NCERT Solutions for Class 12

Social Science - Macro Economics

Chapter 4 – Determination of Income and Employment

1. What is the marginal propensity to consume? How is it related to marginal

propensity to save?

Ans: The term "marginal propensity to consume" refers to a person's proclivity to

Marginal propensity to consume is the ratio of change in consumption (C) to change
in income (Y). Marginal literally means "extra," and tendency to consume refers to
a desire (or impulse) to consume. As a result, MPC is the ratio of increased
consumption to increased income. It shows what percentage of additional money is
spent on additional consumption.

So,

C
MPC 
Y

Where,

C  Change in consumption

Y  Change in income

For example, if revenue rises from Rs 200 crores to Rs 250 crores but consumption
rises from Rs 20 crores to Rs 40 crores, the MPC is $0.4$, implying a 40% increase
in income consumed.

EXPLANATION WITH THE HELP OF DIAGRAM ARE AS FOLLOWS:-

Income in Rs(Y) Consumption expenditure in Rs (C)

200 20

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 250 40

C 20
Then, MPC    0.4
Y 50

Also, MPC can be explained with the given diagram.

In the diagram,x-axis represents national income and y -axis represents

consumption level

BC
So, MPC 
AC

The relationship between MPC and MPS can be explained as

The sum of MPC and MPS is equal to unity i.e., MPC  MPS  1

We know that income (Y ) is either spent on consumption (C) or saved (S).

Symbolically: Y  C  S

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OR,

Y  C  S

Dividing both sides by Y

Or,1  MPC  MPS

Or, MPC  1  MPS

Or, MPS=1-MPC

So, the sum of MPC and MPS is always equal to unity.

2. What is the difference between exante investment and ex post investment?

Ans: Planned investment (Ex-ante) is the investment that enterprises and planners
in the economy wish to make at the start of a period. Ex-post or real investment, on
the other hand, is the actual investment of a period (e.g., a year) measured after the
fact. It's worth noting that Keynes' theory includes stocks of unsold commodities,
which he referred to as "unplanned investment." As a result, actual investment is
equal to the sum of planned and unanticipated investments. In a nutshell, planned
investment is defined as intended (imaginary) or desired investment, whereas actual
investment is defined as planned + unplanned investment. It's important to remember
that sometimes investments are made that weren't originally planned. Unplanned
investment is the term for this type of investment. When unsold completed goods
amass due to poor sales, unplanned investment occurs. As a result, an economy's
actual investment is the sum of planned and unanticipated investment. Ex ante
investment is made based on future expectations, whereas Ex post investment is
made based on the actual outcome of variables.

3. What do you understand by' parametric shift of a line?How does a line shift
when its:

i. slope decreases, and

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ii. its intercept increases?

Ans: A graph resulting from a change in the value of a parameter is known as a

parametric shift.

Considering the equation of a straight line as

b  ma  

Where m  slope of straight line, m  0

  intercept on vertical axis,

 0

Also, when a increases by 1unit,the value of b increases by m units. The parameters

 and m are parameters of a graph.

The straight line spins higher around the same vertical intercept as the value of m
grows. This movement is an example of a graph's parametric shift.

(i) As the slope of a straight line diminishes, it rotates downward around the same
vertical intercept.

(ii) When the intercept of a straight line rises, it shifts upward in a parallel manner.

4. What is effective demand? How will you derive the autonomous expenditure
multiplier when price of final goods and the rate of interest are given?

Ans: Because aggregate demand becomes effective in influencing national income

at the moment of equilibrium, it is referred to as an effective demand. Or the phrase
"effective demand" refers to a situation in which the level of aggregate demand
determines equilibrium output. It's the degree of demand that a corresponding supply
can fully meet without needing to increase or decline. As a result, effective demand
is the amount actually spent. Because aggregate supply (or national income) is
considered to be given and constant in the Keynesian paradigm, which deals with
short run analysis, the level of aggregate demand (i.e., effective demand) determines

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the equilibrium level of income and employment. Furthermore, physical and
technical conditions affecting aggregate supply do not frequently change in the short
term. As a result, the level of effective demand, or AD, has an impact on output,
income, and employment. As a result, a rise in effective demand is required to raise
income levels. In other words, AD is the key to achieving full employment income.

The concept of effective demand can be explained with the help of the diagram
below

Autonomous expenditure multiplier is derived as Y  AD (at equilibrium)

Y  A  cY[ Where AD  A  cY ]
Y  cYn  An

Y (1  c)  A
A
Y
1 C

Where,

A  Autonomous expenditure

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c  MPC
Y  level of income

A
 autonomous expenditure multiplier
1 C

As a result, the autonomous expenditure multiplier is influenced by income and the

MPC.

5. Measure the level of ex-ante aggregate and when autonomous investment and
consumption expenditure (A) is Rs 50 crores,and MPS is 0.2 and level of
income(Y) is Rs 4000 crores. State whether the economy is in equilibrium or
not (cite reasons).

Ans: Consumption expenditure ( A)  Rs 50 Crores

MPS  0.2

So, MPC  1 MPS

 1  0.2

 0.8

Y  4000 Crores

We know that AD  A  cY (1)

Putting the values inequation. (1)

AD  50  0.8  4000
 50  3200
 Rs 3250 Crores
But, Rs 3250  Rs 4000

 AD  Y . or AD(aggregate demand) of Rs. 3250 crores is less than Y (income) of

Rs 4000 crores.

As a result, we might conclude that the economy is out of balance.

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6. Explain Paradox of Thrift'.

Ans: The paradox of thrift refers to a situation in which people tend to save more
money, resulting in a drop in the economy's overall savings. To put it another way,
if everyone increases their saving income proportion, i.e. MPS(s), aggregate demand
will fall as consumption falls. This will result in a reduction in employment and
income, as well as a reduction in total savings for the economy. John Maynard
Keynes, a British economist, proposed and popularized this concept. He believes
that increasing individual saving will contribute to a progressive slowing of the
economy in terms of the circular flow of income. Some have compared it to the
Prisoner's Dilemma in that saving is beneficial to the individual but harmful to the
entire nation. With the help of the diagram below, we can better grasp this statement:

The beginning saving curve is SS, and the investment curve is II in Fig. 8.14. At E,
the economy reaches equilibrium (savings Equals investment), and income is at OY.
Assume that the society decides to become more frugal by cutting consumption and
increasing savings by, say, AE. As a result, the saving curve swings upward,
intersecting Investment curve II at E1 at S1S1.

Unplanned inventories will rise, companies will reduce production and employment,
and move to new equilibrium 1 will be disrupted. The chart depicts how, in the end,
intended saving fell from AY to E1Y1. Notice that at the new point of equilibrium
E1, investment levels and realised savings remain unchanged (E1Y1), but income

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levels have declined from OY to OY1. The paradox of thrift can be seen in the
decline in equilibrium level of income, as the reverse process of multiplier has
worked to reduce consumption expenditure. In reality, increased saving is essentially
a withdrawal from the revenue cycle.

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