Chapter-6

Determination of Income and Employment

Introduction
Equilibrium level of national income is determined by aggregate demand and aggregate supply.
The determination of the equilibrium level of income requires the understanding of concepts like
aggregate demand and aggregate supply, involuntary unemployment and full employment.

AGGREGATE DEMAND
Aggregate demand refers to the total value of final goods and services which all the sectors of an
economy are planning to buy at a given level of income during the period of one year.

Components of Aggregate Demand

Aggregate demand in an economy is measured in terms of total expenditure on goods and
services that various sectors of the economy are willing to incur, during a year. The main
components of aggregate demand are:-

i) Private consumption demand (C):- It refers to the demand for all consumer goods and
services by the households of a country at a level of income during a year. This demand depends
upon the disposable income of the households.

ii) Private Investment demand (I):- It refers to the ex-ante expenditure by private firms on the
purchase of new capital goods like machinery, equipments etc., and change in inventory.

iii) Government demand for goods and services (G):- It refers to the expenditure by the
general government on providing goods and services for collective consumption.

iv) Net exports (X-M) :- It refers to the net demand for domestic goods and services by the rest
of the world. It equals exports (X) minus imports (M).

AD = C + I + G + ( X-M )

AGGREGATE SUPPLY

Aggregate supply means the value of final goods and services that all the producers are willing to
supply in an economy in a given period of time.
Components of Aggregate supply
A major part of income is spent on consumption expenditure (C) and savings (s) in the economy
during a year.

AS = C + S

Consumption function
Consumption means the total expenditure made by the households on the purchase of goods and
services at a given level of income.

On the other hand , consumption function refers to the schedule showing consumption
expenditure at various income levels. The functional relationship between consumption and
income is called consumption function.

It is expressed by following equations:-

C=f(Y)

C denotes the consumption of households and Y denotes the disposable income.

Consumption functions also called as propensity to consume.

There are two measures of propensity to consume.

1. Average propensity to consume (APC)

2. Marginal propensity to consume (MPC)

Average propensity to consume (APC)

The value of consumption at a particular level of income is called average propensity to
consume. In other words, APC is the ratio of total consumption expenditure to total income.

𝑪
APC =
𝒀

APC = Average propensity to consume, C = Consumption, Y = Income

Marginal propensity to consume

Proportion of change in consumption expenditure to change in income is called marginal
propensity to consume. It indicate that part of additional income which is spend on consumption.

𝚫𝑪
MPC =
𝚫𝒀
Consumption Function Curve

Consumption a = 𝐶̅

O Income X

Consumption Function Equation

Algebraically, the general equation for a linear consumption function is given by:

̅ + bY
C=𝑪

Where, C is aggregate consumption expenditure; Y is income.

Intercept of 𝐶̅ represent a positive constant equal to the level of consumption at zero level of
income, b denotes marginal propensity to consume, i.e., the slope of the consumption line, bY
denotes induced consumption which depends on level of income.

Saving Function
Excess of income over consumption is called saving.

Saving unction refers to the functional relationship between saving and income.

This can be expressed as :

S = f (Y)

Saving function is also called propensity to save.

S=Y-C
There are two measures of propensity to Save.

1. Average propensity to save (APS)

2. Marginal propensity to save (MPS)

Average propensity to Save ( APS)

It is the ratio of total saving to total income.

𝑺
APS =
𝒀

APS = Average propensity to save, S = saving; Y = Income

Marginal propensity to Save

It refers to the ratio of the change in savings to the change in income.

𝚫𝑺
MPS =
𝚫𝒀

Saving Function Curve

Y
S1

Saving

O B X
S Income
Saving Function Equation
We know, S=Y-C (i)

and C = 𝐶̅ + bY (ii)

Putting the value of C from (ii) in (i), we get

S = Y - ( 𝐶̅ + bY )

S = Y - 𝐶̅ - bY

S = - 𝐶̅ + Y - bY

S = - 𝐶̅ + (1 - b)Y

Relationship between APC and APS

The sum of APC and APS is always equal to one. This is proved as under:

Income is either consumed or saved.

Thus, Y=C+S

Dividing the equation both side by Y

𝑌 𝐶 𝑆
=𝑌+𝑌
𝑌

1 = APC + APS

Thus relationship can also be stated in the following way:

APC = 1 - APS

APS = 1 - APC

Relationship between MPC and MPS

MPS = 1 - b

MPC = b

Therefore, the sum of MPC and MPS is always equal to one. (1 - b + b = 1). This is because
income is either consumed or saved.
The relationship between MPC and MPS can also be explained in another way. We know that a
major part of increase in income is spent on consumption and the rest is saved.

this can be written as: ∆𝑌 = ∆𝐶 + ∆𝑆 (i)

Now dividing the equation (i) both sides by ∆𝑌

Δ𝑌 Δ𝐶 Δ𝑆
= Δ𝑌 = Δ𝑌
Δ𝑌

1 = MPC + MPS (ii)

This relationship can further be explained as under:

MPC = 1 - MPS

MPS = 1 - MPC

INVESTMENT
Investment means expenditure made up on purchase of new capital assets like machines, tools,
equipments etc. It implies an addition to the existing stock of capital. It increase the productive
capacity of an economy.

Types of Investment

Induced Investment
Induced Investment refers to the investment which is made with the motive of earning profit. It is
directly influenced by income level. It is income elastic.
 Y

I1

Investment I0

O Y0 Y1 X

Income

Autonomous Investment
Autonomous Investment which is independent of the level of income. It is not influenced by the
change in income. It is income inelastic.

Investment (I) I0 I

O Y0 Y1 X

Income
Ex-ante and Ex-post Saving and Investment
'Ex-ante ' means planned and 'Ex-post' means actual or realised. There are two aspects of savings
and investment:

Ex-ante savings and Ex-ante Investment

• Ex-ante saving refers to amount of saving which households plan to save at different
levels of income in the economy.
• Ex-ante investment refers to amount of investment which firms plan to invest at different
levels of income in the economy.

Ex-post saving and Ex-post Investment

• Ex-post saving refers to the actual saving in an economy during a year. It a sum total of
planned saving and unplanned saving.
• Ex-post investment refers to the realised or actual investment in an economy during a
year. It is the sum total of planned investment and unplanned investment.

Full Employment
Full employment is a situation where people willing to work at the existing wage rate have been fully
employed. There is no involuntary unemployment at the full employment i.e. all the resources have
been fully employed.

Involuntary unemployment
Involuntary unemployment occurs when those who are able and willing to work at the existing wage
rate do not get work.

Voluntary unemployment
Voluntary unemployment is that where people consciously decide not to work at the prevailing wage
rate.

Equilibrium Income
Equilibrium level of income is that level of income where aggregate demand equals to aggregate
supply in an economy.
 AD = AS

Full Employment Equilibrium

Full employment equilibrium is a situation when AD and AS are equal. This is also known as
income/output/employment equilibrium.

When AD = AS then that level of aggregate demand is effective demand.

Full employment equilibrium

AD = AS

C+I=C+S

Under Employment Equilibrium

An economy is in equilibrium when aggregate demand and aggregate supply are equal. Aggregate
demand may not be sufficient for aggregate supply at full employment. This means aggregate
demand is only sufficient to support aggregate supply at less than full employment level. So the
two would be equal at less than full employment. Thus the economy can be in equilibrium when
there is unemployment in the economy.

Investment Multiplier
Multiplier is the investment of change in income due to change in investment. It shows how
income is generated in the economy when there is additions investment.

Δ𝑌
K=
Δ𝐼
EXAMS ORIENTED QUESTION/ANSWER
Q1. What is Aggregate demand? State its components?
Ans- Aggregate demand refers to the total value of final goods and services which all the sectors
of an economy are planning to buy at a given level of income during the period of one year.

Components of Aggregate Demand

Aggregate demand in an economy is measured in terms of total expenditure on goods and

services that various sectors of the economy are willing to incur, during a year. The main
components of aggregate demand are:-

i) Private consumption demand (C):- It refers to the demand for all consumer goods and
services by the households of a country at a level of income during a year. This demand depends
upon the disposable income of the households.

ii) Private Investment demand (I):- It refers to the ex-ante expenditure by private firms on the
purchase of new capital goods like machinery, equipments etc., and change in inventory.

iii) Government demand for goods and services (G):- It refers to the expenditure by the
general government on providing goods and services for collective consumption.

iv) Net exports (X-M) :- It refers to the net demand for domestic goods and services by the rest
of the world. It equals exports (X) minus imports (M).

AD = C + I + G + ( X-M )

Q2 What is Aggregate supply? What are its components?

Ans- Aggregate supply (AS) is the total supply of goods and services in the economy in an
accounting year. Aggregate supply is nothing but national income because national income is
defined as the value of final goods and services in the economy. National income is distributed
among the four factors of production.
Hence the components of national income i.e. compensation of employees, rent, interest and
profits also become the components of AS.
Since income is either consumed or saved, we can say national income or aggregate supply (AS)
is the sum of consumption expenditure (C) and savings (S).
AS = C + S.

Q3. What is Consumption Function or propensity to Consume or Keynesian ‘ Psychological Law

of consumption.
Ans- Consumption function or propensity to consume shows the relationship between income
and consumption. Keynes stated that ‘Men are disposed, as a rule and on the average, to increase
their consumption as their income increases, but not as much as the increase in their income’.
Q4. What is Average propensity to consume (APC)?
Ans- APC is the ratio of consumption to income at any particular level of income. APC = C/Y.
For e.g. if income is Rs.1000 and consumption id Rs.500, then APC = 1000/500 = 0.5.
APC declines with the increase in income. This means that as income increases, the proportion
of income saved increases and the proportion of income consumed decreases.

Q5. Define Marginal Propensity to Consume (MPC).

Ans- MPC is defined as the rate of change in consumption per unit change in income. For e.g. if
MPC=0.6 then a rupee change in income causes a 0.60 rupee change in consumption.

Q6. Write the relationship between APC and APS.

Ans- APC + APS = 1

L.H.S = APC + APS

C S
= +
Y Y
C+S
= Y
Y
= Y
=1
L.H.S = R.H.S
APC + APS = 1
APC = 1 – APS
APS = 1 – APC

Q7. Write the relationship between MPC and MPS.

Ans-Relationship between MPC & MPS

MPC + MPS = 1
L.H.S = MPC + MPS
∆C ∆S
= ∆Y + ∆Y
∆C+∆S
= ∆Y
∆Y
=
∆Y
= 1.
L.H.S = R.H.S
 MPC + MPS = 1
MPS = 1 – MPC
MPC = 1 – MPS
Q8. Explain Consumption Function or Propensity to Consume.
Ans- Consumption Function or propensity to Consume shows the relationship between income
and consumption. According to Keynesians ‘Psychological law of consumption’ the following
points become clear:-
(i) Consumption depends upon income. If income is more, consumption will be more and
vice versa.
(ii) Income can be zero but consumption can never be zero. The consumption at zero level
of income is called ‘autonomous consumption’.
(iii) As the income increases, consumption also increases but not as much as the increase in
their income.
The consumption function may be represented by the following equation: C = C` + bY.
Where C = consumption, C` = autonomous consumption, b = marginal propensity to
consume, Y = level of income. The intercept C` represents autonomous consumption that is
amount of consumption expenditure when income is zero. C` is assumed to be positive, that
is there is consumption even in the absence of any income. Hence, it is not possible to think
of a situation where there is no consumption at all.
The slope of the consumption function is ‘b’. It measures the rate of change in consumption
per unit change in income and also known as Marginal propensity to consume. For e.g. if ‘b’
or MPC is 0.5, then a rupee change in income causes a 0.50 rupee change in consumption.
By assumption, the MPC is positive and its value ranges between 0 to 1. This means that
consumption increases with income, but a rupee increases in income causes less than a
rupee increase in consumption. For e.g. if ‘b’ or MPC is 0.90, a rupee increase in income
causes a 0.90 rupee increase in consumption. The consumption function may be plotted in a
graph, with the help of a numerical example. C = 100 + 0.5Y. Since it is an equation of
straight line, the consumption will have a constant slope. The below table shows the level of
consumption for various levels of income.
Consumption, income and marginal propensity to consume (MPC)
INCOME CONSUMPTION CHANGE IN CHANGE IN MPC
(Y) (C) CONSUMPTION INCOME
0 100 - - -
100 150 50 100 0.5
200 200 50 100 0.5
300 250 50 100 0.5
400 300 50 100 0.5
500 350 50 100 0.5
The MPC at all levels of income is same because of consumption function C = 100 + 0.5Y.
The graph below shows consumption function C = 100 + 0.5Y.
 Y

Break-even point Y = (C + S)

Consumption
C<Y
Y=C C

C>Y

O X
Income (Y)

On the OX axis measures income and OY axis measures consumption. The 45* line shows
the equality between income and consumption. At point E, Y = C. It is called break-even
point. Before the break-even point the consumption function lies above the 45* line
therefore, consumption expenditure is greater than income (C>Y). Hence, the households
either sell their assets or borrow to finance the consumption over and above the level of
income. This act on the part of the households to liquidate their own assets or to go in for a
loan is referred to as the process of dissaving. When the two lines, i.e. consumption function
and 45* line intersect the level of consumption is equal to the level of income. It is called
the break even point. Here C = Y. When the consumption function lies below the 45* line,
the level of consumption is less than the level of income. Here Y>C. It means that there is
positive savings. The amount of dissaving or savings are always measured by the vertical
distance between the consumption function and the 45* line.

Q9. Explain Saving Function or propensity to save.

Ans- Saving is that part of income which has not been consumed. Hence, S = Y-C. The saving
function shows the relationship between income and savings. Substituting the consumption
function in to the above equation we can get the saving function.
S = Y-C
= Y-(C` + bY)
 = Y-C` - bY
S = -C` + (1-b) Y
This is saving function. The intercept –C` is the amount of savings done when there is zero
level of income. We know that C` is savings positive. There is negative savings C` at zero level
of income. Since negative saving is nothing but dissaving, this saving of amount C`. The amount
of autonomous consumption is exactly equal to the amount of dissaving at zero level of income
because Y = C + S.
Savings function shows:-
(i) At zero level of income dissavings are equal to autonomous consumption i.e. C`.
(ii) As the income increases, savings also increase.
(iii) When C>Y, savings are negative.
(iv) When C = Y, savings = 0. It is called Break-even point.
(v) When Y>C, savings are positive because income is either consumed or saved.
The slope of the saving function is (1-b). The slope of the savings function gives the
increase in savings per unit increase in income. This is known as Marginal Propensity to
Save (MPS). Since ‘b’ is less than one it follows that (1-b) and therefore MPS is positive.
Therefore, savings is an increasing function of income. Suppose every one rupee increase
in income, savings increase by 0.5 rupee. Note that MPS = 1-b = 1- MPC. This means that
the part of the increase in income, which is not consumed, is saved. This is because income
is either consumed or saved. Therefore MPC + MPS = 1. For e.g. if the consumption
function is C = 100 + 0.8 Y then the saving function will be S = -100 + (1 – 0.8) Y. The
below table shows the levels of consumption sand savings for various levels of income.
Note that consumption plus savings everywhere equals income and MPC + MPS = 1. The
MPS is the same at all levels of income because of the particular savings function (a linear
curve with constant slope and therefore constant MPS is a feature of all straight line
savings functions). Consumption function saving relationship S = -100 + (1-0.5) Y.

Y C MPC S MPS C+S MPC +

MPS
0 100 0.5 -100 - 0 -
100 100 0.5 -50 0.5 100 1
200 100 0.5 0 0.5 200 1
300 100 0.5 50 0.5 300 1
400 100 0.5 100 0.5 400 1
500 100 0.5 150 0.5 500 1
 Y S

B
∆𝑆

Saving (S)

∆𝑌
O X

S Income (Y)

Saving Function is explained with the help of a graph. Part A shows the consumption
function, Part-B shows the saving function, Part- A shows the mount of saving at any level
of income is the vertical distance between the consumption function and the 45* line. The
saving functions shown in part – B can therefore be directly derived from part- A. At OQ
level of income, income is equal to consumption. It is called break even point. When Y=C,
savings are zero. This is depicted in part B by the intersection of the saving function with
the help with the horizontal axis at point B, at income level of OQ. When consumption is
greater than income, the consumption function lies above the 45* line. This is the left of the
break even point E. here the savings are negative. Hence in part B the saving function lies
below the horizontal axis. To the left of point B in part B, there are negative savings.
When income is greater than consumption, the consumption function lies below the 45*
line in part A. It is on the right hand side of the break even point E. Since Y>C, savings are
positive. Hence to the right of the point B in part B, savings are positive and the saving
function lies above the horizontal axis.

Q10. What is Average Propensity to Save (APS)?

Ans- Average propensity to save is defined as the ratio of savings to income at any particular
level of income. APS = S/Y. APS increases as income increases because the proportion of
income saved increases and the proportion of income consumed decreases.

Q11. What is Marginal Propensity to Save (MPS).

Ans- MPS is defined as the rate of change in savings per unit change in income. If MPC = 0.8
then MPS = 0.2. This means that for every one rupee increases in income, savings increase by
0.2 rupee. The sum of MPC and MPs is equal to one.

Q12. Show the algebraically derivation of consumption function

Ans- C = a + bY (Linear consumption function)

a = 𝑐̅ = autonomous consumption (at y = 0)

b = MPC
Y = Income
C = Consumption
Y C b = MPC
∆c
0 50 =
∆y
100 100 −
200 150 0.5
300 200 0.5
400 250 0.5
500 300 0.5
0.5
C = a + bY
C = 50 + 0.5Y
Y=0
C = 50 + 0.5y
= 50 + 0.5(0)
= 50
Y = 500
C = 50 + 0.5y
= 50 + 0.5(500)
= 50 + 250
= 300

Q13. Show the algebraically derivation of saving function.

Ans- S=Y–C

S = Y – (a + bY)
S = Y – a – bY
S = – a + Y – bY
 S = – a + y(1 – b)
S = – a + y × MPS

a = 𝐶̅ = autonomous consumption (at y = 0)

b = MPC

Y = Income

C = Consumption

Y C ∆c S=y–c
b = MPC =
∆y

0 50 − – 50

100 100 0.5 0

200 150 0.5 50

300 200 0.5 100

400 250 0.5 150

500 300 0.5 200

S = – a + (1 – b)y

S = – 50 + (1 – 0.5)y

S = – 50 + 0.5y

Y=0

S = – 50 + 0.5(0)

= – 50

Y = 100

S = – 50 + 0.5(100)

= – 50 + 50

=0
Q14. If C = 100 + 0.5Y, then prove that when income increases, APC decreases?

Ans- Let Income,Y = 0

When Y = 0 When Y = 300

C = 100 + 0.5Y C = 100 + 0.5Y

= 100 + 0.5(0) = 100 + 0.5(300)

= 100 = 100 + 150

= 250

When Y = 100 When Y = 400

C = 100 + 0.5Y C = 100 + 0.5Y

= 100 + 0.5(100) = 100 + 0.5(400)

= 100 + 50 = 100 + 200

= 150 = 300

When Y = 200 When Y = 500

C = 100 + 0.5Y C = 100 + 0.5Y

= 100 + 0.5(200) = 100 + 0.5(500)

= 100 + 100 = 100 + 250

= 200 = 350

Y (Income) C (C = 100 + 0.5y) c

APC =
y
0 100 −
100 150 1.5
200 200 1
300 250 0.83
400 300 0.15
500 350 0.7
Hence, proved when income increases APC decreases
Q15. Prove that when income increases, APC increases. If S = – 30 + 0.5Y

Ans- When Y = 0 When Y = 300

S = – 30 + 0.5Y = – 30 + 0.5Y
= – 30 + 0.5(100) = – 30 + 0.5(400)
= – 30 + 50 = – 30 + 200
= 20 = 170

Y (Income) S s
APS ( )
y
0 –30 −
100 20 0.2
200 70 0.35
300 120 0.4
400 170 0.4
500 220 0.44
Hence, proved, when income increases, APS also increases

Q16. What is break-even point?

OR

Draw a straight line consumption curve and show that point where APC = 1.

OR

Draw a straight line saving curve and show that point where APS is 0.

OR

Explain the derivation of saving curve by income and expenditure (consumption)?

Ans- Saving is the difference of income and consumption S = Y – C. It is that part of income
which is not spends on consumption saving increases due to increase in income but increase in
saving are less than increase in income.
Break-even point is that point where income and consumption are equal and at that same
point APC = 1 and APS = 0. Following is the derivation of saving curve by income and
consumption curve.
Y C S(Y – C)
0 50 −50
100 100 0
200 150 50
300 200 100
400 250 150
500 300 200
Y = C Break-even point.
c 100
APC = y = 100 = 1
APS = 1 – APC
=1–1
= 0. Y
S=Y–C
= 100 – 100
=0

Consumption
Y>C C
Y=C
APC = 1
C BEP
Y<C

O X
Income S
Y

S (+)

Savings

Dissaving S = 0 APS = 0

O S (-) Income X
 In the above drawn diagram income is represented on x-axis and consumption savings are
shown on y-axis. Income curve is a line passing through origin making an angle of 450 as
national output is equal to national income, when autonomous consumption is 50 then
consumption curve starts above original saving curve starts two origin when savings are
negative because is less than consumption saving curve intersect x-axis when savings are
zero due to equality of income and consumption i.e., break-even point saving curve is
above x-axis when income is more than consumption.

Q17. Explain the working of multiplier?

OR

Explain the process of multiplier?

OR

Explain how investment generates income?

Ans. Multiplier is the investment of change in income due to change in investment. It shows
how income is generated in the economy when there is additions investment.

Δ𝑌
K=
Δ𝐼
50
Let MPC = 50% = = 0.5
100

𝑐 = 100
1 1 1
K= = 1−0.5 = 0.5 = 2
1−𝑀𝑃𝐶

Δ𝑌
K=
Δ𝐼
Δ𝑌
2=
100

200 = ∆𝑌
 Rounds ∆𝐼 ∆𝑌 ∆𝐶 ∆𝑆
I 100 100 50 50
II -- 50 25 25
III -- 25 12.5 12.5
IV -- -- -- --
V -- -- -- --
100 200 100 100

In the above drawn table the initial investment in first round is 100 resulting increase in income
is 100 and increase in consumption expenditure & saving is 50 each as MPC is 0.5 (50%). In
second round the additional income is generated is 50 as consumption expenditure of one person
becomes the income of another person so consumption expenditure is 50 in Ist round becomes the
income in IInd round consumption expenditure and saving is 25. This process will go on till
change in income becomes 200, change in consumption and saving 100 each.

Q18. Differentiate between autonomous investment and induced investment.

Autonomous Investment Induced Investment

It is investment which remains constant It is that investment which changes due to

irrespective change in income change in income

This type of investment related to government This type of investment related to private
sector sector

Autonomous Investment curve is a line Induced Investment curve is a line which is

parallel to x-axis upward sloping

Income Investment Income Investment

100 20 100 10
200 20 200 20
300 20 300 30
Q19 Define the following

i) Ex-ante saving

ii) Ex-ante investment

iii) Ex-post saving

iv) Ex-post investment

v) Full employment

vi) Involuntary unemployment

vii) Voluntary unemployment

Ans-

i) Ex-ante saving refers to amount of saving which households plan to save at different levels of
income in the economy.

ii) Ex-ante investment refers to amount of investment which firms plan to invest at different
levels of income in the economy.

iii) Ex-post saving refers to the actual saving in an economy during a year. It a sum total of
planned saving and unplanned saving.

iv) Ex-post investment refers to the realised or actual investment in an economy during a year. It
is the sum total of planned investment and unplanned investment.

v) Full employment is a situation where people willing to work at the existing wage rate have been fully
employed. There is no involuntary unemployment at the full employment i.e. all the resources have
been fully employed.

vi)Involuntary unemployment occurs when those who are able and willing to work at the existing wage
rate do not get work.

vii) Voluntary unemployment is that where people consciously decide not to work at the prevailing
wage rate.
Q20. Explain National Income equilibrium by AD and AS ( Keynesian approach )

OR

Explain full employment equilibrium.

OR
Explain National Income equilibrium by C + I approach

OR

Explain effective demand

OR

Explain Income/Output/employment equilibrium.

Ans-National income equilibrium is a situation when AD and AS are equal. This is also
known as

income/output/employment equilibrium. When AD = AS then that level of aggregate

demand is effective demand. Following is the table and diagram showing

National Income equilibrium

AD = AS

C+I=C+S

Y C S=Y–C I AS AD(C + I)

0 50 −50 100 0 150

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

AS = Y

AD < AS AD = C + I

AD/AS E

Full employment Equilibrium

AD > AS

O Y X

Income

In the above drawn diagram NY is measured on x-axis and AD and AS on Y-axis at point AD
curve intersects AS curve depicting full employment equilibrium with NY of 300. There can be
two situation which may arise in an economy.

(i) When AD>AS.

In this situation investment is more than savings stock of goods lying with the
firms due to investment demand which lead to increase in
output/employment/income and saving. Hence, AD and AS achieve equality.

(ii) When AD<AS.

In this situation Investment is less than savings stock of goods lying with the firm
increase due to investment demand which lead to decrease in output, employment,
Income and saving. Hence AD, AS achieve equality.

Q21. Explain national income equilibrium by saving and investment (S & I approach)

National income equilibrium by saving and investment is determined when saving are
equal to investment (AD = AS). This is can be derived by AD & AS approach.

AD = AS
C+I=C+S
I=S
 Y C S I

0 50 −50 100
100 100 0 100
200 150 50 100
300 200 100 100
400 250 150 100
500 300 200 100
Y S

S=I

I/S E S>I

S<I

O Y X

S Income

In the above drawn diagram income is represented on x-axis saving and investment on y-axis. At
point E, saving curve intersect investment curve depicting national income equilibrium i.e., 300.
There can be two situations:

(i) When planned savings are less than planned investment. (S < I)
In this situation, stock lying with firms will decrease which will lead to increase in
output, employment, income and saving. Hence, savings below equal to
investment.
(ii) When planned saving are more than planned investment (S > I)
In this situation, stock lying with firms will increase which will lead to decrease in
output, employment, income and savings. Hence, savings become equal to
investment.

Q22. From the following consumption and investment function find out equilibrium income,
consumption and savings.

C = 100 + 0.8Y
I = 3800
AD = AS
C+I=C+S
 C+I=Y
100 + 0.8Y + 3800 = Y
3900 + 0.8Y = Y
3900 = Y – 0.8Y
3900 = 0.2Y
39,000
Y=
2
= 19,500

C = 100 + 0.8Y

= 100 + 0.8(19,500)

= 100 + 15,600

= 15,700

S=Y–C

= 19,500 – 15,700

= 3800

Q23. From the following date, find out equilibrium income, consumption and savings.

C = 200 + 0.95Y
I = 2,000

AD = AS
C+I=C+S
C+I=Y
200 + 0.95Y + 2,000 = Y
2,200 + 0.95Y = Y
2,200 = Y – 0.95Y
2,200 = 0.05Y
Y = 2,200 × 20
= 4,400

C = 200 + 0.95Y
= 200 + 0.95 (44,000)
= 200 + 41,800
= 42,000
 S=Y–C
= 44,000 – 42,000
= 2,000

Q24 If S = – 100 + 0.25Y and investment expenditure is 4,000. Calculate equilibrium income,
consumption and savings.

AD = AS
C+I=C+S
I=S
4,000 = - 100 + 0.25Y
4,100 = 0.25Y

4,100
Y= × 100
0.25
= 16,400

S = - 100 + 0.25Y
= - 100 + 0.25 × 16,400
= - 100 + 4,100
= 4,000

C=Y–S
= 16,400 – 4,000
= 12,400

Q25. If S = – 400 + 0.1Y and investment expenditure is 500.calculate equilibrium income,

consumption and savings.

AD = AS
C+I=C+S
I=S

5,000 = - 400 + 0.1Y

5,400 = 0.1Y
54,000
Y= 0.1
= 54,000

S = - 400 + 0.1Y
= - 400 + 0.1(54,000)
= - 400 + 5400
 = 5,000

C=Y–S
= 54,000 – 5,000
= 49,000

Q26. Find national income from the following data:

Autonomous consumption = 200

MPC = 0.70
Investment = 700

AS = AD
Y=C+I
Y = (a + bY) + I
Y = 200 + 0.70Y + 700
Y = 900 + 0.70Y
1Y – 0.70Y = 900
0.30Y = 900
900
Y = 0.30
90,000
Y= 30
= 3,000

ASSIGNMENT

Q1. Suppose that C = 40 + 0.75Y and I = Rs. 60. Find out equilibrium level of income.
Ans. = 400

Q2. Suppose that S = -40 +0.25Y and I = Rs.60, find the equilibrium level of income.
Ans. = 400

Q3. If APC is 0.7, how much will be APS? Ans. 0.3

Q4. If APS is 0.6, how much will be APC? Ans. 0.4

Q5. If MPC is 0.7, how much will be MPS? Ans. 0.3

Q6. If MPS is 0.2, what will be MPC? Ans. 0.8

Q7. The disposable income is Rs.1200 cr. And the level of consumption is Rs.800 cr. Calculate
APC.
Ans. = 0.34

Q8. If the savings out of income of RS.5000 are Rs.500. What is APS?
Ans. = 0.9

Q9. If the disposable income is RS.1000 and consumption expenditure is Rs.750, find out APS.
Ans. = 0.25

Q10. When disposable income rises from Rs.1000 to Rs.1100, savings rises by Rs.30. Find out
MPS and MPC.
Ans. 0.7 and 0.3

Q11. If the MPC is 0.8, Calculate the value of the multiplier.

Ans. 5

Q12. If the value of multiplier is 4, what will be MPC and MPS?

Ans. 0.75 and 0.25

Q13. If the value of multiplier is 4, what will be the effect on income of an economy if
investment Increases by Rs.100 cr.?
Ans. 400cr.

Q14. Using the equation C = 20 + 0.9Y, construct a schedule for consumption where income is
Rs.200, Rs.250, Rs.300 an Rs.350.

Q15. In a two sector economy, the consumption and investment functions are as follows:
Y = C + I, C = 50 + 0.8Y and I = 50
Find (a) the equilibrium level of income, (b) the level of consumption at equilibrium and
(c) the Level of saving at equilibrium. Ans. 500, 450 and 50.

Q16. In a two sector economy, the saving and investment functions are:
S = -10 + 0.2Y and I = -3 + 0.1Y. What will be equilibrium level of income?
Ans. 7

Q17. Derive multiplier when MPC is (a) 0.90, (ii) 0.80 and (iii) 0.75.
Ans. 10, 5, 4.
Q18. From the following table, find out APC and MPC.
Income (Rs.) Consumption (Rs.) APC MPC
100 70
120 80
140 90

Q19. If the level of income in an economy increases from 20000 cr. To 70000cr. And as a result,
the level of consumption increases from 15000cr. To 45000cr. Calculate MPC.
Ans. 0.6

Q20. Calculate change in income when (i) MPC = 0.8 and (ii) change in investment = 1000
Ans. 5000

Q21. If an increase of Rs.10000 investment in an economy results in an income of Rs.40000 ,

calculate MPS. Ans. 0.25.

Q22. Calculate MPC and MPS from the following:

Income (Rs.) Consumption (Rs.) MPC MPS
300 260
400 340

Q23. Calculate MPC and multiplier from the following:

Income (Rs.) Consumption (Rs.) MPC K
100 145
200 185

Q24. Calculate MPS and Multiplier from the following

Y (Rs.) C (Rs.) S (Rs.) MPS K
100 80 20
200 160 40
300 250 50

Q25. If in an economy, investment increases from 1000 to 1200 and as a result of it total income
Increases by 800, Calculate MPS.

Q26. In an economy, investment expenditure is increased by Rs, 400 cr. And MPS = 0.8.
Calculate the total increase in income and savings.
Q27. In an economy MPC = 0.75. Investment expenditure is increased by Rs.500 cr., calculate
the total increase in income and consumption expenditure
Q28. If MPC = 0.3 and income increases from Rs.6000 cr. To Rs.9000 cr. What will be
additional consumption in the economy? Ans. Rs.900 cr.

Q29. Income increases from 1000 to 2000, MPC remains constant, and investment multiplier is
2. Find increase in investment. Ans. 500

Q30. If autonomous investment increases by Rs.100 cr. What should be the value of MPS so that
Increase in income is Rs.500? Ans. 0.2

Q31. In an economy, the level of income is Rs.2000 cr. And MPC is 0.75. Calculate the total
increase in income if investment increases by Rs. 200 cr. Ans. 800

Q32. In an economy, the actual level of income is Rs.500 cr. Whereas the full employment level
of income is Rs.800 cr. The MPC is 0.75. Calculate the increase in investment. Ans. Rs.75 cr.

Q33. An additional investment of Rs.1000cr. in the economy creates how much additional
income if MCP = 0.5.

Q34. Find the value of MCP AND K when additional investment of Rs.200cr. has increased the
level of income to Rs.1250cr.

Q35. If the national income falls by Rs.1000cr. from standard balance, how much investment is
needed to bring back to the old stage when MPC = 0.5 ?

Q36. The level of income in an economy increases from Rs.20,000cr to Rs.70,000cr. And as
result the level of consumption increases from Rs.1500 cr to Rs.45000cr. calculate MPC and
MPS.

Q37. IF MPC in an economy is 0.8 and if investment is increased by Rs.5 cr., how much would
be the increases in income ?
Ans. Rs.25 cr.

Q38. If an increases of Rs.10,000 investment in an economy results in an increases in income of

Rs.40,000 cr . MPS.
Ans. Rs.0.25

Q39. In an economy investment increases from Rs.1000 cr.to Rs.1200 cr. And as a result it total
income increases by Rs.800 cr . calculate MPS.
Ans. Rs.0.75
Q40. The value of MPC = 0.75. In this economy what will be the effect on total income if the
investment increases by Rs.300 cr.
Ans. Rs.1200 cr.

Q41. What is the value of K if additional income of Rs.10,000 is generated by additional

investment of Rs.5000 cr.?
Ans.2

Q42. In an economy MPC = 0.75 . If investment expand is increased by Rs.500 cr. Calculated
total increase in income and consumption expenditure.?
Ans. Rs.2000,1500

Q43. As a result of increases in investment by Rs.125 crores, national income increases by Rs.
500 crores calculate MPC. (CBSE March 2008 M:4).
Ans. Rs.0.75

Q44. A Rs.200 crores increases in investment leads to a rise in national income by Rs.1000 cr.
Find out MPC.

Q45. In an economy investment increases by Rs.120 cr. The value of investment multiplier (K) is
4. Calculate MPC Ans. 0.75