Aggregate Demand

Aggregate demand is the total amount of final goods and services which all the
sectors are planning to buy in an economy at a given level of income over a
given period of time. For example consumer goods, services, and capital goods

OR

Ad is the aggregate expenditure that different sectors of the economy are willing
to incur during a given period of time

It ia flow concept

Components Of Aggregate Demand

There are four components in Aggregate Demand

1. Private Consumption Expenditure (C)

2. Investment Expenditure(I)
3. Government Expenditure(G)
4. Net Exports (X-M)
5.

Aggregate Demand = C+I+G+(X-M)

1. Private consumption expenditure (C) or Household consumption

expenditure
It refers to the expenditure on the final consumer’s goods and services by
the households to satisfy their wants.
2. Investment expenditure (I)
It refers to the expenditure incurred on capital goods by private firms to
increase their production capacity. These capital goods are in the form of
machinery, building, land, etc. It is assumed that investment expenditure
is autonomous and not influenced by level of income.
3. Government expenditure (G) refers to the expenditure incurred by the
government on the purchase of goods and services to meet the needs of
the people in the economy. It is determined by the policy of the
government.
 4. Net Exports (X-M) It refers to the difference between exports and imports
i.e., X-M
Where X stands for Exports and M stands for Imports.

Aggregate Demand In Two-Sector Model

In a two-sector model, it is assumed that Aggregate demand is a function of
Consumption and Investment only.

Aggregate Demand In Two-Sector Model = C+ I

Where

C= consumption expenditure

I = Investment

Aggregate Demand Schedule And Graph

Important Concepts About Aggregate Demand
1. Aggregate demand is a function of Consumption and investment only.
2. The investment expenditure is assumed to be autonomous which means it
will remain constant at all the levels of income.
3. The investment curve will be a straight line, parallel to the X-axis as it is
not affected by the change in income level.
4. Consumption will be positive even at zero level of income as the minimum
level of consumption is done for survival. This consumption is known as
‘Autonomous consumption’.
5. The slope of the consumption curve is positive which shows that when
income increases consumption also increases.
6. The starting point of the AD curve is above zero as there is always a
minimum level of consumption and investment in the economy.
Meaning Of Aggregate Supply
Aggregate Supply is the value of all final goods and services that all the
producers are planning to supply over a period of time.

Aggregate Supply =Y

HOW?: Output produced in an economy is always equal to the income generated

. Aggregate Supply is equal to all final goods and services produced in the
economy which is equal to the national income.the value of total output is
distributed to factors of production in the form of rent,wages,interest and
profit .the sum total of these factor incomes at domestic and national level is
termed as national income.

Aggregate Supply = OUTPUT =Y

Y = Aggregate Supply

Components Of Aggregate Supply

NATIONAL INCOME (Y) = CONSUMPTION (C) + SAVINGS (S)

Y=C+S

Consumption and savings are the two components of Aggregate Supply.

Aggregate Supply Schedule And Graph
Aggregate Supply = C + S

The straight line is obtained which will originate from point of origin will form a 45degree
angle there by establishing the relation of Y=C+S

Important Concept About Aggregate Supply

The slope of the AS curve is positive as the level of income increases aggregate
supply also increases .

Consumption Function Or Propensity To

Consume
Consumption function or propensity to consume is the functional relationship
between consumption and income.

It is psychological concept as it is influenced by subjective factors(consumer

preference)
C= f (Y)

Consumption Equation
C = c‾ + bY

Where

C= Level of consumption

C¯= Autonomous consumption

b = MPC

Y = Level of income

Important Points About Consumption

1. The slope of the consumption curve is positive as consumption increases
when leveling of income increases. Rise in consumption < rise in income
 2. The starting point of the consumption curve is above zero as the is always
some minimum level of consumption which is termed as “Autonomous
consumption”.
3. The point where C=Y is termed as break-even point as at this point
Consumption is equal to income.
4. Before the break-even point in the economy because consumption is more
than income after the break-even point savings will start as now the
increase in consumption is less than the increase in income.

Keynesian psychological law of consumption

This law states that
 There is a minimum consumption known as autonomous consumption
even at zero level of income because survival needs consumption
 As the income increases, consumption also increases
 Income rises at a greater proportion as compared to increase in
consumption

Types Of Propensity
1. Average Propensity to Consume (APC)
2. Marginal Propensity to) Consume (MPC)
Average Propensity To Consume(Apc)

APC is the ratio of total consumption to total income.

Average Propensity To Consume = C/Y

Important Concepts About Apc

1. APC can never be zero as consumption can never be zero.

2. At the break-even point, APC is equal to 1.
3. Before the break-even point, APC is less than 1.
4. After the break-even point, APC is more than 1.
5. APC falls with an increase in income.

Marginal Propensity To Consume

MPC is the ratio of change in consumption to change in income.

MPC = ΔC / ΔY

Important Concepts About Mpc

1. The value of MPC can never be greater than 1.

2. The value of MPC is 1 when the entire additional income is spent on
consumption
3. The value of MPC is 0 when the entire additional income is saved.
4. The value of MPC lies between 0 to 1.

Savings Function Or Propensity To Save

Savings function or propensity to save is the functional relationship between
savings and income.

S= f (Y)

Savings Equation
S = – ¯c+ (1- b)Y
Where

C= Level of consumption

– ¯c= Negative savings at zero level of income

1-b = MPS

Y = Level of income

Important Points About Savings

1. Savings Curve starts from a point below the origin.i.e.negative.
2. The slope of the savings curve is positive
3. At the break-even point, savings are equals to 0.
4. After the break-even point savings become positive.
5.
Types Of Propensity To Save
1. Average Propensity to Save (APS)
2. Marginal Propensity to Save (MPS)
Average Propensity To Save(Aps)
APS is the ratio of total savings to total income.

APS = S/Y

Important Concepts About APS

1. APS is zero at the break-even point.

2. APS can never be equals to 1 or more than 1.
3. APS can be negative or less than
4. APS rises with increase in income.
Marginal Propensity To Save
MPS is the ratio of change in savings to change in savings.

MPS = ΔS / ΔY
Important Concepts About MPS

1. The value of MPS varies between 0 and 1.

2. If the entire increased income is saved the value of MPS will be 1.
3. If the entire increased income is consumed the value of MPS will be 0.

Relationship Between APC And APS

APC + APS = 1

Relationship Between MPC And MPS

MPC + MPS = 1

Full Employment And Involuntary

Unemployment
FULL EMPLOYMENT: It is a situation when people who are willing and able to
work are getting work.

Under full employment, there can be two types of unemployment

 Frictional Unemployment: Frictional unemployment can be defined as a

type of unemployment that occurs when a person is in the process of
moving from one job to another.
 Structural Unemployment: Structural unemployment occurs because of a
mismatch between the skills workers have, and the jobs that are actually
available in the market. Structural unemployment usually happens
because of technological change.
Involuntary Unemployment
Involuntary unemployment refers to a situation when people are ready to work at
the prevailing wage rate in the market but do not find a job
 Formula
1. Y=C+S
2. AD=C+I
3. ASC+S
4. APC=C/Y = 1-APS
5. APS=S/Y =1-APC
6. MPC= ΔC / ΔY = 1-MPS
7. MPS= ΔS / ΔY =1-MPC
8. C== c‾ + bY
9. S = – ¯c+ (1- b)Y