SUBJECT-ECONOMICS

(MACROECONOMICS)
CLASS-XII
CHAPTER-3
DETERMINATION OF INCOME AND
EMPLOYMENT

BY-VISHWAJEET SINGH, PGT (ECO),K.V.(AFS) BAMRAULI,

PRAYAGRAJ
 AGGREGATE DEMAND(AD) AND
AGGREGATE SUPPLY(AS)
AGGREGATE DEMAND(AD)
It refers to the sum total of planned expenditure by all buyer on
all domestically produced goods and services during an
accounting year.
AGGREGATE DEMAND=C+G+I+(X-M)
Where-
C-PRIVATE FINAL CONSUMPTION EXPENDITURE
G-GOVERNMENT FINAL CONSUMPTION EXPENDITURE
I-INVESTMENT EXPENDITURE
(X-M)-NET EXPORT
AGGREGATE DEMAND IN TWO SECTOR ECONOMY
AD=C+I
 AGGREGATE SUPPLY (AS)
It refers to sum total of market values of all goods
and services planned to be produced by all the
producers in an economy during an accounting year.
AGGREGATE SUPPLY (AS)=C+S

So we can say that AD and AS depend on following

three variables-
1-Consumption(C)
2-Savings(S)
3-Investment(I)
 MPC & MPS
MPC
• MPC-Marginal Propensity to
Consume
• It is the ratio between
change in consumption and
change in income.
• MPC = ΔC/ΔY
• It shows the change in
consumption due to unit
change in income.
• It is the slope of
consumption line.
• Its value to lies between 0
and 1 including 0 and 1.
MPS
• MPS-Marginal Propensity
to Save
• It is the ratio between
change in saving and
change in income.
• MPS = ΔS/ΔY
• It shows the change in
savings due to unit
change in income.
• It is the slope of saving
line.
• Its value lies between 0
and 1 including 0 and 1.
 APC & APS
APC APS
• APC-Average Propensity • MPS-Average Propensity
to Consume to Save
• It is the ratio between in • It is the ratio between
consumption and in saving and income.
income. • APS = S/Y
• APC = C/Y • Its value lies between 1
• Its value lies between 0 and-infinite, excluding 1.
and+infinite, excluding 0. • Its value cannot be 1.
• It's value cannot be zero.
RELATION BETWEEN MPC & MPS
MPC+MPS =1

RELATION BETWEEN APC & APS

APC+APS =1
QUE-APC cannot be zero.Why?
Ans-because if APC equals to zero then-
APC= 0
=>. C/Y = 0
=>. C=0
Which is impossible.

QUE-APS cannot be 1.Why?

Ans-because if APS equals to 1 then-
APS= 1
=>. S/Y = 1
=>. S=Y
=>. C=0
Which is impossible
 CONSUMPTION FUNCTION
Consumption function shows the relation between
consumption and income.

C = Ca+cY

Where-
C-Consumption
Ca-Autonomous consumption
c-MPC
Y-Income
cY-Induced consumption-consumption which depends on
income
Autonomous consumption-Level of consumption at zero level
of income=consumption independent of income
.
CONSTRUCTION OF CONSUMPTION LINE
CONSUMPTION SCHEDULE
Ca c(MPC) cY C=Ca+cY
INCOME(Rs)
Y

0 10 0.5 0 10

10 10 0.5 5 15

20 10 0.5 10 20

30 10 0.5 15 25

40 10 0.5 20 30

50 10 0.5 25 35
 SAVING FUNCTION
Caving function shows the relation between saving and
income.

S = -Ca+sY

Where-
S-Saving
-Ca=Autonomous saving
s-MPS
Y-Income
sY-Induced saving-saving which depends on income.
Autonomous saving-Level of saving at zero level of
income=saving independent of income
CONSTRUCTION OF SAVING LINE

SAVING SCHEDULE
Ca c(MPC) cY C=Ca+c S=Y-C
INCOME Y
(Rs)
Y
0 10 0.5 0 10 -10

10 10 0.5 5 15 -5

20 10 0.5 10 20 0

30 10 0.5 15 25 5

40 10 0.5 20 30 10

50 10 0.5 25 35 15
CONSUMPTION LINE & SAVING LINE
 DERIVATION OF SAVING FUNCTION
FROM CONSUMPTION FUNCTION
As we know that consumption function is-
C = Ca+cY
We also know that-
S=Y-C
=> S= Y-(Ca+cY)
=>. S=Y-Ca-cY
=> S= -Ca+(1-c)Y
=> S= -Ca+sY
 DERIVATION OF CONSUMPTION
FUNCTION FROM CONSUMPTION
FUNCTION
As we know that saving function is-
S= -Ca+sY
We also know that-
C= Y-S
=> C= Y-( -Ca+sY)
=>. C=Y+Ca-sY
=> C= Ca+(1-s)Y
=> C= Ca+cY
 DERIVATION OF SAVING LINE FROM
CONSUMPTION LINE
.
 Consumption line is given as CC.
 OC=Ca=Autonomous Consumption => OS=-Ca is
Autonomous Saving. So point S will be the starting point
of saving line.
 Before YA level of income C>Y => saving will be negative.
So saving line will be below X axis.
 At YA level of income C=Y => saving=0. So saving line will
intersect X axis.
 After YA level of income C<Y => saving will be positive.
So saving line will be above x axis.
 Now by joining S ,YA and S we will get saving line.
 DERIVATION CONSUMPTION LINE
FROM SAVING LINE
.
 Saving line is given as SS.
 OS=-Ca=Autonomous Saving => OC=Ca is Autonomous
Consumption. So point C will be the starting point of
consumption line.
 Before YA level of income, saving line is below X axis
=>Saving is negative.So consumption line will be above
income line.
 At YA level of income, saving line is intersecting X
axis=>S=0. Consumption line will intersect income line.
 After YA level of income , saving line is above X
axis=>saving is positive. So consumption line will be
below income line.
 Now by joining C ,A and C we will get consumption line.
 INVESTMENT FUNCTION
Investment is always autonomous
It is independent of income.
I = Ia
Where,
I=Investment
Ia=Autonomous investment
 INVESTMENT LINE
.
 DETERMINATION OF EQUILIBRIUM
INCOME AND EMPLOYMENT
Equilibrium income and employment is determined when
following condition is satisfied-

AD = AS
=> C+I = C+S
I= S
It can be shown with the help of following numerical
example and diagram-
.
.
As it has been shown in above numerical example and
diagram ,the economy will be in equilibrium at 40 level of
income because at this level of income-
AD = AS = 40
I = S = 10
Que-What will happen if-
i) AD>AS
ii) AD<AS
Ans-i) If AD>AS , it means economy is in disequilibrium.
In this situation what buyers are planning to
purchase, is more than what producers are are planning to
sell. So producers will not be able to fulfill the demand of
goods and services by the buyers ,that is why in next
financial year they will increase the production of goods
and services. Because of this national income will start
increasing.
Now this process of increase in national income will
continue until AD=AS, and ultimately there will be
equilibrium in economy.
It can be shown with the help of following diagram-
Ans-ii) If AD<AS , it means economy is in disequilibrium.
In this situation what buyers are planning to
purchase, is less than what producers are are planning to
sell. So unsold stock (inventory) of goods and services with
producers will increase ,that is why in next financial year they
will decrease the production of goods and services.
Because of this national income will start decreasing.
Now this process of decrease in national income will
continue until AD=AS, and ultimately there will be equilibrium
in economy.
It can be shown with the help of following diagram-
Que-What will happen if-
i) I>S
ii) I<S
Ans-i) If I>S , it means economy is in disequilibrium.
In this situation these will be net injection in the
circular flow of income. Because of this national income will
start increasing.
Now this process of increase in national income will
continue until I=S, and ultimately there will be equilibrium in
economy.
It can be shown with the help of following diagram-
Ans-ii) If I<S , it means economy is in disequilibrium.
In this situation these will be net leakage in the
circular flow of income. Because of this national income will
start decreasing.
Now this process of decrease in national income will
continue until I=S, and ultimately there will be equilibrium in
economy.
It can be shown with the help of following diagram-
 FULL EMPLOYMENT EQUILIBRIUM
It is that situation in which-
i)AD=AS => I=S
ii)Full Employment
 UNDER EMPLOYMENT EQUILIBRIUM
It is that situation in which-
i)AD=AS => I=S
ii)Unemployment
 DEFLATIONARY GAP (DEFICIENT DEMAND)
It is that problem in which actual Aggregate Demand(ADA) is less than
Aggregate Demand required for full employment(ADF).

ADA < ADF

DEFLATIONARY GAP (DEFICIENT DEMAND) = ADF - ADA

It creates the following problems-
*Deflation
*Unemployment
CAUSES-
*Low private final consumption expenditure.
*Low government final consumption expenditure.
*Low Investment Expenditure.
*Low export.
*High import.
*High tax.
*Low subsidy.
SOLUTIONS-
i)FISCAL POLICY-
*Increase in Government's expenditure.
*Decrease in tax.
*Increase in subsidy.
ii) MONETARY POLICY-
*Decrease in bank rate.
*Decrease in repo rate.
*Decrease in reverse repo rate.
*Decrease in CRR.
*Decrease in SLR.
*Decrease in margin requirements.
*Purchase of securities under open market operations.
 INFLATIONARY GAP (EXCESS DEMAND)
It is that problem in which actual Aggregate Demand(ADA) is
more than Aggregate Demand required for full employment(ADF).
ADA > ADF
DEFLATIONARY GAP (DEFICIENT DEMAND) = ADA - ADF
It creates the following problem-
*Inflation
CAUSES-
*High private final consumption expenditure.
*High government final consumption expenditure.
*High Investment Expenditure.
*High export.
*Low import.
*Low tax.
*High subsidy
SOLUTIONS-
i)FISCAL POLICY-
*Decrease in Government's expenditure.
*Increase in tax.
*Decrease in subsidy.
ii) MONETARY POLICY-
*Increase in bank rate.
*Increase in repo rate.
*Increase in reverse repo rate.
*Increase in CRR.
*Increase in SLR.
*Increase in margin requirements.
*selling of securities under open market operations.
 INVESTMENT MULTIPLIER(K)
It refers to the change in income due to unit change in
investment.
K = ΔY/ΔI
=>ΔY = K.ΔI
Where-
K- Multiplier
ΔY-Change in income
ΔI- Change in Investment
Relation between K and MPC
K = 1/1-MPC
There is direct relation between K and MPC.
Relation between K and MPS
K = 1/MPS
There is inverse relation between K and MPS.
Que-If consumption function is C = 100 + 0.75Y and I=1000 .
Then find out the followings-
i) Equilibrium Income
ii) Equilibrium consumption
iii) Investment multiplier.
Sol-i)As we know that equilibrium level of income is that at
which following condition is satisfied-
S=I
=> -100+0.25Y=1000
=>Y=1100/0.25=4400
ii) C= 100+ 0.75Y
=>C=100+0.75*4400
=>C=3400
iii)K = 1/1- 0.75= 1/0.25 = 4
Que-If consumption function is C = 100 + 0.75Y and change
in Investment is 200 .Then find out change in income.
Sol-
K = ΔY/ΔI
=>ΔY = K.ΔI

K=1/1-MPC=1/1-0.75=4

ΔY = 4*200=800