Determination of Income and Employment

Economics
Class XII Points To Remember

Power Points
Introductory Macroeconomics
 1. Aggregate Demand and Aggregate Supply
National Income and Related Aggregate demand is measured in terms of total expenditure on the goods and services in the economy
Aggregates during a period of time, generally one year.
 Total Expenditure (Aggregate Demand) is measured as the sum total of consumption expenditure (C)
Money and Banking and investment expenditure (I). Hence,
AD = C + I
 It is important to note that, in the context of macroeconomic equilibrium, AD always refers to ‘desired
Determination of Income and
AD’ or planned AD. It is also called ex-ante AD.
Employment
Aggregate supply is measured as planned output of goods and services during a period of time,
 generally one year. At the +2 level, AS may be treated as identical with GDP. It is indicated by a 45° line
Government Budget and the from the origin when GDP is shown on the X-axis and AS on the Y-axis.
Economy 2. Consumption Function and Saving Function
 Consumption Function
Exchange Rate and Balance of Consumption function is the functional relationship between consumption (C) and income (Y).
Payments Consumption is positively related to income, i.e., rise in Y causes a rise in C and vice versa. However, there
 is always some minimum level of C, irrespective of the level of Y. Thus,
–
C = C + bY
Indian Economic Development
Here, C = Constant C or the minimum level of C.
–

 b = The rate at which C increases when there is a rise in Y. This is called

Examination Corner MPC (marginal propensity to consume).
 Saving Function
Saving function is the functional relationship between saving (S) and income (Y). Saving increases as
Test Yourself income increases. Implying that saving is positively related to income.
 However, since there is always some minimum level of consumption even when income is zero, it implies
that there must be some negative saving (indicated by – C in the saving function) when Y = 0. [Because,
–

Project Work –
Y = C + S. And, if C = 5 when Y = 0, S must be equal to – 5 (= – C ) when Y = 0]. Thus,
–
S =– C + (1 – b) Y

Here, – C = Constant S (indicating S when Y = 0).

–

1 – b = The rate at which S increases when there is a rise in Y.

It is called MPS (marginal propensity to save).
Propensity to Consume (APC and MPC) and Propensity to Save (APS and MPS)
Average Propensity to Consume
Average propensity to consume (APC) refers to the proportion of total income going to consumption
expenditure. It is measured as the ratio between total consumption (C) and total income (Y). Thus,
C
APC =
Y

Marginal Propensity to Consume

Marginal propensity to consume (MPC) refers to the proportion of additional income going to
consumption expenditure. It is measured as the ratio between change in consumption (ΔC) and change
in income (ΔY). Thus,
ΔC
MPC =
ΔY

Average Propensity to Save

Average propensity to save (APS) refers to the proportion of total income that goes to saving. It is
measured as the ratio between total saving (S) and total income (Y). Thus,
S
APS =
Y

Marginal Propensity to Save

Marginal propensity to save (MPS) refers to the proportion of additional income that goes to saving. It is
measured as the ratio between change in saving (ΔS) and change in income (ΔY). Thus,
ΔS
MPS =
ΔY

3. Equilibrium Output/Equilibrium GDP

In the context of macroeconomics, short run may be defined as a period of time when ‘technology’ as a
factor (affecting the level of output) remains constant. Accordingly, level of output is determined
exclusively by the level of employment in the economy (briefly employment of labour). Higher level of
employment causes proportionately higher level of output and vice versa. So long as there is
unemployment in the economy (implying the existence of excess capacity), general price level is assumed
to remain constant even when output level is increased.
Equilibrium output/Equilibrium GDP refers to a situation when in an economy:
AD = AS
[Aggregate Demand = Aggregate Supply]
So that, all that the producers wish to produce (or plan to produce) during the year is exactly equal to
what the buyers wish to spend on the purchase of goods and services during the year.
Since, AD = C + I, and AS = C + S
We can write the equation of equilibrium output/equilibrium GDP as under:
Equilibrium Output/Equilibrium GDP = C + S = C + I
Or, S = I
Thus, equilibrium output/equilibrium GDP is achieved when:
AD = AS
Or
S=I


 Ex-post and Ex-ante AS and AD (or S and I)
Economics In national income accounting,
Class XII (C + S) = (C + I) always
Or, S = I always
 But this equality refers to the equality between ex-post AS and AD or between ex-post S and I which is an
accounting identity. Ex-post means ‘actual’ or ‘realised’ and actual S is always equal to actual I.
Introductory Macroeconomics In the context of equilibrium level of income/output, what matters, is the equality between ex-ante AS and
 AD, or between ex-ante S and I. Ex-ante means ‘planned’ or ‘desired’ or ‘intend’.
Equilibrium is struck only when planned AS = planned AD (or planned S = planned I). It refers to AS as
National Income and Related planned by the producers for the year ahead and AD as planned by the consumers and investors for the
Aggregates year ahead.
 4. Concept of Investment and Multiplier
Money and Banking Investment
 Investment refers to expenditure that increases the stock of capital. It is also called capital formation.
Determination of Income and Types of Investment
Employment (i) Induced investment, and (ii) Autonomous investment.
 Induced Investment is related to the cost of investment (rate of interest) as well as the level of income in
Government Budget and the the economy.
Economy Autonomous Investment is not related to the cost of investment or the level of income in the economy.
 Multiplier
Exchange Rate and Balance of Investment multiplier (briefly called multiplier) is the ratio between change in income and change in
investment.
Payments
 K =
ΔY

ΔI

Where, K = Multiplier; ΔY = Change in income; ΔI = Change in investment.

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 Keep the Basic Fundas in Mind
(i) Higher MPS implies lower multiplier (K), as K = 1

MPS
.
Examination Corner (ii) Higher MPC implies higher multiplier (K), as K = 1
.

1 – MPC

(iii) Generally, 1 ≥ MPC ≥ 0; therefore, K ≥ 1.

Test Yourself 5. Excess Demand, Deficient Demand and their Correction
Meaning of Full Employment and Involuntary Unemployment
 Full Employment refers to a situation when all those who are able to work and are willing to work (at the
Project Work existing wage rate) are getting work.
Involuntary Unemployment refers to a situation when people are willing to work at the existing wage
rate, but are not getting work owing to lack of demand in the market.
Meaning of Excess Demand/Inflationary Gap and Deficient Demand/Deflationary Gap
Excess Demand/Inflationary Gap occurs when AD > AS corresponding to full employment level in the
economy.
Deficient Demand/Deflationary Gap occurs when AD < AS corresponding to full employment level in
the economy.
Situations of excess demand and deficient demand point to instability in economy.
Correction of Excess Demand and Deficient Demand: Fiscal and Monetary Policies
Fiscal Policy refers to the revenue and expenditure policy of the government to control the situations of
inflation and deflation in the economy.
Monetary Policy refers to the policy of controlling inflationary and deflationary situations in the
economy through increase or decrease in the flow of credit in the economy.