CLASS – XII MACROECONOMICS CHAPTER – 7

AGGREGATE DEMAND AND RELATED CONCEPTS

AGGREGATE DEMAND: It refers to sum total of expenditure that people plan to incur on the purchase of
goods and services produced in the economy during the period of an accounting year corresponding to
different levels of income.

COMPONENTS OF AD
(AGGREGATE DEMAND)

CLOSED ECONOMY OPEN ECONOMY

AD = C + I + G + (X – M)
Two sector closed Three sector closed
economy economy

AD = C + I AD = C + I + G
AD Schedule: It is a table showing relation between
aggregate demand and income.
1) There is always some minimum expenditure
Income (Y) Consumption Investment Aggregate even when income is zero. This expenditure
(C) (I) Demand is incurred for survival. It is done through
(AD)
borrowings, called negative savings.
0 30 10 40
20 40 10 50 2) AD increases as income increases. There is
40 50 10 60 positive relationship between income and
60 60 10 70
AD.
80 70 10 80
3) After a certain level of Y is reached, AD lags
100 80 10 90 behind Y because people start saving a part
120 90 10 100 of their income.
 Aggregate Demand Curve
Income Consumpt Investmen Aggregate
(Y) ion (C) t (I) Demand
(AD)
0 30 10 40
20 40 10 50
40 50 10 60
60 60 10 70
80 70 10 80
100 80 10 90
120 90 10 100
AGGREGATE SUPPLY: It refers to aggregate production as planned by the producers during an
accounting year. It means flow of goods and services as planned by the producers during an accounting
year. Y
Aggregate Supply Curve
AS Schedule:
Y= AS
Income (Y) Aggregate
Supply (As)

Aggregate Supply
0 0
20 20
40 40
60 60
80 80
100 100
120 120
0 X
140 140
Income (Y)/GDP
CONSUMPTION FUNCTION:
The functional relationship between consumption (C) and income (Y) is called consumption
function. Y
Y
Income (Y) Consumption C

Consumption (C)
(C)
0 20
50 60
100 100
150 140
200 160 X
0
Income (Y)/GDP
(1) There is always some minimum consumption (C) even when income (Y) is zero. This is called
autonomous consumption. It is incurred for survival on basic needs. This leads to negative
saving.
(2) There is positive relation between Income (Y) and Consumption (C). When income increases
consumption also increases.
(3) After a certain level of Income (Y) is reached, C lags behind Y as a part of income is saved as well.
Slope of Consumption Function (C-line):
Marginal Propensity to Consume
It refers to the rate at which C increases in response to a given increase in Y.
It is the ratio between ΔC (change in C) and ΔY (change in Y).

MPC = ΔC / ΔY

Y C
0 20
50 60
100 100
150 140

APC: Average Propensity to Consume is the ratio between total consumption (C) and total income (Y).
MPC: Marginal Propensity to Consume is the ratio between change in consumption (ΔC) and change in
income (ΔY).
Algebraic Presentation of C-function:

C = C + bY
 SAVING FUNCTION:
The functional relationship between saving (S) and income (Y) is called saving function.

Income Consumption Income Saving

(Y) (C) (Y) S=Y-C
0 20 0 -20
50 60 50 -10
100 100 100 0

Saving (S)
150 140 150 +10
200 180 200 +20
Income (Y)
(1) Initially savings (S) are negative because consumption (C) is
more than income (Y).
(2) There is positive relation between Income (Y) and savings (S).
When income increases savings also increases.
(3) S is always lower than Y because S is a part of Y.
 Slope of Saving Function (S-line):
Marginal Propensity to Save
It refers to the rate at which S increases in
response to a given increase in Y. It is the ratio
between ΔS (change in S) and ΔY (change in Y).

MPS = ΔS / ΔY Income Saving

(Y) S=Y-C
0 -20
50 -10
100 0
150 +10
200 +20

APS: Average Propensity to Save is the ratio

between total saving (S) and total income (Y).
MPS: Marginal Propensity to Save is the ratio
between change in saving (ΔS) and change in
income (ΔY).
 Algebraic Presentation of S-function:

S = -C + (1 - b)Y

Q. Find Savings (S), when autonomous consumption is

₹200, MPC = 0.6 and Y = ₹2,000.

RELATIONSHIP BETWEEN PROPENSITY TO CONSUME AND PROPENSITY TO SAVE

(1) APC + APS = 1 (2) MPC + MPS = 1