Q 5: What is equilibrium level of income?

Determination of Equilibrium Level

The Keynesian Theory states that the equilibrium situation is usually expressed in terms of
Aggregate Demand (AD) and Aggregate Supply (AS). When aggregate demand for products
and services over a given period of time equals aggregate supply, an economy is in
equilibrium.
So, equilibrium is attained when:
AD = AS
Now, we know that,
AD = C + I,
and AS = C + S
Therefore,
C+S=C+I
i.e., S = I
Therefore, according to Keynes, the two approaches to determine the equilibrium level of
income and employment of an economy are Aggregate Demand-Aggregate Supply Approach
(AD-AS Approach) and Saving-Investment Approach (S-I Approach).
However, to determine the equilibrium output, there are certain assumptions that needs to
be kept in mind.
Assumptions
1. The determination of the equilibrium level will be examined using a two-sector model
(households and firms). Simply put, it is assumed that there is no foreign industry or
government in the economy.
2. It is also assumed that investment expenditure is autonomous, i.e., that income level does
not have any impact on investments.
3. It is assumed that the pricing level is constant.
4. Also, to determine equilibrium output, short-run will be considered.

1. Aggregate Demand-Aggregate Supply Approach (AD-AS Approach)

The Keynesian theory states that when aggregate demand as shown by the C+I curve is equal
to the total output (Aggregate Supply or AS), the equilibrium level of income in an economy is
established.
There are two parts to the aggregate demand:
 Consumption Expenditure (C): This expenditure changes directly with income; i.e.,
consumption rises as income rises.
 Investment Expenditure (I): This expenditure is considered to be autonomous and
independent of one’s income level.
So, in the income determination analysis, the AD curve is represented by the C+I curve.
The overall output of goods and services from the national income is known as the aggregate
supply. A 45° line is used to represent it. The AS curve is represented by the (C+S) curve
because the money received is either spent or saved.
Example:

The AD or (C+ I) curve in the above graph shows the desired expenditure level by consumers
and businesses at each level of income. At point E where the (C+ I) curve intersects the 45°
line, the economy is in equilibrium.
Observations:
 The equilibrium point, denoted by the letter E, occurs when desired expenditure on
consumption and investment is equal to the total output.
 OY is the output at the equilibrium level that corresponds to point E.
 In the above table, the Aggregate Demand is equal to the Aggregate Supply; i.e., ₹200
Crores, when the equilibrium level of income is ₹200 Crores.
 It is a case of Effective Demand. Effective demand refers to that level of AD that becomes
‘effective’ since it is equal to AS.

2. Saving-Investment Approach (S-I Approach)
The Saving-Investment Approach states that when the planned saving (S) is equal to the
planned investment (I), the equilibrium level of income in an economy is established.

Example

.com
The Investment curve in the above graph shows the autonomous investment made;
therefore, it is parallel to the X-axis. The Saving Curve S slopes upward, which means that
saving increases with an increase in income. At point E where the investment curve intersects
the saving curve, the economy is in equilibrium.
Observations:
 The equilibrium point, denoted by the letter E, occurs where saving and investment
curves intersect each other.
 Also, at point E, ex-ante saving is equal to ex-ante investment.
 The equilibrium level of output corresponding to the equilibrium point E is OY.
 In the above table, planned saving is equal to planned investment; i.e., ₹30 Crores, when
the equilibrium level of income is ₹200 Crores.
Q6- What is aggregate production function?
Ans: The aggregate production function is the maximum output that can be produced given the
quantities of the factors of production.
The components of aggregate production function are land, labor, capital, and
entrepreneurship.

These are all considered necessary as they impact the production process. Therefore, if
distortion happens in even a single factor, it will affect the economy’s efficiency.
What does the aggregate production function show?
The aggregate production function shows the relationship between input and output. It looks
into the economy’s production efficiency due to production and its productivity standards. As a
result, economists can estimate the predictions of the level of economic activity and its
potential in the future.

What shifts the aggregate production function?

The changes in the factors of production can have a significant impact on the production
capability. It can induce a shift in production function in the economy. For example, the output
out of capital stock at given levels can vary (increase) with new technological developments.

Q 8 -Discuss in detail two methods in market sharing cartel ?

Market-sharing cartels are illegal agreements between firms in which they divide a market
among themselves, typically by allocating customers, territories, or products. These cartels aim
to reduce competition, increase prices, and allow participating firms to enjoy higher profits. I
must emphasize that engaging in market-sharing cartels is illegal in most countries and violates
antitrust laws. However, for educational purposes, I can explain two methods that have been
used in market-sharing cartels:

1. Customer Allocation:

In this method, cartel members agree to divide the customers or consumers in the market
among themselves. Each firm is assigned specific customers or customer groups, and they
refrain from competing for each other's allocated customers. This leads to the creation of
de facto monopolies or duopolies within the cartel. Here's how customer allocation works:
 - Identification of Customers: The cartel members first identify the various customers or
consumer groups within the market. This could include businesses, government agencies, or
individual consumers.

- Assignment of Customers: The cartel members then assign specific customers or territories
to each firm within the cartel. For example, one firm might be assigned all customers in a
particular geographic region, while another firm could be assigned customers in a different
region.

- Non-Compete Agreement: Once customers are allocated, the firms agree not to compete
with each other for the assigned customers. They refrain from marketing to or selling their
products to customers allocated to other cartel members.

- Stability of Prices: Customer allocation tends to lead to stable prices within each allocated
territory or customer group since there is little or no competition. This can result in higher
prices for consumers and increased profits for cartel members.

2. Territorial Division:

In this method, cartel members divide the market geographically, with each firm given
exclusive rights to operate or sell its products in specific geographic areas. Territorial division
can be particularly effective in industries where location matters, such as distribution or retail.
Here's how territorial division works:

- Geographic Zones: The cartel members establish geographic zones or territories within the
market. Each firm is granted exclusive rights to operate within its designated territory.

- Non-Compete Agreement: Similar to customer allocation, the firms agree not to compete
with each other in their respective territories. They avoid entering each other's designated
areas and selling to customers within those areas.

- Market Control: Territorial division can result in each firm having a monopoly or a dominant
position within its assigned territory. This allows them to control prices and limit competition
effectively.

- Cooperation: Cartel members may also cooperate on issues such as pricing policies,
production levels, and distribution within their designated territories to maintain stability and
maximize profits.

It's important to reiterate that market-sharing cartels are illegal and subject to severe penalties
in many countries because they undermine competition, harm consumers, and violate antitrust
laws. Authorities actively investigate and prosecute such cartel activities to maintain fair and
competitive markets. Businesses are encouraged to comply with competition laws and
regulations to avoid legal consequences and promote healthy market competition.

Q 4 -Write short note on the following:

1-Price Elasticity of demand and how its measure:

Price elasticity of demand (PED) is a concept in economics that measures the responsiveness of
the quantity demanded of a good or service to changes in its price. In other words, it quantifies
how much the quantity demanded changes in percentage terms when the price of a product
changes by a certain percentage. Price elasticity of demand is a crucial concept for businesses,
policymakers, and economists, as it helps in understanding consumer behavior and predicting
the impact of price changes on total revenue.

The formula to calculate price elasticity of demand (PED) is as follows:

PED = (% Change in Quantity Demanded) / (% Change in Price)

Here's a more detailed explanation of how to measure price elasticity of demand:

1. Calculate the Initial and Final Values:

- First, you need to identify the initial (starting) price (P1) and the initial quantity demanded
(Q1).

- Then, determine the final (new) price (P2) and the final quantity demanded (Q2) after the
price change.

2. Calculate the Percentage Change in Price and Quantity Demanded:

- Calculate the percentage change in price as follows:

% Change in Price = ((P2 - P1) / P1) * 100

- Calculate the percentage change in quantity demanded as follows:

% Change in Quantity Demanded = ((Q2 - Q1) / Q1) * 100

3. Calculate the Price Elasticity of Demand:

- Finally, use the formula for PED to calculate the price elasticity of demand:

PED = (% Change in Quantity Demanded) / (% Change in Price)

Interpretation of Price Elasticity of Demand:

- If PED > 1 (in absolute value), it indicates elastic demand. This means that consumers are
relatively responsive to price changes, and a percentage change in price leads to a
proportionally larger percentage change in quantity demanded. For example, if PED = 2, a 10%
increase in price would lead to a 20% decrease in quantity demanded.

- If PED < 1 (in absolute value), it indicates inelastic demand. In this case, consumers are
relatively unresponsive to price changes, and a percentage change in price results in a
proportionally smaller percentage change in quantity demanded. For example, if PED = 0.5, a
10% increase in price would lead to only a 5% decrease in quantity demanded.

- If PED = 1 (in absolute value), it indicates unitary elastic demand. Here, the percentage change
in quantity demanded is exactly equal to the percentage change in price. Total revenue remains
constant as price changes.

- If PED = 0 (in absolute value), it indicates perfectly inelastic demand. Quantity demanded does
not respond to changes in price. This is a rare case where consumers are not sensitive to price
changes.

- If PED is undefined (infinite), it indicates perfectly elastic demand. In this case, any increase in
price would result in a quantity demanded of zero, and any decrease in price would lead to an
infinite quantity demanded.

2-Opportunity cost:

Opportunity cost is a fundamental concept in economics that refers to the value of the next
best alternative that must be forgone or sacrificed when a choice is made. In other words, it
represents the cost of choosing one option over another and is related to the idea that
resources are limited, and choices must be made to allocate those resources efficiently.

Formula and Calculation of Opportunity Cost

Opportunity Cost=FO−COwhere:FO=Return on best forgone optionCO=Return on chosen optio
nOpportunity Cost=FO−COwhere:FO=Return on best forgone optionCO=Return on chosen
option

The formula for calculating an opportunity cost is simply the difference between the expected
returns of each option.

Key points about opportunity cost:

1. Scarcity and Choices: Opportunity cost arises from the economic reality of scarcity. Resources
such as time, money, labor, and natural resources are finite, and individuals, businesses, and
societies must make choices about how to allocate these resources.
2. Trade-offs: When a choice is made, the opportunity cost is the value of the benefits that could
have been obtained from the next best alternative that was not chosen. In essence, it's what
you give up when you make a decision.
3. Subjective Nature: Opportunity cost is subjective and can vary from person to person and
situation to situation. What constitutes the next best alternative and its value may differ for
different individuals and circumstances.
4. Examples:
 If a student decides to spend their evening studying for an exam rather than going to a
party, the opportunity cost is the enjoyment and social interaction they miss out on at
the party.
 In business, if a company invests its capital in Project A instead of Project B, the
opportunity cost is the potential profit or benefits it could have gained from Project B.
 In macroeconomics, if a government allocates funds to one public program (e.g.,
healthcare) instead of another (e.g., education), the opportunity cost is the potential
benefits and improvements in education that were foregone.
5. Marginal Analysis: Opportunity cost is often considered when conducting marginal analysis,
which involves assessing the benefits and costs of incremental changes in decision-making.
Understanding the opportunity cost helps individuals and organizations make more informed
choices.
6. Sunk Costs vs. Opportunity Costs: It's important to distinguish between sunk costs and
opportunity costs. Sunk costs are expenditures that have already been incurred and cannot be
recovered, while opportunity costs relate to future choices and involve the comparison of
alternatives.
7. Implicit vs. Explicit Opportunity Costs: Opportunity costs can be explicit, involving measurable
monetary values, or implicit, involving non-monetary factors such as time or personal
satisfaction.
8. Decision-Making Tool: Economists and decision-makers often use the concept of opportunity
cost to evaluate trade-offs, make rational choices, and allocate resources efficiently.

In summary, opportunity cost is a fundamental economic concept that reflects the value of the
foregone alternatives when making choices. It plays a crucial role in decision-making, resource
allocation, and understanding the trade-offs inherent in economic and individual choices.

3- Inflation and its kinds:

Inflation is an economic concept that refers to the sustained increase in the general price level
of goods and services in an economy over a period of time. Inflation leads to a decrease in the
purchasing power of a currency, meaning that the same amount of money can buy fewer goods
and services than it could in the past. Inflation is typically expressed as an annual percentage
increase in prices.
 There are several types or classifications of inflation in economics, based on various factors and
causes. Here are some common types of inflation:

1. Demand-Pull Inflation:
 Demand-pull inflation occurs when the aggregate demand for goods and services in an
economy exceeds aggregate supply.
 It is often caused by factors such as increased consumer spending, increased business
investment, government spending, or strong exports.
 Demand-pull inflation is often associated with a booming economy and is considered a
sign of economic growth.
2. Cost-Push Inflation:
 Cost-push inflation occurs when the cost of production for goods and services increases,
leading producers to raise their prices to maintain profit margins.
 Common factors causing cost-push inflation include rising wages, increases in the prices
of raw materials, energy price spikes, and supply disruptions.
 This type of inflation can be particularly challenging for central banks to manage
because it is driven by supply-side factors.
3. Built-In Inflation (Wage-Price Spiral):
 Built-in inflation is a self-perpetuating cycle in which workers demand higher wages to
keep up with rising prices, and businesses, in turn, raise prices to cover increased labor
costs.
 It can become ingrained in the economy's structure, making it difficult to control.
 Built-in inflation is often associated with long periods of inflationary pressure.
4. Monetary Inflation (Monetary Expansion):
 Monetary inflation occurs when the money supply in an economy increases at a
faster rate than the growth of goods and services.
 It can be caused by factors like central banks printing more money, reducing
interest rates, or engaging in quantitative easing.
 Hyperinflation is an extreme form of monetary inflation, characterized by very
high and rapidly increasing price levels.
5. Hyperinflation:
 Hyperinflation is an extremely high and typically uncontrollable inflation rate
that results in the rapid and exponential increase in prices.
 It can lead to the near worthlessness of a country's currency and severe
economic disruption.
 Hyperinflation is often caused by a combination of factors, including excessive
money printing, loss of confidence in the currency, and economic instability.
6. Core Inflation:
 Core inflation excludes volatile factors like food and energy prices, which can
fluctuate significantly in the short term.
 It provides a measure of underlying inflation trends and is often used by central
banks to make monetary policy decisions.
4- Causes on unemployment:
1. Economic Recession or Downturn:
 One of the primary causes of unemployment is an economic recession or downturn.
During these periods, businesses may experience reduced demand for their products or
services, leading to layoffs or hiring freezes.
2. Technological Advancements:
 Rapid technological advancements can lead to job displacement and unemployment in
certain industries as automation and efficiency improvements reduce the need for
human labor.
3. Globalization and Offshoring:
 The globalization of markets can result in companies moving production or services to
countries with lower labor costs, which can lead to job losses in high-cost regions.
4. Structural Changes in Industries:
 Changes in the structure of industries, such as the decline of traditional manufacturing
sectors or the rise of new industries, can cause structural unemployment as workers
with obsolete skills struggle to find suitable employment.
5. Mismatch of Skills and Job Requirements:
 A mismatch between the skills possessed by job seekers and the skills required by
employers can result in unemployment. This can occur due to rapid changes in job
requirements or inadequate education and training.
6. Minimum Wage and Labor Regulations:
 Labor market regulations, such as minimum wage laws, can impact the demand for
labor and potentially lead to unemployment if employers cannot afford to hire workers
at the mandated wage rate.
7. Discrimination and Barriers to Employment:
 Discrimination based on factors such as race, gender, age, or disability can limit
individuals' access to job opportunities and result in higher unemployment rates for
affected groups.
8. Geographic Mobility:
 Workers who are unable or unwilling to relocate for job opportunities may experience
unemployment if suitable jobs are not available in their current location.
9. Financial Crises and Banking Failures:
 Financial crises and banking failures can disrupt economic activity and lead to a
contraction in lending, making it difficult for businesses to access capital for expansion
and job creation.
10. Educational and Training Gaps:
 Insufficient access to education and training programs that align with labor market
demands can result in skills gaps and hinder individuals' ability to find employment.

5- How MPC and MPS must equal to 1:

 MPC (Marginal Propensity to Consume) and MPS (Marginal Propensity to Save) must sum up to
1 in economics due to the basic principles of income accounting and the way income is
allocated within an economy. Here's a more detailed explanation of why MPC + MPS equals 1:

1. Income Accounting Identity:

 In economics, the total income (Y) generated within an economy must be allocated to
either consumption (C) or saving (S).
 Therefore, by definition, total income (Y) is equal to the total amount spent on
consumption (C) plus the total amount saved (S): Y = C + S
2. MPC and MPS Definitions:
 MPC represents the fraction of an additional unit of income that is spent on
consumption, which can be expressed as ΔC / ΔY.
 MPS represents the fraction of an additional unit of income that is saved, which can be
expressed as ΔS / ΔY.
3. Relationship between MPC and MPS:
 Since all income (Y) is either spent on consumption (C) or saved (S), the relationship
between MPC and MPS can be expressed as follows: ΔC + ΔS = ΔY
4. Sum of MPC and MPS:
 Rearranging the equation above, you get: ΔC = ΔY - ΔS
 Now, substitute the expressions for MPC and MPS: MPC * ΔY = ΔY - MPS * ΔY
 Divide both sides by ΔY: MPC = 1 - MPS
 This equation shows that MPC and MPS are complements, meaning that they are two
sides of the same coin. If you spend more of your income (higher MPC), you save less
(lower MPS), and vice versa.
5. MPC + MPS = 1:
 Finally, by rearranging the equation above, you get: MPC + MPS = 1
 This equation illustrates the fundamental relationship between MPC and MPS. The
fraction of additional income that is spent on consumption (MPC) plus the fraction that
is saved (MPS) equals 1 because all income must be allocated to either consumption or
saving.

In summary, the relationship between MPC and MPS is a reflection of how individuals and
households allocate their income. All income earned within an economy is either spent on
consumption or saved, and this principle is captured by the equation MPC + MPS = 1. If you
spend more, you save less, and if you save more, you spend less, ensuring that the two
propensities always sum to 1.