8

INCOME DETERMINATION
AND MULTIPLIER

L~ANING OBJECTIVES
ETERMINATION OF EQUILIBRIUM LEVEL
S.1 D
S. EQUILIBRIUM LEVEL
2
CONCEPT OF INVESTMENT MULTIPLIER
8.3
_ cr_1c_A_Ls_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _~
I s4._s_o_LV_ED_P_RA

ti DETERMINATION ~F EQUILIBRIUM LEVEL .

:,((ording to the Keynesian Theory, equilibrium condition is generally stated m terms of
~gate demand (AD) '.11'd aggregate supply (AS). A11 economy is in equilibrium when aggregate
r,Jnd [or goods and services is equal to aggregate supply during a period of time.
~ tquilibrium is achieved when:
AD=AS ... (1)
We knoll', AD is the sum total of Conswnption (C) and Investment (I):
AD=C+I ... (2)
IJio,AS is the sum total of consumption (C) and saving (S):
AS=C+S ... (3)
~luting (2) and (3) in (1), we get:
C+S=C+I
Ck, S = I
ltmeans, according to Keynes, there are Two AppJroaches for determining the equilibrium
~elof income and employment in the economy.
li.tbe noted Iha t Equl/ibrium level of income and employment can also be determined according
~ Theory'. However, the scope of syllabus is limited to the Keynesian theory.
0
~ Approaches for Determination of Equilibrium Level
tlvo approaches to determine equilibrium level of income, output and employment in the
~Yare:
'.· Aggregate Demand-Aggregate Supply Approach (AD-AS Approach)
~ Sav·
....~~-Investment Approach (S-1 Approach)
~ i i mind that AD, AS, Saving and Investment areal/ planned orex-ante variables.
8.1
 tntroductory
LI
1 1, . assumptions made in det~..~
Before we proceed further, Jrt us first state the vanous ~
equilibrium output: died in the context of,..,_ ft
Th . . . tpul is to be stu •wu-sec~
e determanalion ofequihbnum ou d th I there is no government '
(ho\lS('holds and (inns), It means, It is assume a cll\d for\i
!!«tor. • • . ·mves tments are not inn
10110111011s, i.e.
15
' It 1s il!ISUmed 1hat i111ttStml'III t.tpt11d1t11rt nu -"•Uei,
hv l<'V<'I of inconl<'. ~
Pri<\! ll•vd is .issunwd lo remain constant.
. eel , ontext of short-run.
Equilibrium output j:; to be detcrmtn inc
/ h (AD-AS Approach)
,....,n..i t·(Q le D. ,nrl AggregateSupply Approac .
,kcording to rl,r Ktyntsian tl,eory, tl,e eq11ilibri11m level ofincomem an eco11omy is detel'llli
whtn nggrrgatr drmnnd, reprtserrted by C + I c11rve is equal to tlle total output (Jlgg,.eg:4
Supply or AS). t

Aggregatt! demand comprises of two components: . .

• Co11~11111ption ,·xl'rud,11irt (C): It varies directly with the level of mcome, 1.e. consu.rnpti

•
. . increase in income.
n..o;cs with
lniJt'stmerrt cxpe11dit1m· (I): It is assumed to be independent of the level of inc0u,e,
.... l,e_
.
-
mvcstment expenditure is _autonomous.
So, AD curve is represented by (C + I) curve in the income determination analysis.
Aggregate supply is the total output of goods and services of the national income. It is depicte4
by a 45° line. Since the income received is either consumed or saved, the AS curve is represented

-
1ry tlie (C + 5) curvt.
The detennu,ation of equilibrium level of income can be better understood with the help of the
following schedule and diagram:
1i10li;I il : Equlllbrlum by AO and AS Approach
Amount in, Cf0/6S

Employment Income Conwmption ; Saving

1 Iinvestment AD AS Remarks
(Lakhs) (Y) (C) (S) (/) C+I C+S
0 0 40 -40 40 80 0 AD>AS
10 100 120 -20 40 160 100 AD>AS
20 200 200 0 40 240 200 AD>AS
30 300 J 280 20 40 320 300 AD>AS
40 400 360 40 40 400 400 Equlllbrlum
(AD::AS)
r-
50 500 440 60 40 480 500 AD<AS
l 60 600 l 520 80 40 560 600 AD<A5 a
 flll,r,,n,111011 and Mullipl,er
·r4'")g =:- C ; =t=
.,
{JI '--;- s 8.3
I the AD or (C + I) curve 5h
~8
ows the y
~ (eve I of expend1ture
, • • •
,'r...d .
by cons umers and
p•· ..., pondmg to each level of i
_,s cO••· 5 . .. . ncome. The
y is in equ111bnum at point 'IE' h
,,11o~e intersects the 450 line. w ere ~
·•~. is the equilibrium point because at thi i
. desired spe n d'mg on
' po inl• the. leveld of
5
e
t3 I ___...;~---
AO (or C-+ I)

c0nsumPhon an investment exactly equals Ml_

J!!
tile level of total output. J
,O
y is the equilibrium level of
. .
t
ou put
f Equillbnumtevel
/ oflncome
c0rresponding to pomt E. ;,;f-,..;::..&--"4:v~---x
, bl T,1ble 8.1, theequiliblium level of income is tncomo /Output/ Employment
, 4oocrores, when AD (or c +[)=AS=? 400 Ftg.8.1
crores.
, It is a situation_ of 'Effective Demand'. Effective demand refers to that level of AD which
b,:(Ollles 'effective' because it is equal to AS.
- is any deviation from the equilibrium ,eve
,.,.. , 1 of output ,.e
. when planned spending (AD) is not
,,iJtopJsnned output (AS), then 8 process of readjustme~t will start in the economy and the output
li/lwJ IO adjust up or down until AD and AS are equal again.
,4'o is less than AS
,hen planned spending (AD) is more than planned output (AS), then (C + I) curve lies above
t-15' line. It means that consumers and firms together would be buying more goods than
:.llS are willing to produce. As a result, the "planned inventory would Jal/ below the desired
al
1&nng the inventory back to the desired level, firms would resort to increase in employment
:a output Wltil the economy is back at output level OY, where AD becomes equaJ to AS and
rreisno further tendency to change.
1\iMed Jnvento,ry Is the unsold stock of goods which has been anticipated in case of an expected
'llilsa/es, while Unplanned Inventory refers to the unanticipated change In stock due to unexpected

Z:;s less than AS

1'il AD< AS, then (C + I) curve lies below the 45° line. It means that consumers and firms
ftherwould be buying less goods than firms are willing to produce. As a result, the plnmzed
r:citory would rise.
odear the Wlwanted increase in inventory, £inns plan to decrease the employment and output
:itillheeconomy is back at output level OY, where AD becomes equal to AS and there is no
~ tendency to change.
'-rbenoted that equilibrium /eve/ may or may not be at the level of full emplorment. 1.e.equilibrium
'IOfaible even at 8 level lower than the full e,:,ployment level. For mstance, mTable 8.1.
,.___ h espond'ng to equihbrlum Income of t 400 crores. It 1s not the full
v,
""..-
.. .,,,, 1ever /s 40 1ak s corr. ,. . .
·ncreases even after the equ1/lbr,um level.
--,,11ont levol smce emp/oymen11
 8.4
''-........ Saving-Investment
.. Approach (S-1 Approach)
. 1-•el .
,ncome .
is determined
0~
""c.,cordlng to this approaclr, tire equllibr1um .. ., i at II lltJ,1
pla""'d saving (S) is eq11al to planned i11vestment (1). . , 1'
Let us understand this with the help of fo)lowing schedule and diagram:
Table 8.2: Equlllbrlum by saving and Investment Approach
-+,,-;-;-;,~--------r---;;:::;:-;:;;--Tt~;;,;;;;;;,-iA~m:,::0~111u~n,;;tllf.liln~,
""ftvfng Investment em..
..:'"I
r eonsumptlon ....
(C) (S) (I) . J

0
100
•
-~
ft)
20
-40
-20
0
- -- ~ ~
40
200 200 40
20
300 280 40
40 Equlllbrturn
4 00 38 0
(S • I)
60 40
500 440 40
520 80
600
y
In Fig 8.2 . lnvestment curve (I) is parallel to the
X-axis because of the autonomous character of
~
investments. The Saving curve (S) slopes upwards ~
sho,ving that as income rises, saving also rises. j
• The economy is in equilibrium at point 'E' c3
where saving and investment curves intersect ~ M
each other. [
• Atpoint'E', ex-ante saving is equal to ex-ante :R
investment.
• OY is the equilibrium level of output corres -
s
ponding to point E. C:
• In Table 8.2, the equilibrium level of income is §
~ 400 crores, when planned saving = planned j
investment= t 40 crores.
Ifthere Is any deviation from the equilibrium level
of Income, i.e., If planned saving is not equal to the lnceme / Oulput / Employment
pfsnned Investment, then a process of readjustment
will start which will bring the economy back to the Flg.8.2
equilibrium level. Y'

When Saving is more than Invesbnent I

If planned saving is more than planned investment, i.e. after point 'E' in Fig. 8.2, it m~ans thJI
households are not consuming as much as the firms expeded them to. As a result, the ,nvt11"1
rises above the desired lev~l. . . 111
To dear the unwanted mcrease m inventory, firms would plan to reduce the productiOII
saving and investment become equal to each other.
 (Jl!!!.f11'na11on end Mu1t,p/1e,

I ~,• is less than lnvn~tn,

i;.1\ ""
-ti- I ""' l'•l! u
....d saving is ess than planned .
jr',.,,...-
,._.~o
. investment . b
Jds are consunung more and saving less 'i.e.
th efore point 'E' in Fig. s.2' it means that
~-pl_111111ed inventory would fall below ti d . an what the firms expected them to. As a
.,IL b re esired /ev I
r. the inventory ack to the des· e.
~riJIS tred level finns
I•' iJ'IS aJ'ld investment become equal ' would plan to increase the production
~"v to each other.
EOUJLIBRIUM LEVEL
JJ_,,iing to the classical eco:n:0:ll\is;.:ts:--u.il~.:-:-.b-.-------------
1
11""'- ent level i e there is ab ' eq nwntalevel of income is attained always at full
,.Jo)'lt' , . . sence of invoJ
/ff' , theory, equilibrium I v 1 un ry unemployment. However, as per the
1J'fles1an e e can be achieved at·
i Fii/1 employment level; or ·
·'
u11deremployment level, i.e. Jess than full
,11 employment level· or
{)vlT/11/1 employment level, i.e. more th full '
,1 an employment level
..• discuss the three possibilities of equilib· •
Lil"' num 1eve.1
: •Employment Equilibrium
;reftrS to a situation whe-11 the aggregate deinand y
:1tipial ta tl1e aggregate supply atfull employment =-
I + Full Employment
krl • 9. Equllib tum
, fnFi6· 8.3, Eis the full employmentequilibrium -g v:.----Ao (or c + I)
because aggregate demand 'EQ' is equal to j
full employment level of output 'OQ'. ~
At OQ level of output, all those who are "'~
willing to work at the prevailing wage rate, f
are able to find employment, i.e. there is 110 ;:;ot----~----x
0
involu11tary 11nemploy111e11t. Income IOutput/ Employment
Fig. 8.3

~deremployment Equilibrium y

It refers to a situatio11 wl1e11 tlle aggregate Full EmplQYrnent

O
lmrand is equal to the aggregate S'41'ply wl1e11 the ~
11$01/fCts are 11ot fully employefft'tt occurs prior

ll lhe full employment level.

r Equlh riu~
L---:;r--- AO (Full Employment AO)
- - - - - AO, (Actual)
0
• In Fig. 8.4, AD1 =AS at point 'F' which is j
lower than full employment level f Underemployment
Equlllbrlum
' As 0Q1 is less than OQ, point 'F' signifies ---l'!!ll...---=-+--+ x
lhe under employment equilibrium.
o Income I Output
a, I Employment
a
Flg.8.4
 I '' /ntroduotory M a ~
•••
Oh ~ull E:mploymonl Equlhbnum _ OIi•• Full Employment
~ equlllbrtum
ll rtftrs to II sihlaHon 1ul1tn AD is tqrurl to AS
~yond lht ftlll rmploymrnt levtl. It occurs after j -·· ..--~ G- ••. Ao, (Ae1ua11
the full rmployment level. . '5 . - E AD(AJII En,
• In r, s. ~ AD, • AS at point •G' which ,s g \ p~
5
higher th,tn the full employment level. i
f Full Employment
Equilibrium
~
• Point 'G' signilil>s the over full employment
~ X
equilibrium. O 1ncome/0Ulput/Employment
Flg.8.5

m1mn,1mU'l#ii'llJ--------
1•or1i'Ili#,,JWM,d·M1:i:r1 mrnw,,,1,wr£t1---- ... . ~
• ~r F\111 Ernpkrim&RI Equlllbrtumslgntles lhal planned expenditure (AO) Is equal to plan~a
outpUI (AS} at a tevol higher lhan full employment level.
• However, in reallly, actual outpul cannol Increase beyond this level as economy Is already at
run employment and there Is no Idle cepaclty.
• So. any ,ncrease In AD beyOnd the tul emploYment output, wlll le~d to increase In general
pnce level (I.e. inflation) and there will be no real Increase In outpu ·
-
She •>1ed Prrce Analysis of Product Markel
l.n the short-run, prices take some lime to respond to the forces ~f excess ~pply or deinai-;1
ilS producers try to update their production plans in the ~ean time. For ~lance, in case 01
excess supply, firms plan to produce less in the next cycle Ill order to avoid accumulaaono1
inventory. Also, an individual firm is very small in relation to entire market and is not Ina
position to influence the market price.
As a result, an individual firm has to accept the price that prevails in the market. Pri~ Jere!
remains constant and it chil\)ges only when the economy is unable to eliminate the effect a
excess demand or supply. So, it is assumed that pflces~n constant in short-run and nry
in the long-run. .,
[n order to derive aggregate demand under fixed price of final goods (i.e. in the short-run),itlw
to be assumed that elasticity of supply is infinite, i.e. suppliers are willing to supply whatev~
amount consumers will demand at the given constant price.It is a necessary assumption becau.'i
if quantity supplied exceeds or falls short of quantity demanded at this price, then price will
change because of excess supply or demand. So, wizen aggregate supply (AS) is ass11med lo~
consta11I, equilibrium is sclely detennined by aggregate demand (AD). We call it 'EffecHve DenUIJIJ
Principle'. Effective Demand refers to lire total demand oftheco,mmmity wltich is met blJ cortespondrri .
s11pp/y.

m:nallon of Equilibrium Output under Fixed Price Model

[ eif'
Under 'Fixed Price Model', the equilibrium output of final goods is determined solely by aggref~
demand (AD).
 ,, ,1,1fl(1n .,no ,,
1,7
$ " r model, AD is a function of Consumption (C) and Investment (I).
I
9 AD=C+ I
~r-s, . ... (i)
J !So kl'ow, consumption function is given by:
ii'
· c==c+b(Y)
... (ii)
_"Autonomous Consumption; b = ~ •.,,..., dy
,,c~ ,rt, C nu·'-, an = lncome.
, ilSO (ctlOW,that 'b' or MPC shows the rate at which consumption increases with increase
: ~111e, i.e. 'b' shows the slope of consumption funcHo •
11

OS iJl~esbl\ents are assumed to be autonomous investments, i.e. they are not influenced by
of income.
:-1JeVel

~eieans, I =i = Autonomous Investment '")

... (w
~JttiJlS value of C from (ii) and I from (ill) in (i), we get:
AD = c + b(Y) + I

l),
AD=c+J + b(Y)

ll'. AD=A+ b(Y)

[Total Autonomous Expenditure (A)= + I] c
~~••• equilibrium level of aggregate demand (AD) or y
Giional income (Y) depends on the values of autonomous
,q>tnditure (A) and MPC (or b). Let 11s deter111i11e the
fiibrium with tlie help ofr ~ 8.6 :
isseen in the diagram, when autonomous expenditure
i~ __________ - :
~ G _:• •••• --AD 1
AD

alheeconomy is A 1, the AD line intersects the 45° line at g,A, *. E

;ant 'E'. So, point 'E' is determined ns /lie eq11ilibri111t1 point, C>
Cl
illidch equilibr/11111 output is OY. <
45'
:,,:!<-=.L..-- --t,---,t----• X
However, if autonomous expenditure increases from 0 Y v,
Income and Output
i. tn ~, lhe AD line wiU shift to AD1• Due to increase Fig, 8.6
In autonomous expenditure, EG is th.e amount of excess

imwid Now, point E will no longer represent the equilibrium point The new equilibrium will
!!determined when new aggregate demand line, i.e. AD1 intersects the 45° line. That occurs at
lttt B1• It is the new equilibrium point. The new equilibrium output and aggregate demand
~I be determined at OY1 and AD1 respectively.
 Introductory

...
f ,,-,mplr- for tktt<'' Undt•r-.r,111d1rHJ autonomous investment and con
Q. 1. EsUmate the valut of ex-anlt AD. ~ Is 0.2 and leY9I of Income Is '300 cto
expendllUNI (A) Is, 50 cfOl8S ancl MP (CSSE, Sample PatJer~

Ans. MPC • , - MPS• 1-o.2" o.B of consumpllon (CJ and lflVflstm&nt {I).
tn a lwO-ffC(Ormodll, AOls B(UtlCI/OII
lltnNIIS,AO•C+I
Also. eonsu,npliOfl Function Is
White, c. Au,onomous CO(ISUITIP
~:.i,~meus"
b ,c:c+b(Y)
MPG; and y = Income.
investments, i.e. I= I
Jrwestments are assumed to be suton_ c+ f + b(Y)
11 means. AO= c + t,(Y} +f or AO - (·. Tots/ Autonomous Expend/lure (A), 2
. ~""'11
AO ■ A+bY
AD•S0+0.8(300)
AO= f 290 crores ti Identify whether Ihe economy 1s
' in
· equilibri
a. 2. On the ba$1s of following informa on. {CBS£. 2020 (SBt Uni
or not: ---- Amount 411))
Pst1Jcula,s - - - - ndilure (A) ~ 500
(i) Autonomous Consumplion and Investment Expe crores
QI) 1 Marginal Propensity to Save (MPS) 0,2
1 ? 4,000 crores
(iii) I Nalional Income
Ms. - The eco~omy is in equillbrfum when AD" AS (Y)
AD=A+bY , (Given Y = t 4,000 crot"")
AD=S00+0.8(4,00011 ••
AD= 500 + 3,200
AD=? 3,7oocrores
Since. AO~ 3.lOO crores) < AS ff 4,()()() crores), the economy is not in equilibrium.

8.3 CONCEPT OF INVESTMENT MULTIPLIER - - - - - - - - - -

The concept of 'Investment Multiplier' isan important contribution . ofbProf. J.M. Keynes. i'M~ ·~,r.ii
belil!Vl'd that an initial incre111e11t in inveshnenl increases theJina/ mcome Y many times. Multipliei
expresses the relationship between an initial increment in investment and the resulting~
in aggregate income.
In practice, it is observed that when investment is increased by a certain amount, then 11-, I
change in income is not restricted to the extent of the initial investment, but it changessevera I
times the change in investment. In other words, change in income is a multiple of thechangeb I
investment. Multiplier explains how many times the income increases as a result of anincrea;i
in the investment.
Multiplier (k) is tl,e ratio of increase i111111tio1111l l11co111e (l\ Y) due to 1111 i11crease ill i11vest1N~ I
CM).
k = l\Y
M
Suppose an additional investment (L\I) of 'f 4,000 crores in an economy generates an additi~
income (t. Y) off 16,000 crores. The value of multiplier (k), in this case will be:
 ~~-------------------
, ,r. n.1/1on 4fl(f Mu/11,:it,or

.
,os, income mcrease
d4
k :: 16,000 _
4,000 - 4
times With a single increase in investment.
l.t

~ 01e

I er 11nr! MPG
1
11P' d' t lati hi b MPC
, exists a ,rec re ons P etween MPc and the value of multiplier. Higlter the '
{lit~ .11 be the value of11111ftiplier, and vice-v-~

":t~ ~ ··-·
11 ceptof multiplier i~ based on the fact that one person's expenditure is another person's
{II
,_..,n,
e. When· investment
ed ·
ts increased, it also increases the income of the people. People spend
sed · e
••· 1of this increas mcome on COnswnption. However, the amount of increa mcom
i ~ on cons~ption depends on ~e value of MPC. .
~, /ti (J1sr of l'.iglter MPC, people Will spend a large proportion of their increased mcome on
(OllSumption. In such case, value of multiplier will be more.
, r,, CI1st of low MPC, people will spend lesser proportion of their increased income on
col\Sumption. In such case, value of multipliel' will be comparatively less.
f!iUS, the value of multiplier depends upon the MPC (refer Table 8.3).
-~br,,ic Relationship between Multiplier and MPC
\fr algebraic relation between Multiplier and MPC can be derived in the following manner:
nie,_
lit"''0 w' at equilibrium, income (Y) is the sum total of con$1lmption (C) and investment (l).
Y::C+I
)DlilMly, any change in income (AY) Will also be equal to (AC + Al).
t,.Y= AC+ M
. ·ding both sides by AY, we get
Oil1
t,.Y _ t..C + tJ
AY - t:.Y t:.Y
1
}::MPC+K
[" AY ·t:.C
- = l 'AY
· t:.Y
M
- = MPC·, ""
•y =..!..]
k
it 1
!l; er k = 1-MPC
•fultiplier (k) in terms of MPS
h 1
~ ll'e know, k - (1 - MPC)
, r l\'ealso know, I - MPC = MPS
1
!« So, k=MPS

ia: •~ns. the value of mult(plleroan be known if the MPC or/he MPS Is known.
Formula of Multlpller (k)

! t
 1.10 . r.r,l!ly related to MPS
Mull,l'h,•r h dln•,·11} rt'l,,ll'd 1t1 Ml'C ,uni uw. . 'ty
of marginal propens1 to cons\ln\e.
1
llw vah1l' or rnulliplil'r depends upan . u,e vanueMPC is . more, k is more and vice-verso
• ~ ;:'I\-
(kl ilnd Mrc ,,re directly related, 1.1?., whe eofmultipheran
contr.uy, higher the MPS, lower will be the valu
cll•ar with the help of the following table:
. d vice
. versa. '"-
ulis
tan~,
ll n.:
"'\
1

Table 8.3: Multlpller, MPC and MPS

Mullipli
• MP5
MPC (t-MPG) k==-c---
1-

1
1 (=-L
1-0
0
1l
2(.. 1-0.501
Q.50
0.50
3 (= 1 ~
0.33 1-0.67,
0.67
4( 1 ,,
0,25 1-0.75)
0.75
5 ( = 1 -~-80)
0.80 0.20

0.10 10 ( 1- ~.90)
0.90

0
oo(=-1
1-1
)
1

It is dear from Table 8.3, that multiplier is directly related to MPC and inversely related to~~

Maximum Value of Multiplier

111e maximum value of multiplier is illftnity when the value of MPC is 1. MPC = 1 indicate
that the economy decides to consume the whole of its additionaUncome. Here, notevenabJ
of the additional lncome is saved. It will lead to a continuous lncrease in the consumptiCII
expenditure and value of multiplier will be infinity.
Proof
1
We know; k -1-MPC
When Ml'C = 1, then:
k =__L =..!.. = oo
1-1 0
(as any II umber, when divided by 0, gives infitPIJ1
 fJl!!!!!:!.nat1on and Multlp//er 8.11
~u~ of Multiplier
11111
~ .,,,.,,,, value of multiplier is on
,iid' . e when the value of MPC is zero. MPC = O indicates
~ eeonomy decides to save the whole . .. . .
•d tl1t . of its additional income and nothing IS spent as
II'" tion expenditure. So, there will b .
~p . e no further increase in income. As a result, the total
.
# .111 income (6•
Y) will be equal t0 th .
e increase in investment (M), i.e., tiY = M. Here, the
~ of fllultiplier 1s equal to 1.
,ii 1
we
r,>f. kflOWi k = 1 - MPC
I
t,4PC ::: 0, then:
~~ 1 1
1
1<"'1-0=,=

.,.,. of Multi plier

/IU'''1119
,orking of multiplier is based on the fact that WORKING OF MULTIPLIER
11
flll
one persons ' expe1:'d'tu
. 1 r~ 1s· another person's Addlllonal Investment
(Al) 01, 100 Crores
c(!Jrfle'. When a,1 add1t'.onal mvestme11t is made, then
..,rit increases many times more than the increase in
<.11/ment. Let us un~e~_s_tand this with the help of
Firs/ Round
Increase In Income
,__ _____
t 100 Crores _.

,iexample. MPC=0.90
, Suppose, an additional iltvest111e11t oft 100
Second Round
crotes (Af) is made to construct a flyover. This Increase In Income '--"'.;.;.;...;c_.,.'-'-..:;..;..=-'--'
extra investment will generate an e>G'tra income
MPC=0.90
of? 100 crores in the first round. But this is not
the end of the story. Third Round , 81 Crores
Increase In Income (90% oft 90 orores)
, If MPC is assumed to be 0.90, then recipients
of this additional income will spend 90% of MPC=0.90
? 100 crores, i.e. ? 90 crores as consumption
Fourth Rour,d t 72.90 Crores
expenditure and the remaining amount will be Increase In Income (90% oft 81 erores)
saved. It wifl increase the income by t 90 crores in
Process Continues
lhe second round. t
'In the next round, 90%of theadditionalincomeof ?90 Total fneteaso t
1,000 Crores
In Income (AY) (100 +90+ 81 + 72.90 + ...
aores, i.e. f 81 crores will be spent on consumption

-
and the re.maining amount will be saved.
' :n,.m111frp[iir process will go en a.t;id _the consumption expenditure in every round will
be0.90 times of the additional income received from the previous rotmd. The multiplier

process is shown in Table 8.4.

 .,, 1,w,_11 In
tnl!ln 11 ,1 Working of Multlpller (MPC • 0,9())
/nc,..10 In lflCreaae I
ucr,,,11~

lrMH'""'"' (/\/) lnvomo (fl YJ Consumption~AC

ft c,o,.,I (f Croro•J (t Crores) }
(hYxMPCJ
100 90 (100 x 0,8)
1(lll
00 81 (90 >< 0.9)
81 72,90 (81 >c 0.9) I
12.90 65.81 (72.90 x 0,9) 8,10

85.81 7~

\
-
-
I- '
-
i

Toto1 100 1,000 900 -

100
hu,,,111 inllhil iawl~tnwnt oH' 100 crores leads to a total increase off l,OOOc .
1 . • t:..Y 1,000 roresmlhe~
,\<:> ,1 1l•~ull, M\llhphl?r (k) =TI= lOO - 10

,•i:H::HH •1iMMtnmet•tit•-iifi•UTUi'l::@-----------
Tho tolal ,nerease In Income can also be calculated as:
{ 100crores 1 x t 100 crores
=
+ +
, 90 cIores 0.9 x , 100 crores
+ +
, 81 crores (0.9)2 x t 100 crores
+ +
, 72.90 crores (0.9)3 x t 100 crores
+ +
t 65.61 crores (0.9)4 x , 100 crores
+ +

' 1,000 crores = [

1
2_9 ] x t 100 crores

-
 ,m,natlon and Multipl,er
0818
~~c Presentation of Multiplier 8.11
,n,- jtipher can also be sho
rt't ~~11co'."e is tak~n on the X-axi:~raaphically using the AD and AS approa~h: ~
p.1·9- ·urn tS deterrruned at point E h ggregate demand on the Y-axis Suppose the IIUtial
11il1rl . OY N w ere ADc . . , . .
rf of iJlCOi:ne ,s · ow, suppose that ~e mtersects the AS curve. The equillbnum
f"'~ ate dern~d curve (AD1) intersects lhe investment increases by l\.l, so that the new
#ref,,
~ew ~-,
.,,,1Jilibrtum level of income .
. .
lhe ag~egate supply curve (AS) at point 'F'. Thus,
is 0 Y1 The
; . I jJlc:rease m 1nvestment (Al) It. • income rises from OY to OY i, in response to
jlllua · IS c1ear fcom th fi (YY
I' tee than incr . . e gure that the increase in income 1
'{) iS grea ease in investment (A[) AY
,i> · The value of multiplier is given by k = Al
Y Multlpller Procea11

__ AO,(C+I +ill)
AO(C+I)

~ .
00F.I..._--J-=-::1__ _ x
llY

I y Y,
ncome /Output / En\plQymeni
Flg. 8.7

Reverse Operation of the Multiplier

Multiplier works in the forward direction as well as in the backward dlreclion. II lhe investment
decreases, the multiplier operate.s ln the backward direction. A reduction In investment
reads to contraction in the income and consumption. tt will lead to a cumulative decline In
the income and consumption levels till the total contraction in income is the product of the
value of multiplier and the Initial decrease In investment. Let us understand this with the
help of an example:
Suppose, investment decreases by t 20 crores. With MPC = 0.5 and k =1/(1 - MPC)-= 2,
there will be net reduction fn income to the extent of f 40 crores. Higher the MPC, greater
the value of multiplier and greater the cumulative decline in income. The multlpller is, thus,
symmetric and worl<s In bolh directions (forward and backWard), I.e., It Is a double-edged
weapon.

8.4 SOLVED PRACTICALS _ _ _ __ _ _ __ _ _ _ _ _ __

Important Formulae at a Glance

1. Multiplier (k) = ~i - 1 _ ~PC = M~S

2. AD=C+I
3. Y(or AS) = C + S
4. Equilfbrium Is achieved when AD= AS or S = I
 )
lntrodvctory Mac
v8,.:.'.,'.14~--------------------~:,:'Deti,,,._
- ~I
5. C:: c+ b(Y)
6. S:-c+Y{1-b)
{c" Autonomous ConsumpUon; b: MPC; and (1 -bJ "~Ps
1 , 1r · Mull 11 I
Calculate mulliplier if MPC is: (i) 0.75; (ii) 0.90.
Solr1tio11:
(I) Multlpller (k) = 1_ ~PC = 1 _ ~.75 = o.~5 = 4

(IQ Mullipller(k) = 1-~PC = 1-~.90 = o.~o" 10

Calculate the value of multiplier if the MPS is: (a) 0.40; (b) Equal to MPc
Solution:

(a) Multiplier (k) = M~S = o.~o = 2.5

(b) If MPS= MPC,, then MPS= 0.5 [·:MPS+ Ml'C,,1

Multiplier (k) =M~ =0~5 = 2

In an economy, income generated is four times the increase in inves1m«J l
expenruture. Calculate the values of MPC and MPS.
So/11tio11:
Multiplier= 4 (As Increase in Income {llY} /s4 limes the Increase In investment/al/ j
1
(a) Multiplier {k) _ MPC
1

4 1
1-MPC

1-MPC =¾
MPC:0.75
MPS= 1-MPC= 1-0.75
MPS=0.25
Ar MPC = 0.75; MPS = 0.25

In an economy, the marginal propensity to consume is 0.8. If the investmentiJlC!'#'

by f 1,000 crores, calculate the total increase in income.
So/111/on:

Multiplier (k) = 1 - ~PC =1- ~-80 = o.~o = s

We also know I<: = Change In Income (AY)
Change Jn Investment (Al)

Given: Change In Investment (Al) = , 1,000 crores

 tem' nat,on and Multiplier

Y ,.e., 5
= Change In Income (AYl_
1,000 - 1.11

SO, Change in Income (AY) = f

. . . 5 •000 crores
Total increase t.n income :::: ~ 5
,u,s, ,000 crores
,111ple 5. In an economy, 60% of increased . .
,, ted in a project, find out the inc . ~come lS spent on consumption. If t 4 crores are
~,-es rease m mcome and saving.
5Jutio11:
Given: MPC = 0.6
(as 60% of Increased income Is spent on consumption)
Multiplier (k) - 1 _ ~PC = _1 _ ::: _
1 06 25

We also know: k = Change in Income (AY)

Change in Investment (41)
Given: Change In Investment (Al) ::: f 4 crores

I.e., 2.5 Change in Income (AY)

4
Change or Increase in Income (AY) = f 10 crores
MPS = 1 - 0.60 = 0.40
[·: MPS = 1 - MPC)
MPS = Change in Saving (AS)
Change In Income (AY)
Change in Saving (AS)= AY x MPS= 10 x 0.4 = f 4 crores
Ans. Increase in income = ~ 10 crores; Increase in saving= t 4 crores
Example 6. In an economy, the actual level of income is f 500 crores, whereas, the full
!!llployment level of income is , 800 crores. If one-fourth of additional income is saved, calculate
increase in investment required to achieve full employment level of income.
Solution:
Given: MPS= 0.25 (as one-fourth or 25% of additional Income Is saved)

MulUplier (k) = M~S - o.15 = 4

. _ Change in Income (AY)
We also know. k - Change in Investment (Al)
Given: Change in Income (6Y) = 800 - 500 = t 300 crores

4 300
I.e., = Change In Investment (Al)
Hence, Change in Investment (Al) = ' 75 crores
~ns. Increase in investment required = t 75 crores
 uunplei. Jn
.i..
ure additional' .
an econom
Y, tile equilibri ,L
----~':.::. nrrod
~:.:u=
ct.:::.
o,y~ IC!il
• mvestmentneed UJnlevelof·
mcome is spent on ed to achieve th mcome falls short by , 500 crores
Solution: consumption. e equilibrium level of income, if 80o/oof~
Given: MPC = 0.BO (as 80% of additional ;ncome is spent on COll5Uni,...

Multiplier (k) = 1 = 1 1 -~
1-MPC 1-0.80 = 0.20 = 5
~
1//e also know: k = Change in Income (AY)
• • Change in Investment (.Al)
Given: Increase in Income (.AY) required = , 500 crores

i.e., 5 = . 500
Change in Investment (.Al)
Hence, Change in Investment (Al) = t 100 crores

j\ns. Additional ~ vestment required = t 100 crores

ExamPle 8. .In an economy, the equilibrium level of income is t 12,000 crore. The ratio f
,.,arg;,,al propensity to consume and ma<ginal propensity to save;,; 3,1. Calculate the addi...:
investment needed to reach a new equilibrium level of income of t 20,000 crore.Al 1 ]11dia 20w
{CBSE,

Solution:
Ratio of 3:1 between marginal propensity to consume (MPC) and marginal propensity to~

(MPS) signifies: MPC = ; or 0. 75 and MPS = ; or 0.25.

Multiplier (k) =_!_ =_,_ = 4

MP5 0.25

We also know: k = Change in Income (AY)

Change In Investment (Al)

Given: Change In Income (AY) = 20•000 _ 12,000 -_ ,• 8,000 crores

i.e., 4 = a,ooo
Change In Investment (Al)
Hence, Change in lnvestm~nt (Al)= ~ 2,000 crores
Ans. Additional inveshnent needed is ~ 2,000 crores

Example 9. ca1cu1ate MPS and MultiPlier (k) from the following data·

I=:: I ': I : i.
 .-
.. ~· • and Mu/tJplJe,
1,17

100
60 100 1,87(=1 +0.60)
0.80
r,!PS • 0.60; Multipliec (k) = 1.67
. .t- .... ,r-- ...
V' In an'econ~ · ·
~ , 10· ~ argmal propensity to consume is0.75. If investment expenditure
500
~sed by crores, calculate the total increase in income and consumption
~tute- {CBSE, Delhi 2004)

Ji"' 1
. "4uitiplier(k) = 1-MPC - ,-~.75 = o.~s =4

we also know: k _ Change In Income (AY)

Change in Investment (D.I)
Change In Income (AY)
4 ::,.- 500
So, Change In Income (A Y) = ~ 2,000 crores
pC _ Change in Consumption (ll.C)
M - Change In Income (AV)
_ Change in Consumption (llC)
0.75 - 2,000
so, Change in Consumption (AC)= t 1,500 crores
'Jol. Total increase in income = f 2,000 crores; Total increase in Consumption Expenditure
= f 1,500 crores

fnmple 11, An increase of f 200 crore in investment leads to a rise in national income by
oOOJaores. Find out marginal propensity to consume. {CBSE, Delhi 2007)
W,.Ji()I!:
Multi lier (k) _ Change In Income (tr. Y) = 1,000 = 5
p Change In Investment (.t.1) 200
1
We know, Multiplier (k)
1-MPC

5= 1
1-MPC

1-MPC =s1
Hence, MPC =1 - 0.20 =0.80
qi, Marginal Propensity to Consume (MPC) = 0.80
 1.11
in\'c.-stmen! bv f 125 cr 1;-es,
c; a result of inacasc 111
•
A · wconsume
f 500 crorl"i Calculate margmal propc-nsity

So/Jllion:
I' ( 1/./.,
C~ange m Incorr.e - , ==-:,:::::- = e.
Multiplier (kJ == Cnange in 1rr,estrr.efl! ':. , =
1
We know, Multiplier (r.) == 1 _ MPG

1
4
- 1-MPC
1
1 -MPC:: 4

MPC = 1-0.25 = 0.75

Ans. Marginal Propensil} to Consume ~C, = 0.75
Example 13. In an economy, investment is increased oy ! 300 -::".l':e. If .::r:.a:g;::-.a. ~=:.?'~
consume is 2/3, calculate increase in national income. ~- 5i.
Solution:
1 1 1
Multiplier (k) = _ MPC - 1-% =-0.33
1
=3
. k _ Change in Income (.lY)
We al so know. - Change .,n nvesunent ..l1J
1
= Change in Income (tiY)
3
300
Hence, Increase in National Income (t.Y) = f900 crores
An.,. Increase in National Income = ~ 900 crores
E:xa II pl e u. If marginal propensity to consume is 0.9. '"ha: :s ±e \"al'.le o: =-~=:Se." H....-
much investment is needed, if national income increases b~- t 3 '.\. '.) crores:
~
'- ~-
·;:

,olution:
1 1 1
Multiplier (k)
1-MPC - 1 - 0.90 = 0.10 = lO
Change in Income (.lY)
We also know: k
Change in Investment {.ll)

10 = 5,000
Change in Investment (Al)
Hence, Change in Investment (Al) = t 500 crores
ns. Multiplier (k) = 10; Increase in in,·esnnent = ~ 500 cror~
<ample J5. In an economy,
. ]" ? the entire increase in incom€lSSJ'ffi~l'ltO.:~'~:l""'.P
· ti ,1n. \\
, the va1ue of muIt1p 1er
 ()it! ,mm,11,on nnd Mult,pt,e, 1.11
~,,o,r
:
J-
.. wi,en enlire Increase In lnco
me II spent on consumption, then: AC • AY, I.e. MPC • 1
we know: Multiplier (k) • 1
1-MPC

When MPC = 1, lhen: k =-L_ 1

1 - 1 .. '" 00 (H any number divided t,y O,. •J
0
le 16, In an c<:onon,y 75 , .
,in1f1 . . , . percent of the increase in income is spent on consumption.
1n,cnt 1s men, ,,~>d by t I 000 c C ·
1111~ . d' ' rore. nlculate: (a) total Increase in Income; (b) total ll\creaBe
..i,umption C).pcn tlurc.
ll'l'" :r /IS 1, 111'11II~,,11,11
•~~/iOII
>
Gtven: MPC = 0.75
(as 75% of increase In Income Is spent on consumption)
1
Mulllpller (k) - = _ 1_ _ 1
1-MPC 1-0.75 - 0.25 = 4
When also know: k _ Change ln Income (AV)
Change In lnveslment (Al)
= Change in Income (AY)
4
1,000
So, Change in Income (AY) ::: ~ 4,000 crores
MPC = Change in Consumption (AC)
Change in Income (AY)
_ = Change in Consumption (AC)
0 75
4,000
So, Change in Consumption (AC)=~ 3,000 crores
,\ns. Total increase in income = ~ 4,000 crores; Total increase in Consumption Expenditure
= t 3,000 crores
Enmple 17 An increase oft 250 crores in investment in an economy resulted in total increase
in income oft 1,000 crores. Calculate the following: (a) Marginal propensity to consume (MPC),
:I,) Change in Saving, (c) Change in consumption expenditure, (d) Value of multiplier.
/CBS/., Snm,1/, Prrp,• W08J
Solution:
. . Change in Income (AY) 1,000 _ 4
Multiplier {k) = Change in Investment {.61) - 250 -

1
We know, Multiplier (k} = 1 _ MPC

4- 1
1-MPC

1
1- MPC =-
4
 lntrOductory

8,22 Ion of Equlllbrlum Level

oetermln•
Pr1ctfC1fl on d d terrnine equilibrium level if investni..._·_
. AD AS an e -~
pll' 22. Calculate saving, ' fj
at t 100 crores: 200 300 400
0 100
150 200 250
50 100

investment

0 50
100 200
100 100 0 100
100 250
200 150 50 200
100 100 300 300
300 200
150 100 350 400
400 250
200 100 400 soo
500 300

Equllibrium level ofincome is t 300 Crores. At this level, AD= AS= t 3oo Crores and Saving:: tnvestmr.w
-= ~ 100Crores
Example 23. Suppose investment in the economy is fixed at f 40 crores. The consump~
expenditure. at different levels of income. is viven in the fO11OWID£
· SCh edule:
J_ncome ft cpreJ 200 300 400 500 600 700
Consumotion ~ crorel 220 300 380 460 540 620
On the bas,s of the given schedule, answer the followlng questions:
(•) Calculate AD and AS for all level of income.
( At what level of income wlll the economy be at equilibrium?
( 1 State the level of income where total saving Is negative.
( Are saving and investment equal at the equilibrium level of income?
I Calculate MPC and MPS, when the income increases from t 400 crores to ~ 500 crores.
( What will be the AD at the Income level of t 300 crores?
Solution:
(tJ

Amt. In t crores
Income Consumption Savlng (S) Investment AD AS
1YL. Y-C I C+ I C+S
200 220 -20 40 260 200
300 300 0 40 340 300
400 380 20 40 420 400
500 460 40 40 500 500
600 540 60
40 580 600
1QQ_
 ,ndMu/llplw

~~IMloflncomt1ataooen...,
~•'40Crorls. Altt111..i,AO ■ A8 ■ t900Crolll
anc1Wf•
-IP"' !ht Income la , 200 cror.. IIIVI 11
aavtng and Investment are ' ng "'Olllvl (-20 CfOfll)
._. 1qua1 (t 40 CfOfll) 11 tht equlllbrlum IMI of MCOffll
• £!'Inge In Consumption (AC) 480 - 380
.,C Change In Income (AV) • -_:.;:.::. • 80
500-400 100
,..pe • 0.80;
tilpS • 1- MPC
tilpS • 1 - 0.80 • 0 20
,-o • , 340 crores at an income 01 , 300 crores
• r :z.i, An::-wl'r tlw followino , ·
I qu~shons b,1seJ on the data given below:
r,
(i) Plill'nrd 1m cstml'nt = t lOd crorc
\11) CC50 + 0.5 y
oet,•.rnune the equilibrium hiwt of inconw.
Calculate the saving and consumption l'llpl'nditure at equilibrium level of National
1J,ronte, ICBSL, / 11 ,, ---in,,
,..•J.')11. .
_,equihbnum level of National Income {Y)
Al Equilibrium. y = C • I [·:AD= AS = y and AD = C + I)
Or Y = 50 + 0.5V + 100 (·: C = 50 + 0.5Y)
osY= 1so
y:: t 300 crores
S:: -c + (1 - b)Y
:: -50 + {1 - 0.5)(300)
== , 100 crores

Y::C+S
300=C + 100
C:: 300 - 100 = , 200 crores
(a) Equilibrium level of National Income = t 300 crores; (b) Saving Expenditure at
equilibrium level of National Income = t 100 crores; Consumption Expenditure at
equilibrium level of National Income = , 200 crores.
• . ," 25. In an economy, C = 200 + 0.5 Y is the consumption function, where C is the
aruumption expenditure and Yis the national income. Investment expenditure is~ 400 crores.
htheeconomy in equilibrium at an income level t 1,500 crores? Justify your answer.
/CBS£. Sample p,, it 2021}
>',,/ulion:
Given, Consumption Function (C) =200 + 0.5Y, Investment {I)== 400, Level of Income (Y) =1,500.
At Equilibrium Level ... AD = AS
Y=C+I
 ~:
8.24
Introductory rv, \
thus, Y = (200 + O.SY) + 400
Y-0 .SY =60 0
Y = 600/ 0.5 = 'f 1,20 0 crores.
The Equilibrium Level of Inco me = t 1,20
0 crores. The give n Income (t 1,50 0 crore
grea ter than Equilibrium Level of Income (f
1,20 0 crores). The refo re, the econ omy lss~ Is
in equ ilibri um.
ot
r pl• The savi ng func tion of an eco nom y is S = -
200 + 0.25 Y. The econo .
equ ilibr ium whe n in com e is equ al to 2,000. Ca_Jcul
leve l of income; (b) Autonomous con sum
ate: (a) Inve stm ent e':P':"diture at
ptio n; (c) Inve stm ent mul tipli er.
eq:~: in IUii
{CBS£, Sample p ,,.
Sol11tio11: 11
,..r 20101
(al Investment expenditure at equilibrium level of
inco me
Given, Equilibrium Level of Inco me (Y) = 2,00
0. Putting value ofY in saving function, we get
S = - 200 + 0 .25 X 2,00 0 = 300
At equillbrlum, Planned Sr"•ng (S) = Planned
Investment (I). It mea ns:
Investment expenditure (I) at equilibrium leve
l of inco me = 300
Autonomous consumption
We know, Con sum ption (C) + Saving (S) =
Inco me (Y)
Auto nomous cons ump tion means the level
of cons ump tion expe nditu re whe n Income is
Whe n Y = 0: Sav ing = - 200; So, auto nom ous zero.
cons ump tion = 200
{Alte mately. a uton omo us cons ump tion can
also be calc ulate d from the savi ng function.
Saving func tion is expr esse d as: S = - c + Weknov,
Y (1 - b). It mea ns, - 200 indic ates that auton
cons ump tion (c) = 200 ) omous
(c) Inve stment Multiplie r
From the saving function, we know that MPS
= 0.25
Inve stme nt Multiplier (k) = M~S = 0 _~ = 4
5
Ans (a) Invesbnent exp end itur e at equ ilib rium leve
l of inco me = 300; (b) Auto nomous 1
con sum ption = 200; (c) Inve stm ent mul tipl ier
=4
r " z.1 U savi ng function for an eco nom y is give
n as: S = - 500 + 0.2Y and investment 1
exp end i ture is f 100 cror es, then dete rmi ne: (i)
Level of inco me whe n sav ing will become wo;
(ii) Lev el of inco me whe n savi ng is equ
al to inve stm ent.
Solution:
flJ Give n Saving Function: S = - 5~ + 0 .2Y
Putt ing valu e of S = 0 in the slvi ng Fun ction
, we get:
0 = - 500 + 0.2Y
Y = 2 ,500
Sav ing will beco fne zero whe n the leve l of
• inco me is t 2,50 0 cror es .
(111 Sav ing is equa l to Inve stme nt at equilibr
ium leve l of inco me.
Putt ing valu e of S = 100 In the Sav ing Fun
ction , we get:
 ,m111~f1~8l=IO~fl~8n~d~M~u~ltip::::1t:er_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _8.25
_ _
o,18 -
~500+0.2Y
y:::3,000
ss\li"9 will be equal to Investment at the equlllbrium level of , 3,000 crores.
1e zs. The eq uil'b
1 ·
is,
num level of income in an economy 5 000 crores. The au tonomous
£''111P ption expenditure ·is equal to ~ 250 crores and invesbnent' expenditure
. '9 1' 000 crores.
.
;IJJ!lie: (i) Consumption expenditure at equilibrium level of national income; (ii) Margtnalf
•: ,,t!)a (" ') S · F
~ity to save; w avmg unction; (iv) Invesbnent Multiplier; (v) Bre -eve
ak n level o

~(Oll'e.
~utiDTI:
(t) CQnsumption expenditure at equilibrium level of national income.
or, C+ I =y [·: AD = C + I]

putting value of Investment Expenditure (I) oft 1,000 and income (Y) oft 5,000, we get:
c:: 5,000 -1,000
c=t 4,000 crores
(ii) Marginal Propensity to save (MPS)

consumption Function is given as: C = c+ b(Y)

putting the values of C, candY In the consumption function, we get:

4,000 = 250 + 5,000b

5,000b = 3,750
bor MPC = 0.75

MPS= 1 -MPC = 1-0.75 = 0.25

(lll) Saving Function

Saving Function Is given as: S = - c+ (1 - b)Y
Putting the values of (1 - b) or MPS and - c, we get: S =-250 + 0.25 (Y)
(iv) Investment Multiplier

Investment Multiplier (k) = M~S =o.~s =4

(v) Break-even level of Income
At break-even point, C = Y
Putting y = c in the consumption function. We get:
Y = 250 + 0.75Y
0.25Y =250
Y = 1,000
Break-even level of Income = t 1,000 crores
 I111,orl, :ctory ~ - ·-

!1:!ll!,__ _ _ _ _ _ _ _ _~===:;dl;.ture;;:is~f~7~0~C~ro;r;es~a~n~d:c, · 'P ~

In aneconomY, the 1nves~en~ ~ e l of income; (ii) Find U,... '-'I ""•u, • ~,
isC •60+0.80Y. (I) 0eterrninethe~u•~z:ium ased by f IO crores; (iii) Value of rnu~;"'.",
when planned investment expen~tture is mere Plier 11\ie
to maease in Investment expenditure•
Solutiorr:
Equllibnum 181191 ol income (Y} [·: AD= AS = y alld AO
Al Equilibrium, Y • C + I (... C "'-60 "C•IJ
+O.IIO'tj
Or, y.,60+0.SOY + 70
0.20Y• 130
Y:fe50cl'Of99 ed I vestment expenditure ·1s Increasedby ~ 10 c
Equilibrium income when plann n rores, 1.1.
l:f80CIOt8S.
Al Equilibrium, Y = C + I
Or. Y= 60+ 0.80Y +80
0.20Y= 140
Y = f 700 crores
Value of Multiplier (k)
As result of f 1o ct'Ores increase in Investment, income increases by ? 50 crores.
8
_ Change in Income (~ Y)
k - Change In Investment (~I)
50
k - fO = 5
(i) t' 650 crores; (ii) t' 700 crores; (iii) 5
The saving at different levels of income are given in the following schedule:
Income tr Cf0f8) o 200 / 400 I
600 800 1,000
Saving{fCIOftl) -120 -601 o _ 60 120 180
On the basis of the given schedule, answer the following questions:
Calculate MPC at different levels of Income.
If Investment Is t' 120 crores, determine the equilibrium level of income.
Derive the Consumption and Saving function.
What Is the break-even level of Income.
olution:
Amt. In t crores
Income Sa'ling Consumption Change in Change in MPC
(Y) (SJ (CJ , Income l
Consumption MPCe:bC+AY

-
1
Y-S (AY) (AC)
-·---
0 -120 120 "
200 ~ 260 200 140 0.70
400 0 400 200 140 0.10
 600 60
800
1,000
120
160
I 54()
eao
200
140 0.70
l 8'!0 200
200 !
140 0.70
equllibrium level 01 ineo- . · 140 o.70
( ) _,.. C '.,9 IS detem,1
t ovv ro~es (AO ::::: C+I ::::: 680+ 120 - ned When AO ,. AS. Both are ual at Income of
11111 consumpt,on Function is ex re - 800 and AS. C.S. 680+ ~SOO).
MPCorb=:0.70 p SS&das:c .. t+b(Y) 120
Gwen: Autonomous Cons
umptlon (c) ,
Pulling the values of band-. "' 120 crores
c in the co
c = 120 + 0.7 {Y) nsumpUon function, we get:
Saving Function is expressed . _
MPS or 1-b=0.30 as.s"'-C+Y(l-b)
G1~en: Autonomous Consum ,
1 {c)- '120 [·:MPS• 1 - MPCJ
Pion
Pumng the values of 1 _ b d-. - crores
an c1nthesav1 ,
s = - 120 + 0.3 (Y) ng 1unction, we get
[IV) The break-even level of Income is ,
4
also t 400 Crores. oo Crorea as at this Income level, consumption Is
,:rnple 31. Find national income from th ,
AUtonomous consumption =, e 1o11owing·
· /Cl! if
100
Marginal propensity to consume
tnvestmenl
"'o.ao
tion:
We know: ~ational Income (Y) = Consumption (C) + Investment (I)
Consumption Function is given as: c = c + b{Y)
So, Y=C+b(Y)+l
Putting the values ofC, band I, we get
Y=100+0.8Y+SO
0.2Y =- 150
Nalional Income (Y) = t 750

iample 32. The saving function of an economy is given as: S =- 25 + 0·25 Y. If the planned
~naslment is~ 200 crores, calculate the following: (i) Equilibrium level of income in the economy.
fQJAggregate demand at income of? 500 crores. {CBSJ 11/1
>liuflim.
1
il We know !hat the equilibrium level of income in an economy is determined when: S = I.
According to the question:
200 = -25 + 0.25V
225=0.25Y
Y= ~ 900 crores.
 ... w. tcnow that In an economv: AD• c + •·~
Acoo,dlng to 1118 questlOn, AD at ,ncorne
C • 25 + (1 - 0·25) Y
500 crores wtll be:

AD •25+ (1-0.25)Y +200

AO• 25 + 0.75 (500) + 200
( ) 10 + o·20 Y. If the
l urnpl,
.
AD• f 600 crorea.
. .
The sa,'lng function of an
• 240
economy is given as: S = -
f ll ing• (i) Equilibri um level of inco
calculate the o ow . !tie i..
eic,
investments are, crores, 'ch will be needed to double the present "''
economy. (Ii) Additional investments whi (CBSE, All Ind ~el Of
equilibrium income. za io19 <1111
.
Solution: . . f income In an economy is determined when: s == 1
, We know that the equillbnum 1eve1o .
According to the question:
240 = -10 + 0.20Y
250=0.20 Y
Y = , 1,250 crores.
, l Given Equlllbrlum Level of Income= t 1,250 crores.To double this existing Income level, we Oeea
additional income of, 1,250 crores, I.e. fly=, 1,250 crores.To calculate the additional lnves1rneris
(Ill), we first need to calculate Investment Multiplier (k).

Investment Multiplier (k) = M~S = o.~O = 5

Change in Income (flY)
We also know: i< = Change in Investment (Ill)
1,250
Change In Investment (Ill) = 5
So, Change in Investment (Ill) = f 250 crores.

t xam plc> J4. Calculate the value of Marginal Propensi ty to Consume (MPC), if in an economy,
autonom ous consumption is t 500 crores, ex-ante investme nts are t 4,000 crores and equilibrium
level of Income of the economy is t 18,000 crores. {Cb . 1,,,,~i1 'llJ'l'f 2020
Solution:
Given, Autonomous Consumption (c) = t 500 crores and Ex-ante Investments (I) = t 4,000 Cl0le5
We know that consumption function Is: C = + MPC. c y (11 ,.
At equilibrium level of Income in the economy, Y = C + I or C = Y - I ...(2)
Putting value of C from (2) in (1 ), we get: Y - I= c + MPC. y
18,000 - 4,000 = 500 + MPC (18,000)
14,000 - 500 = MPC (18,000)
MPC (18,000) = 13,500
MPC = 13,500/18,000
MPC =0.75
~ {)B~ts;:;rm~ln~a_tfo_n__an_d_M_u_1t...ip_f,..;;,'e~r;;::;:::::::=------------------..!•.2:!!t
~ ~ IOF KEY P01NTSJ
,Approaches for determining Equilibrium·
1"'° D (or C + I) and AS Approach· E . . .
' (I} ,4AD) is equal to the planned avalt~bl~~l:num Is achieved_ when pla~ned expenditure of the economy
< vlng and Investment Approach·
58 goOds and serv1ces (AS). 1.e., when AD= AS.
(b) 5 . 9 Is equal to planned ln st • Equlllbrlum level of income Is determined at the level where planned
avin ve ment, i.e., when s =
ptoyment Equilibrium refers t It 1·
E111 O
' fl.IllWIY~ full employment level· as uatlon when aggregate demand Is equal to the aggregate
stJ ,nptoyment Equlllbriurn refer t • .
tJndere I vel where th s Q a situation when aggregate demand is equal to the aggregate
' stJPPIY al a e e resources are not fully employed.

, ()11Sr Full Emplol

ernpioyment leve .yment Equilibrium refers to a situation when AD Is equal to AS beyond the full

th
e ratio of change in income (6Y), to a change in investment (61). k=t:..Y_
, Multlpller (k) refers to
t:,,I
n,8 minimum value of multiplier can be one and the maximum value can be infinity.
Multiplier Is directly related with the MPC i.e. k = 1
' ' 1-MPC
Multiplier is inversely related with the MPS i.e. k = 1
' ' ' MPS
, working of Multiplier I~ based on the fact "One person's expenditure Is another person's income".
so, multiplier expre~es· the relationship between an initial Increment in investment and the resulting
increase in aggregate income.

HOTS HIGHER ORDER THINKING SKILLS QUESTIONS

0.1. •when MPC is equal to MPS, increase in income will be two times the Increase in investment".
Comment.
Ans. The given statement is correct. Equality between MPC and MPS signffies /hat both of them are equaf to

o.s (as MPC + MPS= 1). ft means, Multiplier (k) : M~S = ~ = 2. Ask= 2, it proves that increase in
05
Income wl(( be two times the Increase in investment
0.2. The saving function of an economy Is given as: S = - 40 + 0.4 (Y). Calculate the total increase in
income if investment expenditure increases by~ 700 crores.
Ans. We know, Saving function is expressed as: S = -c + (1-b)Y. It means, 0.4 indlcate.s (1 -b), i.e. MPS. So,
1 1
MPS= 0.4. Multipfier {k) = MPS _
04
= 2 ·5 ·
Change in Income (t:,. Y)
We afso know: Muftip/fer (k) Change fn Investment (t:,.I)
Given: Increase in investment expenditure (t:,.J) = t 700 crores

2_5 = Change in Income {I:> Y)

700
Change in fncome (t:,. Y) = ('1, 750 crores