economics examination. Revision should be an ongoing process, not just a last-minute activity you carry out just
before a written examination. A lack of time and an inability to understand the relevance of directive words are the most
common causes of under performance.
I know Board examinations create a lot of anxiety among students. Everyone expects good performance so as to get
admission in a college of repute. My advice to you is:
To work hard and give your 100%.
emember: Success will never lower its standard to accommodate you. You have to raise your standard to achieve it. For
R
every bird, God provides food but not in their nest.
Always believe in yourself. Don’t give up.
One thing keep in mind: You are something! Because God does not create garbage.
Always remember God.
ithout Him, your all efforts are in vain! 0 0 0 0 0 0 0 = 0. But if you put 1 before these zeros, you get 1 crore (10000000).
W
We human beings are zeros without Him! And 1 is God!
I’ll feel pleasure to solve any of your queries/doubts related to the subject through my social media handles.
Phone/Whatsapp Number 9810475716

Facebook: Subhash Dey’s Shree Radhey Publications & Academy: https://www.facebook.com/Subhash-Deys-Shree-
Radhey-Publications-Academy-537031643452290/
Instagram: subhashdey_20: https://www.instagram.com/subhashdey_20/
Email: subhashdey200881@gmail.com
Mobile App: Shree Radhey Publications: https://play.google.com/store/apps/details?id=com.
shreeradheypublications&hl=en
Finally I pray the Supreme Divine to bestow the best of blessings on you!
Regards
Your servant
SUBHASH DEY
B.Com. (Hons.), M.Com. (DSE), M.A. (Economics), PGDBA (Finance), B.Ed, PGD in Labour and Administrative Laws
• Author and Publisher of CBSE Books – Accountancy, Business Studies, Economics, Mathematics and English
• M.Com (Delhi School of Economics)– Gold Medalist, Topper of Delhi University
• Consecutive four years’ Economics topper of Delhi University
• Ex-Lecturer of Commerce in Hindu College, Delhi University
• Resource Person and Educationist conducting Workshops/Seminars of Teachers and Students
• Founder/Director of ‘Shree Radhey Academy, The Gurukul’ (C-3/6 Yamuna Vihar, Delhi-53)
Sample Question Papers
CBSE Question Paper Design

Economics XII (Code No. 030)
Marks: 80 Duration: 3 hrs.
Objective Short Short Long
Type/ MCQ Answer I Answer II Answer
S. No. Typology of Questions Marks
1 Mark 3 Marks 4 Marks I
6 Marks
1. Remembering
Exhibit memory of previously learned material 5 1 2 1 22
by recalling facts, terms, basic concepts, and
answers.
2. Understanding
Demonstrate understanding of facts and
ideas by organizing, comparing, translating, 5 1 2 1 22
interpreting, giving descriptions, and stating
main ideas
3. Applying
Solve problems to new situations by applying 5 1 1 1 18
acquired knowledge, facts, techniques and rules
in a different way.
4. Analysing and Evaluating
Examine and break information into parts by
identifying motives or causes. Make inferences
and find evidence to support generalizations.
Present and defend opinions by making
judgments about information, validity of ideas, 5 1 1 1 18
or quality of work based on a set of criteria.
Creating
Compile information together in a different
way by combining elements in a new
pattern or proposing alternative solutions.
TOTAL 20x1=20 4x3=12 6x4=24 4x6=24 80 (32)
There will be Internal Choices in questions of 1 mark, 3 marks, 4 marks and 6 marks in both sections (A & B). In all,
total 8 internal choices.
Sample Question Paper - 1

(CBSE Sample Question Paper 2020)
General Instructions:
i. All the questions are compulsory. Marks for questions are indicated against each question.
ii. Question number 1 - 10 are very short-answer questions carrying 1 mark each to be answered in one word or one sentence each.
iii. Question number 11-12 are short-answer questions carrying 3 marks each. Answers to them should not normally exceed 60-80 words each.
iv. Question number 13-15 are also short-answer questions carrying 4 marks each. Answers to them should not exceed 80-100 words each.
v. Question number 16 - 17 are long answer questions carrying 6 marks each. Answers to them should not exceed 100-150 words each.
vi. Answer should be brief and to the point and the above word limit be adhered to as far as possible.
Section - A (Macroeconomics)
Q.1 Value of Money Multiplier ___________ (increases/decreases/remains unchanged) with an increase in Cash
Reserve Ratio. (Fill up the blank with correct option) (1)
Q.2 Define an intermediate good. (1)
Q.3 Average Propensity to Consume can never be _____. (Choose the correct alternative) (1)
(a) positive (b) zero
(c) more than one (d) less than one
Q.4 Name any two quantitative tools to control credit creation in an economy. (1)
OR
What are demand deposits? (1)
Q.5 The monetary policy generally targets to ensure ____. (Choose the correct alternative) (1)
(a) price stability in the economy (b) employment generation in the country
(c) stable foreign relations (d) greater tax collections for the government
Q.6 In an economy, break-even point and equilibrium point may lie at the same level of income, if ex-ante investments
are ___________. (Fill up the blank with correct answer) (1)
Q.7 State whether the given statement is true or false:
‘Managed Floating Exchange Rate is decided by market forces but remains within a specific range as decided by
central bank’. (1)
Q.8 The formula to calculate Primary deficit is _______. (Fill up the blank) (1)
Q.9 From the set of statements given in Column I and Column II, choose the correct pair of statements: (1)
Column I Column II
(a) Export of software to France (i) Debit side of current account
(b) Import of Machinery from China (ii) Capital Account of Balance of Payments
(c) Remittances to relative staying abroad (iii) Debit side of Current Account of Balance of Payments
(d) Investment by Apple phones firm in India (iv) Credit side of Current Account of Balance of Payments
Q.10 Government expenditure on Mid-Day Meal scheme running in government (state run) schools is a type of
_____________ expenditure in government budget. (Fill up the blank with correct answer) (1)
Q.11 “India’s GDP is expected to expand 7.5% in 2019‑20: World Bank” - The Economic Times. Does the given
statement mean that welfare of people of India increase at the same rate? Comment with reason. (3)
Q.12 Calculate the value of Marginal Propensity to Consume, if in an economy, autonomous consumption is `500 crore,
ex-ante investments are `4000 crore and equilibrium level of Income of the economy is `18,000 crore. (3)
OR
Suppose in a hypothetical economy, the savings increase by `20 crore when national income increases by `100
crore. Compute the additional investments needed to attain an increase in national income by `6,000 crore. (3)
Q.13 Discuss any one of the following functions of a central bank:
(a) As government’s bank
(b) Open market operations. (4)
Q.14 “Foreign Institutional Investors (FIIs) remained net seller in the Indian capital markets over the last few weeks”.
–The Economic Times.
State and discuss the likely effects of the given statement on foreign exchange rate with reference to the Indian
Economy. (4)
OR
“Many large Multinational Corporations (MNCs) have recently shifted their investments from China and have started
their production in India, thereby boosting the Make in India plans of the Government.”
Presuming other factors being constant, discuss the effects of the given statement on Foreign Exchange rates with
reference to the Indian Economy. (4)
Q.15 Elaborate the objective of ‘reallocation of resources’ in the government budget. (4)
Q.16 (a) “Real Gross Domestic Product is a better indicator of economic growth than Nominal Gross Domestic Product.”
Do you agree with the given statement? Support your answer with a suitable numerical example. (4)
(b) Calculate ‘Depreciation on Capital Asset’: (2)
S. No. Particulars Amount (` crore)
i. Capital value of the asset 1,000
ii. Estimated life of the asset 20 years
iii. Scrap Value Nil
OR
(a) “Circular flow of income in a two sector economy is based on the axiom that one’s expenditure is other’s income.”
Do you agree with the given statement? Support your answer with valid reasons. (3)
(b) Calculate compensation of employees from the following data: (3)
S. No. Particulars Amount (` crore)
i. Profits after tax 20
ii. Interest 45
iii. Gross Domestic Product at Market Price 200
iv. Goods and Services Tax 10
v. Consumption of Fixed Capital 50
vi. Rent 25
vii. Corporate Tax 5
Q.17 “An economy is operating at under-employment level of income.” What is meant by the given statement? Discuss one
fiscal measure and one monetary measure to tackle the situation. (6)
ANSWERS
(through Author’s Pen)




SOLUTIONS
(through Author’s Pen)

(Expected Questions for CBSE Economics XII Examination)
Q.1 Give any two examples of flow concept. (1)
Q.2 The Central Bank holds surplus cash reserves of the commercial banks. It also lends to commercial banks when
they are in need of funds. This is called __________ function of the Central Bank. (1)
OR
Demand deposits created by the commercial banks are called _____________ . (1)
(a) High powered money (b) Money
(c) Bank money (d) Time deposits
Q.3 __________ is the main source of money in an economy. (1)
(a) Central bank of the economy (b) Commercial banking system
(c) Both (a) and (b) (d) Government
Q.4 Suppose in a hypothetical economy, the income rises from `5,000 crores to `6,000 crores. As a result, the
consumption expenditure rises from ` 4,000 crores to ` 4,600 crores. Marginal propensity to consume in such a
case would be _______. (1)
(a) 0.8 (b) 0.4
(c) 0.2 (d) 0.6
Q.5 In which one of the following situation, there will be unplanned increase in inventory of unsold goods? (1)
(a) AD > AS (b) AD = AS
(c) AD < AS (d) None of these
Q.6 The savings function of an economy is given as: S = –10 + 0.20Y. If the planned investment is `100 crore, the
equilibrium level of income in the economy will be__________ . (1)
Q.7 _______ is a compulsory payment made by the individuals and the firms to the government. (1)
Q.8 The primary deficit is the difference between___________ . (1)
Q.9 Which of the following will be entered as a Credit in the Balance of Payments of a country? (Choose the
correct alternative) (1)
(a) Imports of goods and services (b) Portfolio investments
(c) Purchase of foreign securities (d) Transfer payments
Q.10 Which of the following items is not included in the current account of the Balance of Payments of a country?
(Choose the correct alternative) (1)
(a) Income from software services (b) Interest, profits and dividends on assets abroad
(c) Remittances from abroad (d) Foreign direct investment
Q.11 Define the problem of double counting in the computation of national income. State any two approaches to
correct the problem of double counting. (3)
OR
‘‘Gross Domestic product (GDP) does not give us a clear indication of economic welfare of a country.’’ Define or
refute the given statement with valid reason. (3)
Q.12 If in an economy, change in Initial Investment (ΔI) = ` 500 crores, marginal Propensity to Save (MPS) = 0.2
Find the values of the following:
(a) Investment multiplier (k)
(b) Change in final income (ΔY) (3)
Q.13 Elaborate any two instruments of Credit control, as exercised by the Reserve Bank of India. (4)
OR
Define Credit Multiplier. What role does it play in determining the credit creation power of the banking system?
Use a numerical illustration to explain. (4)
Q.14 (a) How are tax receipts different from non-tax receipts ? Discuss briefly.
(b) State any two items of revenue expenditure in a Government budget. (3 + 1)
Q.15 (a) Define ‘‘Trade surplus’’. How is it different from ‘‘Current account surplus’’? (2)
(b) ‘‘Indian rupee (`) plunged to all time low of ` 74.48 against the US Dollar ($)’’. — The Economic times
In the light of the above report, discuss the impact of the situation on Indian Imports. (2)
Q.16 (a) State and discuss the components of Aggregate Demand in a two sector economy. (3)
(b) In the given figure, what does the gap ‘KT’ represent? State any two fiscal measure to correach the
situation. (3)
Y
Aggregate Demand
AS= Y
AD
K
E T
o
45
O Y Yf Income/Output X
OR
(a) What is meant by deflationary gap? State any two fiscal measures to correct the situation of deflationary gap. (3)
(b) Discuss the working of the adjustment mechanism in the following situation : (3)
(i) Aggregate demand is greater than Aggregate supply.
(ii) Ex Ante Investments are lesser than Ex Ante Savings.
Q.17 Given the following data, find the missing value of ‘Government Final Consumption Expenditure’ and ‘Mixed
Income of Self Employed’. (6)
S. No. Particulars Amount (in ` crores)
(i) National Income 71,000
(ii) Gross Domestic Capital Formation 10,000
(iii) Government Final consumption Expenditure ?
(iv) Mixed Income of self-Employed ?
(v) Net Factor Income from abroad 1,000
(vi) Net Indirect Taxes 2,000
(vii) Profits 1,200
(viii) Wages and Salaries 15,000
(ix) Net Exports 5,000
(x) Private Final Consumption Expenditure 40,000
(xi) Consumption of fixed Capital 3,000
(xii) Operating Surplus 30,000

Q.1 If the slope of the consumption curve is twice more than the slope of the savings curve in an economy, what is
the value of investment multiplier? (1)
Q.2 Borrowing in government budget is: (choose the correct alternative) (1)
(a) Revenue deficit (b) Fiscal deficit
(c) Primary deficit (d) Deficit in taxes
Q.3 The non-tax revenue in the following is: (1)
(a) Export duty (b) Import duty
(c) Dividends (d) Excise
Q.4 When the Central bank sells the government security through an agreement which has a specification about the
date and price at which it will repurchased. This type of agreement is called a (i)_______. The rate at which the
money is withdrawn in this manner is called the (ii)_______ . (1)
Q.5 The RBI can influence money supply by changing the rate at which it gives loans to the commercial banks for
long-term periods. This rate is called the ___________ in India. (1)
(a) Bank Rate (b) Repo Rate
(c) High powered money (d) Lending Rate.
Q.6 To soak the liquidity from the market: (1)
(a) Government securities should be purchased.
(b) Government securities should be sold.
(c) Repo rate should be decreased.
(d) Cash reserve ratio should be decreased.
Q.7 When the consumption curve in an economy lies above the 45° line from origin, the value of APC is:
(Choose the correct alternative) (1)
(a) Greater than one (b) Zero
(c) One (d) Less than one
Q.8 Ex-post investment means fixed capital with production units during a particular period of time. True/False?
Give reason. (1)
Q.9 In the Keynesian analysis of determination of equilibrium income in the short run, the justification for taking
the price level as fixed is: (1)
(a) We are assuming an economy with unused resources: machineries, buildings and labours.
(b) In such a situation, the law of diminishing returns will not apply.
(c) Additional output can be produced without increasing marginal cost.
Q.10 A change in initial investment causes a change in final income by an amplified amount, which is a multiple of
the change in initial investment and depends upon the value of ____________. (1)
Q.11 (a) What is ‘aggregate supply’ in macroeconomics? (3)
(b) If MPC = 1, find the value of multiplier.
(c) What is autonomous consumption?
Q.12 Currency is issued by the Central Bank, yet we say that commercial banks create money. Explain. (3)
OR
Explain briefly any three functions of the Central Bank. (3)
Q.13 Explain the concept of Inflationary Gap. Explain the role of Repo Rate in reducing this gap. (4)
Q.14 From the following data about a government budget find (a) Revenue deficit, (b) Fiscal deficit and (c) Primary
deficit: (4)
S. No. Particulars Amount (` in crore)
(i) Tax revenue 1,037
(ii) Revenue expenditure 2,811
(iii) Non-tax revenues 1,000
(iv) Recovery of loans 135
(v) Capital expenditure 574
(vi) Proceeds from sale of shares in PSUs 100
(vii) Interest payments on accumulated debts 1,013
Q.15 Differentiate between National Income at Current Prices and National Income at Constant Prices. Which of the
two presents a better view of the economic growth of economy and why? (4)
OR
What are non-monetary exchanges? Give an example. Explain their impact on use of gross domestic product as
an index of welfare of the people. (4)
Q.16 (a) Calculate National Income. (4)
(i) Personal tax 80
(ii) Private final consumption expenditure 600
(iii) Undistributed profits 30
(iv) Private income 650
(v) Government final consumption expenditure 100
(vi) Corporate tax 50
(vii) Net domestic fixed capital formation 70
(viii) Net indirect tax 60
(ix) Depreciation 14
(x) Change in stocks (–) 10
(xi) Net imports 20
(xii) Net factor income to abroad 10
(b) If the Real GDP is `500 crore and Price Index (base = 100) is 125, calculate the Nominal GDP. (2)
OR
Giving reason explain how should the following be treated in estimation of national income: (6)
(i) Expenditure by a firm on payment of fees to a chartered accountant
(ii) Payment of corporate tax by a firm
(iii) Purchase of refrigerator by a firm for own use
(iv) Payment of interest by a firm to a bank
(v) Payment of interest by a bank to an individual
(vi) Payment of interest by an individual to a bank
Q.17 (a) Name the broad categories of transactions recorded in the ‘capital account’ and ‘current account’ of the
Balance of Payments Accounts. (3)
(b) When exchange rate of foreign currency rises, its demand rises. Explain how. (3)

Q.1 _________ are called legal tenders. (1)
(a) Demand deposits (b) Time deposits
(c) Inter-bank deposits (d) Currency notes and coins
Q.2 What is High powered money? (1)
OR
What are time deposits? (1)
Q.3 The value of marginal propensity to consume is double the value of marginal propensity to save. The value of
multiplier will be ___________ . (1)
Q.4 S = –100 + 0.2Y is the savings function in an economy. Investment expenditure is `5,000 crore. The equilibrium
level of income will be ___________ . (1)
Q.5 Which of the following is within the domestic territory of India? (1)
(a) State Bank of India in UK
(b) Google office in India
(c) Office of Tata Motors in USA
(d) Russian Embassy in India
Q.6 In situation of excess demand, the central bank ______ the margin requirement. (1)
(a) Decreases (b) Increases
(c) Removes (d) Does not change
Q.7 To obtain an estimate of borrowing on account of current expenditure exceeding revenues, we need to calculate
__________. (1)
(a) Revenue deficit (b) Fiscal deficit
(c) Primary deficit (d) None of the above
Q.8 When the government receives money by way of loans or from the sale of its assets, such receipts are called
____________ in a government budget. (1)
Q.9 The component of demand for foreign exchange are: (1)
(a) Repayment of international debts
(b) Imports
(c) Exports
(d) Remittances from abroad
Q.10 If income increases in the home country as well as abroad, what is the likely effect on the value of domestic
currency? (1)
(a) Domestic currency will be depreciating
(b) Domestic currency will be appreciating
(c) Domestic currency may be depreciating or appreciating
(d) None of the above
Q.11 State giving reasons whether the following statements are true or false: (3)
(a) When marginal propensity to consume is greater than marginal propensity to save, the value of investment
multiplier will be greater than 5.
(b) If the ratio of marginal propensity to consume and marginal propensity to save is 4 : 1, the value of
investment multiplier will be 4.
Q.12 Calculate national income: (3)

(i) Net domestic capital formation 150
(ii) Government final consumption expenditure 300
(iii) Net factor income from abroad (–) 20
(iv) Private final consumption expenditure 600
(v) Depreciation 30
(vi) Net exports 50
(vii) Net indirect taxes 90
(viii) Net current transfers from rest of the world 40
OR
From the following data calculate the Gross National Product at Market Price. (3)
(i) Wages and Salaries 700
(ii) Rent 100
(iii) Current replacement cost 50
(iv) Net factor income from abroad (–)10
(v) Mixed income 400
(vi) Subsidies 100
(vii) Profits 400
(viii) Indirect taxes 300
(ix) Employers’ contribution to social security schemes 50
(x) Interest 40
Q.13 What does the Balance of Payments show? Distinguish between current account and capital account of the
Balance of Payments on the basis of its components. (4)
Q.14 Give the meaning of Open Market Operations. How is it used by the Central Bank to control money supply ? (4)
OR
Give the meaning of Bank Rate. How do changes in Bank Rate affect the money supply in an economy? (4)
Q.15 (a) Explain the basis of classifying taxes into direct and indirect tax. Give examples. (2)
(b) Explain the role the government can play through the budget in reducing inequalities in incomes. (2)
Q.16 Is gross domestic product a true index of economic welfare of the people ? Give three reasons in support of your
answer. (6)
OR
(a) Explain with diagram the circular flow of income in a two sector economy. (4)
(b) Explain the concepts of Real GDP and Nominal GDP, using a suitable numerical example. (2)
Q.17 (a) Explain the distinction between ex-ante measures and ex-post measures, giving an example of each. (3)
(b) From the following data about an economy, calculate its equilibrium level of income: (3)
(i) Autonomous consumption `200 crore
(ii) Marginal propensity to consume 0.9
(iii) Investment ` 1,000 crore (6)
asd
Project Work 319
20 Marks
CBSE Guidelines for Project Work
and Sample Project
Objectives
The objectives of the project work are to enable learners to:
 probe deeper into theoretical concepts learnt in class XII
 analyse and evaluate real world economic scenarios using theoretical constructs and arguments
 demonstrate the learning of economic theory
 follow up aspects of economics in which learners have interest
 develop the communication skills to argue logically
Expections
The expectations of the project work are that:
 learners will complete only ONE project during the academic session.
 project should be of 3,500 - 4,000 words (excluding diagrams & graphs), preferably hand-written.
 it will be an independent, self-directed piece of study.
Role of the teacher:

The teacher plays a critical role in developing thinking skills of the learners. A teacher should:
 help each learner select the topic based on recently published extracts from the news media, government policies,
RBI bulletin, NITI Aayog reports, IMF/World Bank reports etc., after detailed discussions and deliberations of
the topic
 play the role of a facilitator and supervisor to monitor the project work of the learner through periodic discussions
 guide the research work in terms of sources for the relevant data
 educate learner about plagiarism and the importance of quoting the source of the information to ensure authenticity
of research work
 prepare the learner for the presentation of the project work
 arrange a presentation of the project file
Scope of the project:

Learners may work upon the following lines as a suggested flow chart:
Choose a title/topic
Collection of the research material/data
Organization of material/data
Present material/data
Analysing the material/data for conclusion
Draw the relevant conclusion
Presentation of the Project Work
Expected Checklist:
 Introduction of topic/title
 Identifying the causes, consequences and/or remedies
 Various stakeholders and effect on each of them
 Advantages and disadvantages of situations or issues identified
 Short-term and long-term implications of economic strategies suggested in the course of research
 Validity, reliability, appropriateness and relevance of data used for research work and for presentation in the project
file
 Presentation and writing that is succinct and coherent in project file
 Citation of the materials referred to, in the file in footnotes, resources section, bibliography etc.
Mode of presentation/submission of the Project:

At the end of the stipulated term, each learner will present the research work in the Project File to the External and
Internal examiner. The questions should be asked from the Research Work/ Project File of the learner. The Internal
Examiner should ensure that the study submitted by the learner is his/her own original work. In case of any doubt,
authenticity should be checked and verified.
Project Work 321
Marking Scheme:
Marks are suggested to be given as:
S. No. Heading Marks Allotted
1. Relevance of the topic 3
2. Knowledge Content/Research Work 6
3. Presentation Technique 3
4. Viva-voce 8
Total 20 Marks
Suggestive List of Projects:

• Micro and Small Scale Industries • Food Supply Channel in India
• Contemporary Employment situation in India • Disinvestment policy of the government
• Goods and Services Tax Act and its Impact • Health Expenditure (of any state)
on GDP
• Human Development Index • Inclusive Growth Strategy
• Self-help group • Trends in Credit availability in India
• Monetary policy committee and its functions • Role of RBI in Control of Credit
• Government Budget & its Components • Trends in budgetary condition of India
• Exchange Rate determination – Methods and • Currency War – reasons and repercussions
Techniques
• Livestock – Backbone of Rural India • Alternate fuel – types and importance
• Sarwa Siksha Abhiyan – Cost Ratio Benefits • Golden Quadrilateral- Cost ratio benefit
• Minimum Support Prices • Relation between Stock Price Index and
Economic Health of Nation
• Waste Management in India – Need of the • Minimum Wage Rate – approach and Appli-
hour cation
• Digital India- Step towards the future • Rain Water Harvesting – a solution to water
crises
• Vertical Farming – an alternate way • Silk Route- Revival of the past
• Make in India – The way ahead • Bumper Production- Boon or Bane for the
farmer
• Rise of Concrete Jungle- Trend Analysis • Organic Farming – Back to the Nature
• Any other newspaper article and its • Any other topic
evaluation on basis of economic principles
Money
and
Banking From BARTER to CRYPTO
In stone age days we used to rely on barter system to trade where goods were exchanged for goods. Gradually, money came
into existence which carried certain values and got accepted as a medium of payment for transacting goods and services. It
was adopted as a legal tender within the country to be used in any market.
What is Money?
Money is a kind of legal tender acceptable by people of any country where it has been legalized and carries certain value. It
is used as an official payment mode for exchange of any goods and services or to clear any debts.
PRE MONEY ERA – BARTER EXCHANGE SYSTEM

A barter system is an age old practice and its history dates back to 6000 BC introduced by Mesopotamia tribes and well
adopted by Phoenicians where they traded goods across cities and oceans.
Bartering was officially first recorded in Egypt in 9000 B.C., when farmers would go to the market to exchange cows for
sheep, with grains passing through the hands of harvesters in exchange for oil.
Barter is a system of exchange where goods or services are directly exchanged for other goods or services with mutual
consent on the value of goods, by the people involved.
HOW MONEY CAME INTO EXISTENCE
When agriculture became mainstream in 9000–6000 BC , both livestock and plant products were used as money. There is
a remarkable statement by Aristotle where he spoke why money got created he said:
"When the inhabitants of one country became more dependent on those of another, and they imported what they
needed, and exported what they had too much of, money necessarily came into use."
INDIAN CURRENCY
THROUGH THE AGES
From shell money to cashless transactions
HUMBLE BEGINNINGS
Cowrie Shells are some of the earliest documented
forms of a currency system in India, pre-dating
many Indian dynasties and kingdoms.
EARLY COINAGE
The first coinage systems appeared around the
7th to 6th centuries BC. Pictured on the left is a
collection of silver Mauryan coins.
COLONIAL CURRENCY
Under British rule, Indian currency went through
several iterations with different series (Right) 1
Mohur from 1862, the Victoria series.

THE AGE OF PAPER MONEY
Post-independence cash– especially paper money
– established an unshakeable foothold in India.
Despite two denomination cycles, paper money
continues to hold sway over large chunks of the
Indian currency system.
THE ROAD AHEAD

The recent demonetisation cycle has increased
adoption of digital and cashless payment systems
in India. Is paper money on the way out? Only
time will tell!
INDIA– A DIGITAL ECONOMY

Computerisation first entered the Indian banking industry in 1988, and internet banking in the 1990s. But it was only in
the 2000s when online payment systems — like Electronic Funds Transfer (EFT), Real Time Gross Settlement (RTGS),
National Electronic Funds Transfer (NEFT), and Interbank Mobile Payment System (IMPS) — started being used.
While NEFT and other forms of online payment required a computer and often featured lengthy transaction times, the
new wave of e-payments brought about by digital wallets has made transferring money a lot easier and quicker. Since
internet availability and smartphone usage have become virtually ubiquitous, e-wallets like PayU, Paytm, and MobiKwik
are being used by millions for financial transactions, both personal and commercial.
The government too is pushing its ‘cashless economy’ missive with the Unified Payments Interface (UPI) system backed up by
the BHIM App — an Aadhaar-based mobile wallet which can be used to make digital payments directly from bank accounts.
The demonetisation move by the Narendra Modi-led government saw a sharp uptake in cashless transactions in November
and December 2016 — mobile wallet transactions recorded a 114 percent rise, Point of Sale (PoS) transactions an 88
percent rise, and mobile banking transactions a 30 percent rise. From November 2016 to May 2017, the total digital
transactions in India went up by 23 percent, from 22.4 million to 27.5 million. A Google-BCG study also predicts that
the Indian digital payments industry will grow to $500 billion by 2020, accounting for 15 percent of the GDP.
But in a country whose economy was 90 percent cash-reliant pre-demonetisation, cash remains the most commonly used
medium for financial transactions. RBI data shows that as of April 2017, Rs 2,171 billion was withdrawn via ATMs, while
UPI transactions at that point were at Rs 22.41 billion, meaning that UPI replaced cash by merely one percent. Cash
withdrawals, which were at a low of Rs 850 billion in November 2016, increased to Rs 2,262 billion in March 2017.
Pre-demonetisation in October 2016 and September 2016, this was at Rs 2,223 billion and Rs 2,551 billion respectively.
Unlike digital payments, which rely on a steady internet connection and acceptance from both buyer and seller, cash
is quick, easy, and instantly available for further offline transactions. That makes it the mode of payment of choice for
Indians right now. This is unlikely to change until the digital infrastructure in the country is improved to the extent that
every Indian, no matter how remote their location, can make digital transactions as easily as they can pay with cash.
Project Work 329
Digital payments themselves are evolving with the inception of cryptocurrency. Since they are a decentralised and highly
secure form of money, currencies like Bitcoin, Ethereum, and Monero are rapidly gaining popularity around the world.
While it may take a while for them to be accepted as a formal currency by the world’s governments, they are undoubtedly
the next step in this long evolution of payments.
Glossary of Key Terms 331
MACRO
Economics
XII
Key terms used in CBSE

Economics XII Exam
Accommodating transactions – These are the balance of payments transactions which are determined by the gap in the
balance of payments, i.e. whether there is a deficit or surplus in the balance of payments.
Aggregate Demand (AD) – It means the total demand for final goods in an economy during an accounting year.
Aggregate Supply (AS) – It is the value of total quantity of final goods and services produced in the economic teritory of a
country.
Appreciation of domestic currency – In a flexible exchange rate system, when the price of foreign currency (say, dollars) in
terms of domestic currency (rupees) falls, the value of domestic currency in terms of foreign currency increases, it is called
appreciation of domestic currency.
Autonomous consumption – Consumption at zero level of income i.e., consumption which is independent of income. It
is the subsistence level of consumption.
Autonomous expenditure (A) – It is the sum of autonomous consumption (C) and Autonomous investment (I)
Autonomous investment – It refers to the investment expenditure which is independent of income.
Autonomous transactions – These are international economic transactions made due to some reason other than to bridge
the gap in the balance of payments, i.e. these transactions are independent of the state of country’s BoP.
Average propensity to consume (APC) – APC is the consumption per unit of income, i.e. C/Y.
Average propensity to save (APS) – It is the savings per unit of income, i.e. S/Y.
Balanced Budget – When the government's budgetary expenditure is equal to the revenue it collects, this is known as a
balanced budget.
SOLUTION BOOKLET
for
MACROECONOMICS-XII 2020 Edition by Subhash Dey
Do it yourself 12: Gross National Product at Market Price

UNIT 1: National Income and Related Aggregates = Compensation of Employees (Wages and Salaries
Do it yourself 1: Value of the machine which is being gradually used up + Employers’ contribution to social security schemes)
in each year’s production process, i.e. Depreciation on machine = (Cost of + Operating Surplus (Rent + Profits + Interest) + Mixed Income
the machine – Scrap value)/Estimated life of the machine = (2,00,000 – + Current replacement cost + Indirect taxes – Subsidies + NFIA
0)/5 = `40,000 = (700 + 50) + (100 + 400 + 40) + 400 +50 + 300 – 100 + (–10)
Do it yourself 2: National Income (NNPfc) = `1930 crore
= GNPmp – Depreciation – Indirect Taxes + Subsidies Do it yourself 13: GNPmp = Compensation of employees (Wages and
= 120000 – 60000 (20% of 300000) – 30000 + 15000 Salaries + Employers’ contribution to social security schemes) + Operating
= `45000 crore surplus (Rent and interest + Profits) + Depreciation + Goods and Services
Do it yourself 3: (a) Value Added by Firm A Tax – Subsidies + NFIA
= Value of output of firm A – Intermediate consumption = (500 + 20) + (250 + 400) + 20 + 50 – 10 + (–10) = `1220 crore
= [sales + change in stock (closing stock – opening stock)] Note: (i) Depreciation = Gross capital formation – Net capital formation
– (purchases from firm B + Import of raw materials) = 120 – 100 = 20
= [300 + (20 – 5)] – (100 + 50) = `165 lakh (ii) Profits = Profits after tax + Corporate Tax = 300 + 100 = 400
(b) Value Added by Firm B Do it yourself 14: Gross value added at market price
= Value of output of firm B – Intermediate consumption = Wages and salaries + Operating surplus + Consumption of fixed capital
= [Domestic sales + Exports + change in stock + Net indirect taxes
(closing stock – opening stock)] – Purchases from firm A 15000 = 5000 + Operating surplus + 250 + 750
= [250 + 30 + (15 – 10)] – 80 = `205 lakh Operating surplus = 15000 – 5000 – 250 – 750 = `9000 crore
Do it yourself 4: Net value added at factor cost Do it yourself 15: (a) Net National Product at Factor Cost (or National income)
= Sales + Closing stock – Opening stock – Intermediate purchases = Wages and salaries + Employers’ contribution to social security schemes
– Depreciation + Subsidy + Rent + Interest + Profits + Royalty + Net factor income from abroad
= 800 + 20 – 50 – 500 – 30 + 40 = `280 lakh = 170 + 30 + 10 + 20 + 25 + 5 + (–3) = `257 crore
Do it yourself 5: Net value added at factor cost (b) Gross Domestic Product at Market Price = Net national product at Factor Cost
= Sales + Closing stock – Opening stock – Intermediate consumption + Consumption of fixed capital + Net indirect taxes
– Current replacement cost – Excise – Net factor income from abroad
= 100 + 20 – 10 – 50 – 12 + 15 = `33 lakh = 257 + 34 + 38 – (–3) = `332 crore
Do it yourself 6: Net Value Added at market price = (iii) + (iv) – (ii) – Depreciation Do it yourself 16: GDPMP = NDPFC+ Depreciation + Net indirect tax
= 25 + (–2) – 6 – 3 = `14 lakhs (v) = (vi) + (viii)+ [(iii)+(ix) + interest] + (iv) + [(i) – (ii)]
Note: Depreciation = 15/5 = `3 lakhs 17,500 = (9,300+3,500+1,100+800+interest) + 700+ (1,500-700)
Do it yourself 7: Net value added at factor cost = Value of output 17,500 = 16,200 + Interest
– Intermediate costs – Depreciation – Excise duty + Subsidy Interest = 1,300 crore
100 = Value of output – 75 – 10 – 20 + 5 Do it yourself 17: GDPMP = (i) + [(ix) + (ii) + (viii)]
Value of output = 100 + 75 + 10 + 20 – 5 + Mixed Income of Self employed + (iii) + (vii- v)
Value of output = `200 lakhs 500 = 17,300 + (2000+ 1200 + 1800)
Do it yourself 8: (a) Gross National product at market price (GNPmp) + Mixed Income of Self employed +1100 +(2100-750)
= Value of output of all the sectors Mixed Income of Self employed =`2,750crore
– Intermediate consumption of all the sectors + NFIA Do it yourself 18: National income = Private final consumption expenditure
= (1,000 + 900 + 700) – (500 + 400 + 300) + (–20) = `1,380 crore + Government final consumption expenditure
(b) National Income (NNPfc) + Gross domestic capital formation – Net imports
= GNPmp – Consumption of fixed capital – Net indirect taxes – Consumption of fixed capital – Net indirect taxes
= 1,380 – 100 – 300 = `980 crore + Net factor income from abroad
Do it yourself 9: (a) Net value added at factor cost (NVAfc) = 900 + 400 + 250 – 30 – 20 – 100 + (– 40) = `1360 crore
= Sum of factor incomes Do it yourself 19: Net National Product at factor cost
= Compensation of employees + Rent + Royalty + Interest + Profit = Private final consumption expenditure
= 400 + 10 + 5 + 25+ 60 = `500 arab + Government final consumption expenditure
(b) NVAfc = Value of output – Intermediate costs + Net fixed capital formation + Change in stocks
– Depreciation – Indirect taxes + Subsidies + Exports – Imports – Indirect taxes + Subsidies + NFIA
500 = Value of output – 200 – 50 – 100 + 40 = 1020 + 100 + 180 + 60 + 100 – 120 – 180 + 20 + (–10) = `1170 crore
Value of output at market price = 500 + 200 + 50 + 100 – 40 = `810 arab Do it yourself 20: Gross National Produce at Factor Cost
Do it yourself 10: National Income = Compensation of employees = Private final consumption expenditure
+ Rent + Interest + Profits + Mixed income of self-employed + Government final consumption expenditure
+ Net factor income from abroad + Gross domestic capital formation
= 500 + 80 + 100 + 210 + 250 + (– 20) = `1120 crore + Net exports – Net indirect taxes + NFIA
Do it yourself 11: Net national product at market price (NNPmp) = 1500 + 200 + 400 + (–10) – 50 + (–10) = `2030 crore
= Wages and salaries + Social security contributions by employers Note: Gross domestic capital formation
+ Rent + Interest + Corporation tax + Dividend = Net domestic fixed capital formation
+ Undistributed profits – Net factor income to abroad + Net indirect tax + Change in stock + Consumption of fixed capital
= 1,000 + 100 + 300 + 400 + 50 + 200 + 60 – (–20) + 80 = `2,210 crore = 310 + (100 – 60) + 50 = `400 crore
SOLUTION BOOKLET for Introductory Macroeconomics-XII 2020 Edition – by Subhash Dey 1

Do it yourself 21: Gross National Product at market price + Factor income from abroad – Factor income to abroad
= Government final consumption expenditure = 220 + 85 + 50 + 15 + 20 – 25 – 30 + 10 + 10 – 15 = `340 crore
+ Private final consumption expenditure Do it yourself 28: Operating surplus = (i) – [(vii) + (ix) + (xi)]
+ Gross domestic fixed capital formation = 50,000 – (20,000 + 13,000 + 500) = `16,500 crore
+ Net exports (Exports – Imports) Private final Consumption expenditure = (i)–[(iv)+(vi)+(xi)+(xii)]+(vii)+(ii)
+ Change in stock (closing stock – opening stock) = 50000 – (17000 + 12500 + 2000 + 500) + 700 + 1000 = `19,700 crore
+ Net factor income from abroad Do it yourself 29: Gross Domestic Capital Formation
= 200 + 800 + 230 + (50 – 60) + (20 – 30) + (–10) = `1200 crore = (i) – {iii+vii+x} + vi – xii + iv
Do it yourself 22: (i) Value Added Method GDCF = 22,100 – {7,200 + 6,100 + 3,400} + 500 – (–150) + 700
Value Added (VA) = Value of output – Intermediate costs GDCF = 6,750 crore
VA by Farmer = 100 – 0 = `100 crore Operating surplus = National Income – wages and salaries
VA by Bakers = 200 – 50 = `150 crore – Mixed Income of Self Employed – Net Factor Income from Abroad
Thus, GDP = VA by Farmers + VA by Bakers = 100 + 150 = (i) – (ii) – (viii) – (xii) = 22,100 – 12,000 – 4,800 – (–150) = 5,450 crore
= `250 crore Do it yourself 30: Operating surplus = (ii) – (iv) – (vi) – (i)
NDP = GDP – Depreciation (value of capital consumption) = 4200 – 200 – 400 – 2400 = 1200 crore
= 250 – 10 = `240 crore Net exports = (ii) – (vii) – (x) – (v) + (xi) + (viii) – (iv)
(ii) Expenditure Method = 4200 – 2000 – 1000 – 1100 + 100 + 150 – 200 = 150 crore
GDP = Sum of final expenditures, i.e. expenditures on goods and Do it yourself 31:
services for end use Goods Price of Price of Quantity of Nominal Real GNP
= Final consumption expenditures by consumers Current Base Year Current GNP (P0Q1)
= Purchases of wheat by consumers from Farmers + Purchases of Year (P1) (P0) (in `) Year (Q1) (P1Q1)
Bread from Bakers = 50 + 200 = `250 crore (in `) (in units)
NDP = GDP – Depreciation = 250 – 10 = `240 crore
Do it yourself 23: (a) Gross National Product at market price (Expenditure method) A 20 10 100 2,000 1,000
= Private final consumption expenditure B 10 5 200 2,000 1,000
+ Government final consumption expenditure C 30 20 50 1,500 1,000
+ Gross domestic capital formation + Net exports
ΣP1Q1 = ΣP0Q1 =
+ Net factor income from abroad
5,500 3,000
= 200 + 20 + 40 + (–5) + 5 = `260 crore
(b) Gross Domestic Product at market price (Income method) Nominal GNP= ΣP1Q1 = `5,500; Real GNP = ΣP0Q1 = `3,000
= Wages and salaries + Employers’ contribution to social security schemes Price index = Nominal GNP/Real GNP × 100 = 5,500/3,000 × 100 = 183.33%
+ Profits + Interest + Rent + Indirect taxes – Subsidies Interpretation: Price index of 183.33% signifies that price level has increased
+ Consumption of fixed capital by 83.33% between the base year and the current year.
= 165 + 10 + 15 + 20 + 15 + 30 – 5 + 5 = `255 crore Do it yourself 32
Do it yourself 24: (a) National income (Income method) Real GNP = Nominal GNP/Price index × 100
= Compensation of employees + Rent + Royalty + Interest ⇒ 500 = Nominal GNP/125 × 100
+ Profit after tax + Corporate tax + NFIA ⇒ Nominal GNP = (500 × 125)/100 = `625 crore
= 500 + 50 + 20 + 40 + 100 + 20 + 5 = `735 crore Do it yourself 33: (i) For the year 2017-2018, real GDP and nominal GDP
(b) National income (Expenditure method) are same as it is the base year and thus, GDP deflator is 100.
= Private final consumption expenditure (ii)
+ Government final consumption expenditure
+ Net domestic fixed capital formation Year 2017-2018 2018-2019 2019-2020
+ Change in stocks + Net exports Nominal GDP 6.5 8.4 9
– Indirect tax + Subsidies + Net factor income from abroad GDP deflator 100 140 125
= 630 + 120 + 60 + 10 + (–20) – 100 + 30 + 5 = `735 crore
Real GDP* 6.5 6 7.2
Do it yourself 25: National income (Expenditure method)
= Private final consumption expenditure * Real GDP = Nominal GDP/GDP Deflator × 100
+ Government final consumption expenditure The real GDP declined in the year 2018-2019. It is due to high rate of
+ Net domestic capital formation + Net exports inflation or price level. (Price level has risen by 40% between the base year
– Net factor payment made abroad – Net indirect taxes and the year 2018-2019.)
= 300 + 60 + 40 + (–10) – 20 – 50 = `320 crore Self Assessment Test 1
National income (Income method) = Compensation of employees 2. National income, Investment
+ Operating surplus – Net factor payment made abroad 3. (b) CPI has risen at a rate lower than the preceding year
= 230 + 110 – 20 = `320 crore 4. (c) Capital allowance
Do it yourself 26: (a) Gross National Product at Market price (Income Method) 5. Intermediate consumption = (i)- (iv)-(Indirect tax – iii) – (ii)
= Compensation of employees+ Mixed income of self-employed = 300 – 30 – (0-15) – 100 = 300 – 30 + 15 – 100 = `185 crore
+ Interest + Rent + Corporation tax + Undistributed profits 6. (a) Wages received by an Indian working in British embassy in India
+ Dividends – Net factor income to abroad is not a part of economic territory of India, as British Embassy is a
+ Current replacement cost + Net indirect taxes part of Economic territory of Britain.
= 1200 + 800 + 100 + 80 + 50 + 150 + 70 – 20 + 50 + 100 (b) Financial aid is a transfer income as no factor service is provided in
= `2580 crore return. Hence, it is not included while estimating the value of GDP.
(b) Gross National Product at market price (Expenditure Method) (c) Purchase of second hand machinery from abroad is not included as
= Private final consumption expenditure the value of imports are deducted while estimation GDP of a country.
+ Government final consumption expenditure 8. (b) The given statement is correct. Real Gross Domestic Product (GDP) is
+ Gross capital formation + Net exports – Net factor income to abroad a better indicator of economic growth than Nominal Gross Domestic
= 1580 + 730 + 300 + (–10) – 20 = `2580 crore Product (GDP) as it is not affected by changes in general price level.
Do it yourself 27: GNPfc (Income method) = Compensation of employees Numerical Example:
+ Interest + Rent + Profit + Consumption of fixed capital
+ Factor income from abroad – Factor income to abroad Goods P1 P0 Q1 P1Q1 P0Q1
= 150 + 40 + 40 + 100 + 15 + 10 – 15 = `340 crore A 20 10 100 2,000 1,000
GNPfc (Expenditure method) = Private final consumption expenditure B 10 5 200 2,000 1,000
+ Government final consumption expenditure
C 30 20 50 1,500 1,000
+ Net domestic capital formation
+ Consumption of fixed capital + Exports ΣP1Q1 = ΣP0Q1 =
– Imports – Indirect taxes + Subsidies 5,500 3,000
2 SOLUTION BOOKLET for Introductory Macroeconomics-XII 2020 Edition – by Subhash Dey

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The Divine Book

(‘Check List to Objective Type Questions’ is

‘Do it yourself’ Exercise with every Numerical

(Answers have been given in Solution Booklet

‘Key Terms’ at the end of each topic

‘Glossary of Key Terms’ at the end of the

‘Self-Assessment Tests 4-5’ based on current

(Answers have been given in Solution Booklet

Formulae — National Income Accounting and

Diagrams and Schedules — Determination of

A Wealth of Objective Type Questions, MCQs

< NUMERICAL QUESTIONS (with solutions) and ‘Do it yourself’ exercises

25 Sample Question Papers (based on CBSE New Question Paper Design)

Shree Radhey Publications

Introduction National Income and Related Aggregates

National income accounting is a branch of macroeconomics of which estimation of national income

1.1 Some Basic Concepts of National Income Accounting

Consumption Goods and Capital Goods

Stocks and Flows

Gross Investment and Depreciation

Calculate ‘Depreciation on Capital Asset’ from the following data:

Cost of the capital asset - Scrap value 1, 000 - 0

Additional NCERT Content Extracted from latest NCERT Book

Objective Type Questions 1.1

21. New addition to capital stock in an economy is ________________.

39. Which of the following is a flow? (Choose the correct alternative)

1.4 Production Method of Calculating National Income

Problem of Double Counting

Steps for calculation of national income by product method

Note: Sales = Output sold (in units) × Market price

or, Value of output = Sales + Closing stock – Opening stock

Why is GDPmp called gross?

or, NDPfc = GDPmp – Depreciation – Net indirect taxes

or, NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA

Other Basic National Income Aggregates

Steps for calculation of national income by product method

Objective Type Questions 1.4

HOTS Analysing, Evaluating & Creating Type Questions

In an economy, the following transactions took place.

[Ans. (a) `165 lakh (b) `205 lakh ]

S. No. Items (` in lakh)

[Ans. `280 lakh]

Calculate GVA at factor cost of a firm: (3 marks)

Find net value added at factor cost: 3 marks

S. No. Items (` in lakh)

[Ans. `33 lakh]

Find NVA at factor cost of a firm. (3 marks)

cost of fixed capital good - scrap value 10 - 0

Find Net Value Added at market price of a firm: 3 marks

S. No. Items (` in lakh)

[Ans. `14 lakh]

Calculate ‘Sales’ from the following: (3 marks)

Calculate ‘Value of output’ from the following: 3 marks

S. No. Items (` in lakh)

[Ans. `200 lakh]

S. No. Items (` in lakh)

[Ans. (a) `1,380 crore (b) `980 crore]

1.5 Income Method of Calculating National Income

The main components of compensation of employees are:

Precautions in making estimates of national income by income method

Treatment of Items in the Estimation of National Income by Income Method

CBSE Syllabus Content