TOPIC 1

AGGREGATE DEMAND
Aggregate demand is the total demand for final goods and services produced
in an economy. Aggregate demand depends on the level of employment in
an economy. There is a direct and positive relationship between the level of
employment and the level of output in the economy. The sum of consumption
and investment is referred to as aggregate demand.
AD = C + I
AD = Aggregate Demand
C = Consumption
I = Investment
Important
 In a two sector economy, the components of AD include only C and I. But in
a four sector model, AD will also include government expenditure (G) and net
exports (X-M).
Concept of Aggregate Demand
Aggregate demand (AD) is an economic concept that represents the total
amount of goods and services demanded in an economy at a given overall
price level. It is the sum of the demand for all individual goods and services in an
economy. The total amount of money exchanged for those goods and services
at a specific price level and point in time is commonly expressed as aggregate
demand. AD is made up of four components: consumer spending, investment
spending, government spending, and net exports. AD is an important concept
in macroeconomics because it helps to explain the level of economic activity in
an economy and can be used to determine the level of inflation. AD is also used
to measure the impact of government policies on the economy.
Caution
 Students should note that aggregate demand is what people wish to
spend or are planning to spend, not what they have actually spent.
Components of Aggregate Demand
Components of aggregate demand (AD) include the following:
(1) Consumption Expenditure (C): Consumer expenditure is the total amount
of money spent by individuals and households in an economy on final goods
and services for personal use and satisfaction.
(2) Investment Expenditure (I): Investment expenditure refers to the total
amount spent by all firms on capital goods. It includes expenses such as land
investment, plant and machinery purchases, and inventory changes.

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(3) Government Expenditure (G): Government expenditure refers to money
spent by the government on the acquisition of goods and the provision of
services such as education, healthcare, social protection, and defence.
(4) Net Exports (X-M): A country’s net export is the amount by which the total
value of its exports exceeds the total value of its imports.
Thus, the following is the AD function in a four sector economy:
AD = C + I + G + (X – M)
Ex-ante and Ex-post investment
Ex-ante
Planned values of consumption, investment or total output of goods. In simple
words ex-ante depicts what has been planned.
Ex-post
Actual values of consumption investment or total output of goods. In simple
words ex-post depicts what has actually happened. This aspect of investment
is considered in the calculation of National Income.
Relationship Between Income and AD
The AD schedule shows the relationship between income (Y) and AD. The y
axis represents income, and the x axis represents AD. Here, in the two-sector
model, AD is the sum of Consumption (C) and Investment (I).
For instance, the following is an AD schedule:
Income Consump- Investment Aggregate Demand
(Y) tion (C) (I) (AD)
0 100 100 200
200 200 100 300
400 300 100 400
600 400 100 500
800 500 100 600
1,000 600 100 700

Price
Aggregate
level
demand

Output or
Income

Through this example, the following conclusions can be drawn:

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(1) Minimum level of consumption- Even at zero level of income, there is some
consumption because even at zero level of income there is some expenditure
required in an economy which is done from savings and past borrowings.
(2) AD increases with increase in level of income.
(3) As the income increases the savings also increases, therefore at higher
levels of income the expenditure is less than income.
Example 1. Differentiate between ex-ante and ex-post investment.
[NCERT]
Ans. Ex-ante and ex-post investments are two terms used to describe
different stages of the investment process. Ex-ante investment refers to
the evaluation of potential investments before they are made, while ex-
post investment refers to the evaluation of investments after they have
been made. Ex-ante investment typically involves analysing the potential
risks and rewards of a given investment, while ex post investment
typically involves assessing the actual performance of an investment.

...
Ex-ante investment is used to determine whether a given investment is
worth making, while ex-post investment is used to determine whether
the expected returns were achieved. Ultimately, ex-ante and ex-post
investments are both important stages of the investment process, as they
allow investors to make informed decisions about their investments.

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 OBJECTIVE Type Questions
[ 1 mark ]
Multiple Choice Questions
1.Given below are some basic activities that occur in an economy.
Identify the activity that would not help to study the economy in its
totality?
(a) government introducing policies
(b) aggregate demand and supply of goods
(c) determination of the consumer's equilibrium
(d) determination of equilibrium level of income and employment
 [CBSE Question Bank 2023]
Ans. (c) determination of the consumer's equilibrium
Explanation: While all the activities mentioned have relevance to
studying the economy, the determination of the consumer's equilibrium
specifically focuses on individual consumer behaviour and decision-
making. It primarily deals with analysing how individual consumers
allocate their income among different goods and services to maximize
their satisfaction or utility.
2. Given below are two statements.
Statement 1:When aggregate supply is plotted as a 45°line graph,
the economy is said to be at equilibrium.
Statement 2:The total amount spent on aggregate demand is equal
to the total expenditure in the country.
Choose the correct option:
(a) Statement 1 is true and statement 2 is false
(b) Statement 1 is false and statement 2 is true
(c) Both statements 1 and 2 are true
(d) Both statements 1 and 2 are false
 [CBSE Question Bank 2023]
Ans. (a)Statement 1 is true and statement 2 is false.
Explanation: Statement (1) is true: When aggregate supply is plotted as

a 45° line graph, the point where the aggregate demand curve intersects
the 45° line represents the equilibrium in the economy. At this point,
the quantity of goods and services supplied is equal to the quantity

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 demanded, indicating a balance between supply and demand.Statement
(2) is false: The total amount spent on aggregate demand represents the
total expenditure in the economy, but it does not necessarily mean that
it is equal to the total expenditure in the country. The aggregate demand
reflects the spending on goods and services within a specific economic
framework or context, which may not cover the entire country's
expenditure.

Assertion-Reason Questions
In the following questions a statement of assertion followed by a statement
of reason is given. Choose the correct answer out of the following choices:
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct
explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the
correct explanation of Assertion (A).
(c) Assertion (A) is true, but Reason (R) is false.
(d) Assertion (A) is false, but Reason (R) is true.
3. Assertion (A): Saving curve makes a negative intercept on the vertical
axis at zero level of income.
Reason (R): Saving function refers to the functional relationship between
saving and income.
 [CBSE SQP 2022]
Ans. (b)Both Assertion (A) and Reason (R) are true but Reason (R) is not the
correct explanation of Assertion (A).
 [CBSE Marking Scheme SQP 2022]
Explanation: Saving curve (SS) starts from point S on the Y-axis, indicating that

there is negative saving (equal to amount of autonomous consumption) when
national income is zero. Saving function refers to the functional relationship
between saving and national income.

CASE BASED Questions (CBQs)

[ 5 & 6 marks ]
Read the following passages and answer the question that follows:
4.In an economy autonomous consumption is 1.4 Crore and the national
income computed is ` 700 Crore. The marginal propensity to save

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 computed is one fourth of the marginal propensity to consume.
(A) Calculate the value of MPC.
(B) Calculate the following:
(i) Consumption expenditure
(ii) Savings
Ans. (A) Value of MPC will be 0.8
Explanation: Since, MPC + MPS = 1
MPC + ¼ MPC = 1
MPC = 4/5
MPC = 0.8
(B) (i) C = C + bY
C = 1.4 + (0.8) 700
C = 1.4 + 560
C = 561.4 Crore
(ii) S = – C + (1 – b) Y
S = – 1.4 + (1 – 0.8) 700
S = – 1.4 + 140
S = 138.6 Crore

VERY SHORT ANSWER Type Questions (VSA)

[ 1 mark ]

5.What do you mean by underemployment?

Ans. Underemployment is a situation in which workers are employed below
their education or skill level, or their availability.
Related Theory
U
   nderemployment can have a number of negative impacts on individuals
and the economy as a whole. For individuals, underemployment can
lead to a lack of job satisfaction and a feeling of being underutilized.
This can lead to a decrease in motivation and productivity. Additionally,
underemployment can lead to a decrease in wages, as individuals
are not able to earn the full potential of their skills. This can lead to a
decrease in the standard of living for individuals, as they are unable to
afford the same goods and services as they could when they were fully
employed. For the economy, underemployment can lead to an overall

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 decrease in productivity, as individuals are not able to use their full
potential to contribute to the economy. This can lead to a decrease in
economic growth and an increase in unemployment.

SHORT ANSWER Type-I Questions (SA-I)

[ 2 marks ]

6. Calculate equilibrium level of income for a hypothetical economy, for

which it is given that:
(1) Autonomous
 Investments = ` 500 crores, and
(2) Consumption function, C = 100 + 0.80 Y
 [CBSE SQP Term-2 2022]
Ans. Given Consumption function is,
C = 100 + 0.8 Y
Autonomous investments = ` 500 crores
We know, at equilibrium level
Y=C+I
Y = 100 + 0.8 Y + 500
Y – 0.8Y = 600
0.2 Y = 600
Y = ` 3,000 crores
 [CBSE Marking Scheme SQP Term-2 2022]

SHORT ANSWER Type-II Questions (SA-II)

[ 3 & 4 marks ]

7. Distinguish between APC and MPC using a numerical example:

Ans. (1) APC is the ratio between total consumption and total income
(2) MPC is the ratio between change in consumption and change in
income.
(3) Numerical example:
Let Initial C = 4000
Consumption after increase in income = 5000
Initial income = 10000
New income = 15000
Increase in income= 5000
Increase in consumption= 1000

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 ∅C 1000
MPC = = = 0.2
∅Y 5000
APC for original income and consumption level
C 4000

= = = 0.4
Y 10000

APC after change in income and consumption levels = New consumption = 5000
=
New Income 15000
0.33 (Figures of C and Y in Rupees)

LONG ANSWER Type Questions (LA)

[ 5 & 6 marks ]

8. What are the elements that private investor demand for investment?
Ans. Following are the three elements important for determination of
investment by private investors.
(1) Expected Returns or Revenue: An investment is undertaken on the
basis of expected demand or expected returns to the producers.
(2) Cost: It has three components viz, cost of purchase of equipment,
cost of maintenance of equipment (depreciation) and cost of funds
borrowed for investment.
(3) Business Expectations: Bullish expectations attract, more investment.
Bearish expectations result in low investments.

Determination of Income and Employment 9

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