Determination of Income

and Employment 4
AGGREGATE DEMAND (AD)
It refers to total demand for all goods and services in an economy during a
fiscal year (1st April to 31st March).
Components of Aggregate Demand (AD)
1. Private Final Consumption Expenditure (C)0
It is also called household expenditure. It depends on the level of disposable income of
household. Higher the level of Disposable income, higher is private final consumpton
expenditure and vice versa.
2. Private Investment Expenditure (I)
It refers to expenditure by private investors on the purchase of such goods which add to
their stock of capital i.e. investment (Two types of investment):
(i) Induced investment: It refers to the investment,
which is made with the motive of earning profit. It is
generally done in private sector. It depends upon level
of income Induced investment curve moves upwards
from left to right.

(ii) Autonomous investment: It refers to the investment,

which is made irrespective of level of income. It is generally
done by government with the motive of social welfare.
Autonomous investment curve remains parallel to X-axis. It is
constant irrespective the level of income.

Marginal efficiency of investment (MEI): It refers to the expected rate of return on

additional investment.
3. Government final consumption expenditure (G): 
It refers to the expenditure incurred by government on consumer goods to meet public
needs like law and order, education, health, transport, defence, etc.
4. Government investment expenditure (G): 
It refers to the expenditure incurred by the government on Capital goods. These
expenditure are need to develop the economy. Like construction of highways, roads,
hospital building, school, power plant, etc.

(42)
44 MACRO ECONOMICS

5. Net Export (X – M)
Expenditure by the foreigners on our goods is added to total expenditure (AD) while
expenditure on imports is subtracted. So difference between export and imports is
considered as a component of Aggregate Demand.
So AD = C + I + G + (X – M)
The all expenditures i.e. discussed above is desired expenditure that the,
household, firms, the Govt. and rest of the world wish to make on purchase of
domestically produced goods in a fiscal year.
But in two sector economy.
AD = C + I
C = Desired consumption, I = Desired Investment
Schedule
Y C I AD = C + I
0 20 10 30 = 20 + 10
20 25 10 35 = 25 + 10
40 30 10 40 = 30 + 10
60 35 10 45 = 35 + 10
80 40 10 50 = 40 + 10

y A = y C + y I
AD
C C
AD I I I
L c

O x O Y
x o Y
x
Y

Notes: (i) Consumption expenditure (c) can never be zero. A+ level of income
there should be a minimum consumption. It is essential even when income does
not permit it. It is also called autonomous consumption expenditure past savings
and borrowings may be the source of such expenditure.
(ii) Investment is assumed to be constant irrespective the level of income. i.e.
Autonomous investment.
(iii) Consumption can never be zero. Hence AD also can never be zero because
AD is the sum of consumption and investment.
AGGREGATE SUPPLY (AS)
It is the total production or supply of all goods and services in the economy
during first year.
DETERMINATION OF INCOME AND EMPLOYMENT 45

Components of Aggregate Supply (AS)

(i) Consumption:  It is the part of income which is spent on consumption (c).
(ii) Savings: It is the part of income which is not y S
consumed i.e. saved. (S).
AS = C + S
(Y = C + S) S
+ve
Initially saving is negative but after a stage it is positive.
o
AS (Output) = Y (National income) o –ve Y
x

Schedule
Y C S AS y

100 70 30 100 AS=Y

200 140 60 200

300 200 100 300 AS

Aggregate supply is 45º slope line. 45º

x
o
Y
*Break even point is a point where income is
equal to consumption. i.e. zero savings. y
Y
Savings
* Equilibrium level of output / income Y/C C

I.  AD-AS Approach: Break even point

dissavings

In this approach, equilibrium level output

(GDP) is achieved when aggregate demand is
B
O x
equal to aggregate supply. Y

i.e. [AD = AS]

Schedule y
AS(Y)
Y C I AD S AS
e AD = C+I
100 150 50 200 –50 100
AD/AS
200 200 50 250 0 200 Full employment
equilibrium
300 250 50 300 50 300
400 300 50 350 100 400 45º
500 350 50 400 150 500 O Y x
OY is equilibrium level of output. Point e is Full employment
(f.e)
equilibrium point where AD = AS at full employment level in schedule at `300 level
of income AD & AS are equal. So equilibrium level of income is `300.
*What happens if AD > AS?
• When AS is less than AD, flow of goods and services in the economy
tends to be less than their demand.
• Producers need to produce more goods and services in the economy.
• Whole existing stock sold out producers would suffer the loss of unfulfilled
demand.
46 MACRO ECONOMICS

*What happens if AD < AS?

• When AS is more than AD, flow of goods and services in the economy
tends to exceed their demand. As a result, some of the goods would
remain unsold. To clear unwanted stock, the producer would plan a cut
in production. Consequently, AS would reduce to become equal to AD.

II. S-I Approach:

In saving investment approach equilibrium level of output (GDP) is achieved
when planned saving is equal to planned investment.
i.e. [S = I] y
Schedule
Y S I S

0 –10 10
e
100 0 10 S/I I

200 10 10
Full employment
300 20 10 +ve
Point e is equilibrium point where (S = I) at o
o x
–ve Y
full employment level of income `200. Level of output /income

*What happens if S > I ?

It implies that when planned savings (S) is greater than the planned investments
(I) is to the circular flow of income.
Accordingly, overall expenditure in the economy would remain lower than
what is require to buy the planned output. Some output would remain unsold and
producers will have undesired stock. To clear their stocks, the producer would now
plan lesser output. The process would continue till S = I.
*What happens if S < I ?
It implies that planned savings (S) is less than planned investments (I) into
the circular flow of income. Accordingly, overall expenditure in the economy would
turn out to be greater than what is required to buy the planned output. Here the
producers would suffer the losses of unfulfulled demand. To manage the situation,
the producer would now plan higher production. The process would continue till
S=I y
over full employment
AS(Y)
A. Excess Demand equilibrium
AD′
It refers to the situation when aggregate e′

demand (AD) is in excess of aggregate supply AD

(AS) corresponding to full employment level
of output in the economy. e Inflationary
AD/AS
AD > AS
gap

Inflationary gap is the difference between full employment
AD at full employment level and AD at equilibrium
excess employment level. i.e.
45°
⇒  AD′ – AD o Y Y′ x
(excess/beyond
Income/output/employment
full employment)
DETERMINATION OF INCOME AND EMPLOYMENT 47

Causes of Excess Demand and Inflationary Gap

(i) increase in private final consumption expenditure.
(ii) increase in private investment expenditure.
(iii) increase in govt. final consumption expenditure.
(iv) increase in govt. investment expenditure.
(v) Increase in exports, owing to lower domestic prices in relation to
international prices.
(vi) Decrease in imports, owing to higher international prices as compared to
domestic prices.
(vii) A cut in tax rates leads to higher disposable income of people.

B. Deficient Demand
It refers to the situation when aggregate
demand (AD) is less than aggregate supply
(AS) corresponding to full employment in the
economy. AD/AS

AD < AS
Deflationary gap is the difference between
AD at full employment level and AD at under
employment level. i.e. 45°

⇒  AD – AD′

Causes of Deficient Demand and Deflationary Gap

(i) Decrease in private final consumption expenditure.
(ii) Decrease in private investment expenditure.
(iii) Decrease in government expenditure.
(iv) Decrease in exports and increase in imports.
(v) Increase in tax rate leads to decrease in disposable income of people.
Full employment and involuntary unemployment
(i) Full employment:  It refers to a situation when all those who are able to
work and are willing to work (at the existing wage rate) are getting work.
It is a situation when, corresponding to a given wage rate, demand for labour
force is equal to supply of labour force and the labour market is in equilibrium.
However, full employment does not mean that there is no unemployment in
the economy. Some people may voluntarily choose to remain unemployed they
are not be willing to work at all or not willing to work at the existing wage rate.
This is a situation of voluntary unemployment.
48 MACRO ECONOMICS

i.e. in full employment situation unemployment can be occurs like:

(a) Structural unemployment:  It refers to the situation of unemployment
where poor people remains unemployed due to modernisation or
structural changes in the economy like due to computerisation many
unskilled peoples are unemployed.
(b) Frictional unemloyment:  When a person leave one job and find other
job then the time period at which he is unemployd for some days. That is
called frictional unemployment.
(ii) Voluntary unemployment occurs when some people are not willig to
work at all or are not willing to work at an existing wage rate.
(iii) Involuntary unemployment occurs when some people are not getting
work, even when they are willing to work at an existing wage rate. Here
economy fails to create enough jobs because planned output is lower
than the potential output.
Measures to correct excess demand & deficient demand
A. Monetary measures  (By RBI)
B. Fiscal measures (By government)
A. Monetary measures: 
1. Quantitative Measures.
2. Qualitative Measures.
Quantitative Measures Qualitative Measures
Instruments Instruments
(i) Banks Rate and Repo Rate (i) Marginal Requirement

(ii) CRR + SLR = LRR (ii) Moral suasion

(iii) Open market operations. (iii) Credit Rationing
(iv) Reverse Repo Rate

1. Quantitative Measures
Quantitative instruments are traditional tools related to the Quantity or
Volume of the money. These are also called general tools. It comprises of the
following instruments.
(i) Bank Rate (or) Discount Rate:  It is the rate at which Commercial Banks
borrow money from Central Bank to meet their long term needs.
Repo Rate (or Repurchase rate):  It is the rate at which Commercial Banks
borrow money from Central Bank to meet their day to day requirement on short
term basis.
(Generally Repo Rate is lower than Bank Rate).
To Control Inflation: RBI increase Bank Rate / Repo Rate as a follow-
up action the Commercial Banks raise the rate of interest (the rate at which
the Commercial Banks lend money to its depositors). This leads to decrease
in demand for loans or credit. Consequently, consumption and investment
DETERMINATION OF INCOME AND EMPLOYMENT 49

expenditure are reduced. This process continue till Demand is equal to supply
and inflation is controlled.
To Control Deflation:  RBI decrease Bank Rate / Repo Rate as a follow-up
action the commercial reduce the rate of interest. This leads to increase in demand
for loans or credit. Consequently, consumption and investment expenditure are
increased. This process continue till demand is equal to supply and deflation is
controlled.
(ii) Legal Reserve Ratio: All Commercial Banks has to maintain legal
Reserve Ratio. It is a legal obligation. Commercial Banks maintains reserves on
two accounts.
(a) Cash Reserve Ratio (CRR):  It is a fix percentage of every initial deposit
that all Commercial Banks have to hold as reserves with the Central Bank.
(b) Statutory Liquidity Ratio (SLR):  It is a fix percentage of every initial
deposit that a Commercial Banks are required to maintain with themselves in
form of cash, gold and government approved securities.
To Control Inflation:  RBI increase legal Reserve Ratio (CRR & SLR). This
reduce their capacity to create credit. Reduction in credit leads to decrease in
money supply in the economy accordingly amount of loan reduces and hence
consumption and investment expenditure also reduce. This process continue till
demand is equal to supply and inflation is controlled.
To Control Deflation:  RBI decreases legal Reserve Ratio (CRR & SLR). This
increase their capacity to create more credit. Increase in credit leads to increase
in money supply in the economy. Accordingly amount of loan increases and
hence consumption and investment expenditure also increases. This process
continue till demand is equal to supply and deflation is controlled.
(iii) Open Market Operation:  It refers to sale and purchase of government
securities by Central Bank.
To Control Inflation:  RBI sell government securities to public, for making
payment public withdraw money from Commercial Banks. This reduce the credit
availability of Commercial Banks. So amount of credit or loans reduce in the
market. Consequently consumption and investment expenditure will reduce.
This process continues till demand is equal to supply and inflation is controlled.
To control Deflation: RBI buys securities from public, public receives
money in consideration and deposit the same in Commercial Banks. This raised
the credit availability of Commercial Banks. So amount of credit or loans are
increased in the market. Consequently consumption and investment expenditure
also increases. This process continues till demand is equal to supply and deflation
is controlled.
(iv) Reverse Repo Rate:  It is the rate at which Commercial Banks transfer
its surplus money to a non-current A/c with RBI for earning income on idle
funds.
To Control Inflation: RBI increase Reverse Repo Rate this induce the
Commercial Banks to park more funds with the RBI to generate more interest
income. This leads to decrease in money supply in the economy. Consequently
consumption and investment expenditure will reduce. This process continues till
demand is equal to supply and inflation is controlled.
50 MACRO ECONOMICS

To Control Deflation: RBI decrease Reserve Repo Rate, this discourage

the Commercial Banks to park their surplus funds with the RBI. This leads
to increase in money supply in the economy. Consequently consumption and
investment expenditure will increase. This process continues till demand is equal
to supply and deflation is controlled.
2. Qualitative Measures
These are those instrument which focus on selected sectors of the economy.
They are used for discriminating between different uses of credit.
This policy of credit control is also called ‘Policy of Selective Credit Control’.
It comprise the following instruments.
(i) Marginal Requirement:  It is the difference between the Current Value of
asset mortgaged or pledged and amount of loan taken.
Marginal requirement = Value of Assets – Amount of loan
To control inflation: Marginal requirement is raised. Higher marginal
requirement implies lower the amount of loan. Accordingly demand decreases and
this process continues till demand is equal to supply and inflation is controlled.
To control deflation: Marginal requirement is reduced. Lower marginal
requirement implies higher the amount of loan. Accordingly demand increases
and this process continues till demand is equal to supply and deflation is
controlled.
(ii) Moral Suation:  It refers to moral pressure on the Commercial Banks by
the central bank to be liberal in lending during deflation and banks are adviced
to restrict and selective loans in inflation except farmers.
The Commercial Bank generally don’t ignore the advice of RBI.
(iii) Credit Rationing:  It means fixing of credit quotas for different business
activities. To control inflation credit needs to be restricted. The Commercial Banks
can’t exceed the quota limit while granting loans. To control deflation rationing of
credit is withdrawn to increase money supply in the economy.
B. Fiscal Policy (Fiscal Measures)
It refers to budgetary policy of the government to correct the situation of
excess demand and deficient demand.
Components of Fiscal Policy (instruments in fiscal policy)
(i) Government expenditure:  It refers to the expenditure of govt. on public
welfare works such as construction of roads, dams, bridges, expenditure on
education, defence, maintenance of laws, etc.
To correct situation of excess demand govt. reduces their all expenditures.
So that less income generation in the economy and consequently AD will be less
as require to correct excess demand.
To correct situation of deficient demand govt. increases their all expenditure.
So that more income generation in the economy. And consequently AD will be
more as required to correct deficient demand.
DETERMINATION OF INCOME AND EMPLOYMENT 51

(ii) Taxation policy: Taxes are a compulsory payment made to the

government under any law.
By increasing tax burden on the households and the producers govt. reduces
the purchasing power in the economy on the other hand by lowering the tax
burden, the government increases the purchasing power and excess demand
and deficit demand are corrected.
Consumption Function
The functional relationship between C and Y is called consumption functon.
C = a + bY
Here C = Consumption expenditure.
a = Autonomous consumption
*b = Marginal propensity to consume i.e. MPC
Y = National income
Saving Function
The functional relationship between S and Y is called saving function
S = – a + (1 – b)Y
Here S = Saving
– a = Autonomous savings
(1 - b) i.e. (1 – MPC)  i.e.  MPS
Y = National income
*APC (Average Propensity to Consume)
It is the part of income which is consumed. (or)
It shows the relationship between consumption and income.
C APC can be equal to 1 (when C = Y at Break even point.)
APC = Y APC can be less than 1 (when C < Y)
APC can be more than 1 (when C > Y)
It can never be zero and negative

*APS (Average Propensity to Save)

It is the part of income which is saved.
It shows the relationship between savings and income.
APS can be negative when S is –ve.
S
APS = APS can be zero when S = 0.
Y
APS can be positive when S is +ve but not equal to one &
more than One

APC + APS = 1
*MPC (Marginal propensity to consume)
52 MACRO ECONOMICS

It shows change in consumption due to change in income.

MPC is always more than zero less than one.
∆C
MPC = [0 < MPC < 1] i.e. (0 to 1)
∆Y

∆C = C2 – C1 ;  ∆Y = Y2 – Y1
*MPS (Marginal propensity to save)
It shows change in savings due to change in income.
∆S
MPS =    MPS is always more than zero less than one
∆Y
[0 < MPS < 1] i.e. (0 to 1)

– S1; ∆Y = Y2 – Y1   MPC + MPS = 1

∆S = S2
y
Note: •  MPC is slope of consumption function. Y
•  MPC is constant at each level. 1) C
C = ven
•  MPS is slope of saving function P
(A ake
Bre
• MPS is constant for a straight line
S-function. 20
*Derivation of saving function from o
45º
x
consumption function
S = − a + (1 − b )Y & C = a + bY y
S=Y–C
S = Y − ( a + bY )
S = Y − a + bY S

S = − a + (1 − b)Y o x

1. S-line must start from the point which indicate (–)–20

that the value of S (the value of S when Y = 0) level of income
corresponds to the value of C (the value of C when
Y = 0). 

Here S-line starts from –20 where C line starts from +20 because C = 20,
Y = 0 and S = –20.
2. S-line must cross the X-axis when (Y = C) so that S = 0. Thus S-line
crosses X-axis when Y = C = 100 and therefore S = 0.
3. The slope of S-line must be equal to (1 – slope of C-line) while slope of C
line is 0.8 = MPC and slope of S line is (1 – MPC) i.e. 0.2 i.e. MPS.
Investment Multiplier
DETERMINATION OF INCOME AND EMPLOYMENT 53

It measures change in income due to change in investment in the economy.

We have noted that increase in income is many times more than the increase in
investment. The number of times by which the increase in income exceeds the
increase in investment is called investment multiplier or output multiplier.
It is denoted by “K”.
∆Y 1 1
K = or K = or K =
∆I MPS 1 − MPC
∆Y = Y2 – Y1;  ∆I = I2 – I1  
Maximum value of K is infinity and minimum value is 1.
Relationship between MPC &K, MPS &K, &MPC & MPC
MPC K MPS K
0.2 1.25 0.8 1.25
MPC + MPS = 1
0.4 1.67 0.6 1.67 1 1
K= or
0.5 2 0.5 2 MPS 1 − MPC
0.8 5 0.2 5
Conclusion
* There is inverse relationship between MPC & MPS as value of MPC increases
then value of MPS decreases as shown in above schedule.
* There is inverse relationship between multiplier and MPS. Higher the value
of MPS, lower the value of multiplier & vice versa.
* There is a direct relationship between multiplier and MPC. Higher the
value of MPC, higher the value of multiplier and vice versa as shown in above
schedule.

*Working of investment multiplier with a numerical example.

Multiplier measures change in national income, caused by change in
investment. This can be illustrated with the help of an example. Suppose there is
an initial increase in investment of `100 crores in the economy further suppose
the value of MPC is 0.8. This increase of investment of `100 crores results an
increase of income of `100 of people working in the investment industry. They
will together spend `80 (80% of `100) on consumption goods. This increase
in consumption of `80 crores will increase the income of people working
in consumption goods industry in 2nd round. This additional income of `80
crores will lead to an additional income of `80 crores will lead to an additioal
consumption of `64 crores (80% of 80 crores) in the economy. As some people
spend this additioinal income of `64 crores. Someones get it. This is the 3rd
round increase in the level of income in the economy. Since this process will
continues with each round of income being 80% of the previous level. Thus there
are many rounds of increase in income due to increase investment (∆I).
This can be explain through a table as given below:
54 MACRO ECONOMICS

∆ in Change in Change in Change in

investment Income Consumption Income

s ∆I ∆Y ∆C ∆Y
ces
Pro

Investment Multiplier Process assume (MPC = 0.8 i.e. 80%)

Round Increase in Increase in Increase in
investment income Consumption
1 `100 crores 100 80
2 — 80 64
3 — 64 51.20
All other round — 256 204.80
Total 100 500 400
The above table clearly shows that initial increase in investment of `100
crores has resulted in an increase of additional income of `500 crores. i.e. the
resultant increase in income is 5 times the initial investment.
∆Y 500 1 1
i.e.  K = = = 5 Times or = = 5 times
∆I 100 MPS 0.2

* Ex – ante saving:  It refers to planned saving in an economy in a year.

* Ex – ante investment:  It refers to planned investment in an economy in
a year.
* Ex – post investment:  It refers to the actual amount of investment in an
economy during a year.
* Ex-post saving : It refers to actual savings in an economy in a year.
NUMERICALS
Q.1. Find “Investment” from the following:
National income = `800
Autonomous consumption = `50
MPC = 0.8 Ans. 110
Q.2. Find consmption expenditure from the following:
Autonomous consumption = `150
MPC = 0.75
Ntional income = `1000 Ans. 900
Q.3. An economy is in equilibrium. The economy’s consumption function is
C = 100 + 0.5Y where C is consumption expenditure and Y is national
income. National income is 1000. Find out investment expenditure, MPS
and K. Ans. (400, 0.5 & 2)
Q.4. In an economy, S = –100 + 0.6Y is the saving function. Where S is saving
DETERMINATION OF INCOME AND EMPLOYMENT 55

and Y is national income if investment expenditure is `1100. Calculate:

(i) equilibrium level of national income.
(ii) Consumption expenditure at that level of income.  Ans. (2000, 900)
Q.5. Calculate (a) equilibrium level of national income and (b) Consumption
expenditure and (c) Investment multiplier if C = 200 + 0.5Y and investment
expenditure is 1500. Ans. (3400, 1900 & 2)
Q.6. Complete the following table and calculate MPC at each level:
Consumption (`) 100 175 250 325
Saving (`) 50 75 100 125
Income ` 150 — — —

Q.7. In an economy, MPC = 0.75. What will be he effect on total income if

investment increase by `300 crores.      Ans. (1200)
Q.8. Given that national income is `80 crores and consumptin expenditure `64
crores, find out APS. When income rises to `100 crore and consumption
expenditure is `78 crore. What will be the APC and MPC.
Ans. (0.2, 0.78 & 0.7)
Q.9. In an economy 75% of increased in income is spend an consumption.
Investment is increased by `1000 crore. Calculate ∆Y (increase in income)
and ∆C (total increase in C). Ans. (4000 & 3000)
Q.10. In an economy the equilibrium level of income is `12000 crore. The ratio
of marginal propensity to consume and marginal propensity to save is
3:1. Calculate additional investment needed to reach a new equilibrium
level of income of `20,000 crore. Ans. (2000)
Q.11. Given consumption function C = 100 + 0.75Y and investment expenditure
`1000. Calculate (a) equilibrium level of national income (b) consumption
exenditure at that level. Ans. (4400 & 3400)
Q.12. In an economy, with every increase in income 10% of the rise in income
is saved. Suppose a fresh investment of `120 crores takes place in the
economy. Calculate (i) change in income (ii) change in consumption.
Ans. (1200 & 1080)
Q.13. Find national income from the following:
Autonomous consumption = `100
MPC = 0.80
Investment = `50. Ans. (750)
Q.14. Complete the following table:
Income C APS MPC
400 240 0.4
800 440 — —
— 520 0.48 —
Q.15. Complete the following table:
56 MACRO ECONOMICS

Income Savings MPC APC

100 40 — —
200 0 — —
250 120 — —
Q.16. State the following statements are true or false (with reason):
(a) The value of MPS can never be negative.
(b) When MPC is zero, the value investment multiplier is zero.
(c) Value of APS can never be less than zero.
(d) When investment multiplier is 1, the value of MPC is 0.
(e) The value of APS can never be greater than 1.
Q.17. Complete the following table:
Income C APS MPC APC Multiplier (K)
0 15 — — — —
50 50 — — — —
100 85 — — — —
150 120 — — — —
Q.18. Calculate MPC is K is 4.
Q.19. Calculate change in consumption if saving increase from 700 to 1200
and income increase 1000 to 1200.
Q.20. Complete the following table:

Y C MPS APS
0 80 — —
100 140 0.4 —
200 — — 0
— 240 — 0.20
— 260 0.8 0.35

Q.21. Complete the following table:

Y S APC MPC
0 –40 — —
50 –20 — —
100 0 — —
150 30 — —
200 50 — —
Q.22. The following table illustrate the multiplier process after making an
DETERMINATION OF INCOME AND EMPLOYMENT 57

additional investment of `1000 crores. Calculate missing values:

Increase in Increase in Increase in
Income (`) Consumption Saving (`)
(`)
First Round ? ? 200
Second Round ? 640 ?
Third Round ? ? ?
All other Round ? ? ?
Total ? ? ?
Q.23. C = 50 + 0.5Y is the consumption function and investment expenditure
is `2000 in an economy.
Calculate:
(i) equilibrium level of income.
(ii) consumption expenditure at that level
(iii) investment multiplier. (Ans. 4100, 2100 & 2)
Q.24. In an economy S = – 50 + 0.5Y is the saving function and investment
expenditure is `7000. Calculate equilibrium level of income and
consumption expenditure at that level. (Ans. 14100 & 7100)
Q.25. Calculate MPC from the following:
(i) Investment `350
(ii) Consumption expenditure at zero level income `20
(iii) National Income 1000. Ans. 0.63
Q.26. Complete the following table:
Y MPC S APC
0 — – 30 —
100 0.75 — —
200 0.75 — —
300 0.75 — —
Q.27. On the basis of consumption function
C = 120 + 0.40Y
Calculate:
(i) Saving function
(ii) Determine saving at `500 level of income.
(iii) At what level of income saving becomes zero?
(Ans. –120 + 0.60Y, 180 & 200)
Q.28. In an economy, an increase in investment leads to increase in national
income which is three times more than the increase investment. Calculate
marginal propensity to consume.            (Ans. 0.75)
Q.29. An increase of `250 crores in investment in an economy resulted in total
increase in income of `1000 crores. Calculate the following:
(a) Marginal propensity to consume (MPC).
58 MACRO ECONOMICS

(b) Change in saving

(c) Change in consumption expenditure
(d) Valule of multiplier. (Ans. 0.75, 250, 750 & 4)
30. In an economy, investment is increased by `300 crore. If marginal
propensity to consume is 2/3, calculate increase in National Income.
(Ans. 900)

TRUE OR FALSE (CBSE Questions)

Q.1. Sate wheher the followg staements are true or false. Give reasons for
your answer:
(i)  When marginal propensity to consume is greater than marginal
propensity to save, the value of investment multiplier will be greater
than 5.
(ii) The value of marginal propensity to save can never be negative.
[CBSE Delh 2010]
Ans. (i) N
 o, the statement is not fully correct.
1
  We know, K= , where K = Multiplier.
MPS
  In case, K = 5 then,
1 1
MPS = = = 0.2
K 5
  Where MPS = 0.2, MPC = 0.8 (as MPS + MPC = 1)
  Thus, K = 5, when MPS = 0.8
  It also implies that K will be greater than 5 only when:
  (a) MPC > 0.8 and
  (b) MPC > MPS.
(ii) Yes, the statement is true, Marginal propensity to sve is the ratio
between additional saving and additional income which is always
positive because of positive relationship between saving and income.
Q.2. State whether the following statements are true or false. Give reasons.
(i) Average propensity to save is always greater than zero.
(ii) Value of investment multiplier varies between zero and infinity.
[CBSE Delhi 2010]
Ans. (i) No, the statement is false. Average propensity to save is not always
greater than zero. It can be negative in situation when saving in
negative or when consumption is greater than income.
(ii) No, the statement is alse. Value of investment multiplier varies between
one and infinity. The minimum value of investment multiplier is 1. It
can never be less than one because MPC is never negative. At least it
is = 0, at at most it is = 1.
   In case MPC = 0.
1 1
K= = =1
1 − MPC 1 − 0
DETERMINATION OF INCOME AND EMPLOYMENT 59

  In case MPC = 1,
1 1 1
K= = = =∞
1 − MPC 1 − 1 0

  So that value of K (multiplier) always varies between 1 and ∞.

Q.3. State whether the following statements are true or false. Give reasons.
(i) When marginal propensity to consume is zero, the valuie of investment
multiplier will also be zero.
(ii) Value of average propensity to save can never be less than zero.
[CBSE (A) 2010]
1
Ans. (i) False. Because K =
1 − MPC

   When: MPC = 0
1 1
K= = =1
1− 0 1
Therefore, when marginal propensity to consume is zero, the value of
investment multiplier will be one.
(ii) False. The value of average propensity to save (APS) can be less be
than zero. It happens when consumption is greater than income or when
APC > 1.
Illustration:
Let us assume,
Y = 100
C = 120
S = Y – C
= 100 – 120 = – 20
In such a situation,
S − 20
APS = = = 0.2
Y 100
C 120
APC = = = 1.2
Y 100
Q.4. State whether the following statements are true or false. Give reasons.
(i)  There is an inverse relationship between the value of marginal
propensity to sae and investment multiplier.
(ii) When the value of average propensity to save is negative, the value of
marginal propensity to sae will also be negative.    [CBSE(A) 2010]
Ans. (i) 
Yes, the statement is true. Marginal propensity to save (MPS) and
multiplier are inversely related. Higher the MPS, lower the multiplier
1
and lower the MPS, higher the multiplier, as K = .
MPS
(ii) No, it is not true. The value of average propensity to save is negative
60 MACRO ECONOMICS

when consumption is greater than income but this does not mean
that marginal propensity to save (MPS) will also be negative. In fact
MPS is never negative. Because it is the ratio between ∆S and ∆Y and
∆S can never be negative, as a component of ∆Y.
Q.5. Statement whether the following statements are true or false. Give reasons.
(i) If the ratio of marginal propensity to consume and marginal propensity
to save is 4 : 1, the value of investment multiplier will be 4.
(ii) Sum of average propensity to consume and marginal propensity to
consume is always equal to 1.     [CBSE (A) 2010]
Ans. (i) False. Because if the ratio of marginal propensity to consume and
marginal propensity to save is 4 : 1, MPC will be 0.8 and MPS = 0.2
(because MPC + MPS = 1). In such a cae,
1 1 1
K = = = =5
1 − MPS 1 − 0.8 0.2
Details:
Let us assume that MPC = 4x and MPS = 1x, as ratio of MPC and MPS = 4 : 1.
We know,
MPC + MPS = 1
4x + 1x = 1
5x = 1
x = 1 = 0.2 (implying MPS = 0.2)
5
According , MPC = 4 × 0.2 = 0.8
(ii) False. Because, whether APC is the ratio between total consumption and
total income. MPC is the ratio between additional consumptioi and additional
income. And while APC can be greater than one. MPC can never be negatie.
Q.6. State whether the following statements are true or false. Give reasons for youer
answer.
(i) When investment multiplier is 1, the value of marginal propensity to consume
is zero.
(ii) The value of average propensity to save can never be greater than 1.
[CBSE (F) 2010]
Ans. (i) Yes, the statement is true. When investment multiplier is 1, marginal
propensity to consume is zero.
We know that,
1
Muultiplier (K) =
1 − MPC
1
Thus, = 1
1 − MPC
1 = 1 – MPC
MPC = 1 – 1 = 0
(ii) True. The value of average propensity to save can never be greater than 1 because
DETERMINATION OF INCOME AND EMPLOYMENT 61

even when all the income is saved and nothing is spent on consumption, saving
will be equal to income. In this case, average propensity to save (APS) will be
equal to 1 and not greater than 1.
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