UNIT: Determination of Income and

Employment

“Chapter: 1”
Concepts related to Income determination

 The term "income" refers to national income and word "determination" refers
to “determination of Equilibrium level".
 Equilibrium level of national income is determined by “Aggregate Demand”
and “Aggregate supply”.
 The determination of Equilibrium level of income requires understanding of
some Basic Concepts like AD, AS etc.

[A] Aggregate Demand (1 Mark)

Aggregate demand refers to the Total Value of final goods and services
demanded in An Economy during a year.

OR
In other words, it implies the total Amount of Expenditure that all the sectors of
an Economy are ready to spend (Planned expd) on final goods in the Economy.
Hence
*Aggregate Demand and Aggregate Expenditure Mean the same thing.

[4 Marks] COMPONENTS OF AGGREGATE DEMAND

(i) Consumption Expenditure (C)
It refers to the total Expenditure incurred By Household on Purchase of goods
and services during an Accounting year. This Expenditure is directly influenced
by level disposable Income (Y)
So there exists a positive relation between consumption Expenditure and
disposable Income.
Higher the disposable income, Higher will be the consumption Expenditure vice
versa.
(ii) Investment Expenditure (I) [AKA Capital formation]
This Expenditure is incurred by private firms on capital goods. (Land, Building,
Plant etc.)
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In this chapter, Investment Expd. is assumed to Be Constant as it’s not
influenced by level of disposable income, it’s influenced by ROI. (Return Over
Investment)
(iii) Government Expenditure (G)
It refers to the total expenditure incurred by the government on consumption
and investment to satisfy common needs of the society.

Government as consumption Government as Investment

Expenditure Expenditure

 It is incurred by government to  It involves construction of roads,

meet public needs like law and flyovers, highways, etc.
order, free education & health etc.

(iv) Net Exports (X-M)

It refers to the difference between the value of exports and imports.
Export refers to the expenditure incurred by foreigners on purchase of domestic
goods.
Import refers to the expenditure incurred by normal residents on purchase of
goods from abroad.
Hence,

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

But in this chapter AD will be studied in Two sector economy.

So in Two sector economy AD has two components:
1.) Consumption
2.) Investment
Two sector Economy comprises:
1.) Household sector
2.) Producer sector
So in two sector AD is the sum total of Consumption and Investment.
(Closed Economy)
AD = C + I
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 AD Schedule
Income (Y) Consumption Expd Investment Expd AD = C + I
0 40 40 80
100 120 40 160
200 200 40 240
300 280 40 320
400 360 40 400
500 440 40 480
600 520 40 560

Important observations about Aggregate Demand

1.) AD = C + I which means that AD has Two components Consumption
Expenditure and Investment Expenditure.
2.) ̅ = Autonomous Consumption
It is that level of minimum consumption which is always there even at “0” level
of income.
It is incurred on those goods and services which are required for the survival. It is
done out of savings.
3.) Slope of Consumption Curve
Consumption Curve slopes upwards because Consumption has positive relation
with Income. i.e. when income rises Consumption also Rises.
However the proportionate Increase in Consumption is always less than the
proportionate Increase in income because after reaching particular level people
start saving.
4.) Slope of Investment Curve
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Investment curve is a horizontal straight Line parallel to X Axis because it is
assumed to be Constant.
5.) Slope of AD Curve
AD slopes upwards because it has two Components "C" and "I'.
Consumption Increases with increase in income and I is Constant.

CONSUMPTION FUNCTION
(Propensity to Consume)
 It states functional relationship Between Consumption (C) and Income (Y)

C = f (Y)
 Consumption function helps us to understand How C behaves with respect to
Y.
**Here Consumption should not Be Confused with the Consumption function.
Consumption refers to the Amount of Expenditure spent on purchase of goods
and Services.
On the other hand Consumption function signifies a schedule showing
Consumption Expenditure at Various levels of income. It is also known as
“Propensity to Consume”.
Consumption is an important Component of AD which depends upon level of
Income.

Consumption Schedule
Income (Y) Consumption (C) Savings (S) ( Y – C)
0 40 -40
Dissavings
100 120 -20
200 200 0 --- B.E.P
300 280 20
400 360 40
500 440 60 Savings
600 520 80
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 Important observations about Consumption
1.) ***Consumption Curve always starts from a point above the Origin on Y axis
which shows Autonomous Consumption (C). It also shows that Consumption
can never be zero.
2.) Slope of Consumption Curve is left to right upward sloping because
Consumption is directly related with Income. As Income (Y) increases,
Consumption also increases.
**However proportionate increase in Consumption is always less than the
proportionate Increase in income, because after reaching a certain level people
start saving.
3.) When Y<C (Before Break Even Point) shows dissavings.
4.) When Y = C (Break Even Point) and Savings = 0
5.) When Y > C (After Break Even Point) shows Savings

Keynesian Psychological Law of Consumption

1.) Consumption can’t be Zero due to Autonomous Consumption ̅

2.) As Income Consumption

3.) Δ Change in income > Δ Change in Consumption

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 “TYPES OF PROPENSITIES TO CONSUME”
There are two types/measures to consume

Average Marginal
Propensity to Propensity to
consume (APC) consume (MPS)

** [A] Average Propensity to Consume (APC)

It refers to the consumption expenditure per unit of income.
OR
It is the ratio of Aggregate Consumption to National Income.

APC = C/Y

where; C= Consumption and Y= National Income

Example: If consumption expenditure is ` 70 cr. And national income is ` 100 cr.

Then:
APC = 70/100 = 0.70 i.e. 70% of income is spent on consumption.

APC Schedule
Income (Y) Consumption (C) APC = C/Y
0 40 -
100 120 1.2 (120/100)
200 200 1 (200/200)
300 280 0.93 (280/300)
400 360 0.90 (360/400)
500 440 0.88 (440/500)
600 520 0.88 (520/600)
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 Important observations about APC
1.) When Y > C (After B.E.P) APC > 1
2.) When Y < C (Before B.E.P) APC > 1
3.) When Y = C (B.E.P) APC = 1
4.) APC falls as income rises because the proportionate of income spent on
consumption keeps on decreasing.
5.) *** APC can never be “ZERO” due to Autonomous Consumption. Even at 0
level of national income there is a minimum level of consumption
(Autonomous Consumption)

[B] Marginal Propensity to Consume (MPC)

 It refers to the ratio of change in consumption expenditure to change in total
income.
 It indicates that part of additional income which is spent on consumption.
 It measures the rate at which consumption changes as income changes.

MPC = ΔC / ΔY, where ΔC is the change in consumption, and ΔY is the change in

income

MPC Schedule
Income (Y) Consumption ΔC ΔY MPC = ΔC /
(C) ΔY
0 40 - - -
100 120 80 100 0.8
200 200 80 100 0.8
300 280 80 100 0.8
400 360 80 100 0.8
500 440 80 100 0.8
600 520 80 100 0.8
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 *** Important Observations about MPC
1.) The value of MPC varies between 0 and 1.
As we now the additional / incremental income is either spent on consumption or
saved for future.

(a) If the Entire income (when ΔC = ΔY) is Consumed then ΔS = 0, then MPC =
1
(b) If the Entire, Income ΔC=0 then MPC =0 is Saved (when Consumption is
constant)

2.) MPC of Poor is More than that of rich

Because poor people spend a greater proportion of their increased income on
Consumption as most of their needs are unsatisfied.
On the other hand rich people spend a smaller proportion of their increased
income because they have already enjoyed high standard of living or they have
satisfied most of their needs.
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 SAVING FUNCTION
(Propensity to Save)
 Just like consumption, saving is also a function of income, i.e. saving also
depends upon the level of income.
 It refers to the functional relationship between saving and income.

S = f (Y) OR Saving = Y - C
Where S= Saving, Y= National Income

Saving function OR Propensity to save shows the different level of savings

at different level of income in an economy.

Saving Schedule
Income Consumption Saving
0 40 -40
100 120 -20
200 200 0
300 280 20
400 360 40
500 440 60
600 520 800

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 “Important Observations about saving function”
1.) Starting point of saving curve
Saving curve (SS) starts from point S on the Y Axis indicating that there is
Negative savings due to autonomous consumption.
2.) Saving curve has positive slope which shows that saving and income has
positive relation.

3.) At B.E.P = S= 0 OR Y=C

4.) Before B.E.P saving is negative
5.) After B.E.P saving is positive

Types of Propensities to save

Average propensity to Marginal propensity

save (APS) to save (MPS)

[A] Average Propensity to save (APS)

1.) It refers to saving per unit of national income.
S= Saving Y= Income
APS = S/Y

If consumption expenditure is ` 70 and national income is ` 100, then APS=?

S= Y-C, S=100 – 0 = 30
APS = S/Y = 30/100 = 0.30
i.e. 30% of the income is saved.

Income (Y) Consumption Saving APS = S/Y

0 40 -40 -
100 120 -20 -0.2
200 200 0 0
300 280 20 0.67
400 360 40 0.10
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 Important Observations about APS
1.) *** APS can never be 1 or more than 1 as saving can never be equal to or
more than national income.’
2.) APS = 0 when S=0 at B.E.P
3.) APS can be negative or less than 1 before break-even point where Y<C
4.) APS rises with rise in income because the proportion of income saved goes on
increasing.

[B] Marginal Propensity to Save (MPS)

 It is the ratio of change in saving to a change in income.
MPS = ΔS / ΔY
ΔS = change in saving
ΔY = change in income

MPS Schedule
Income Consumption Saving Change in Change MPS =
income ΔY in saving ΔS / ΔY
ΔS
0 40 -40 - - -
100 120 -20 100 20 0.2
200 200 0 100 20 0.2
300 280 20 100 20 0.2
400 360 40 100 20 0.2
500 440 60 100 20 0.2
600 520 80 100 20 0.2

** MPS also varies from 0 to 1

 MPS= 0 when the entire additional income is spent on consumption, saving is
0.
MPS= 1 when the entire additional income is saved i.e. ΔS = ΔY
** MPS can never be negative because of direct relationship between income and
savings.
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 1. Consumption Function Equation
C= ̅ + b(Y)
Where

C = consumption, ̅ = autonomous consumption

b= MPC, Y= National income

2. Saving Function Equation

S =− + (1-b)(Y)
S= saving, − ̅ = autonomous consumption

(1-b) = MPS, Y= National income

3. Relationship between APC and APS

Y = C + S ------------------- (1)
By dividing both the sides by Y we get

= +

1 = APC + APS **

So APC = 1-APS
Or
APS = 1-APC

4. Relationship between APC and APS

ΔY = ΔC + ΔS ------------- (1)
By dividing both the sides by ΔY we get

= +
ΔY ΔY ΔY

1 = MPC + MPS

So MPC = 1 – MPS
OR
MPS = 1 – MPC
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 Points to be remembered

C= ̅ + b(Y)
S =− ̅ + (1-b)(Y)
APC + APS = 1 MPC = 1 – MPS
MPC + MPS = 1 APC = 1 – APS
S=Y–C
̅ = Autonomous Consumption
APC = C/Y APS = S/Y

MPC = MPS =
ΔY = ΔC + ΔS
Y=C+S
Top tip
Derivation of consumption function form savings function
Given the savings function, we can derive the corresponding consumption
function. The two functions are closely related, since income always equals
consumption plus saving (Y = C + S)
C=Y–S

Substituting the savings function equation S= − ̅ + sY into the above equation,

we can get the consumption function equation.

C = Y – (− ̅ + ) C = Y + ̅ – sY C = ̅ + (1-s)Y
C= +bY
Example: Given the savings function S= -100 + 0.2y, we can derive the
corresponding consumption function.

C=Y–S
Substituting the savings function S= - 100 + 0.2Y into the above equation, we
can get the consumption function.
C = Y – (– 100 + 0.2Y) C = Y + 100 – 0.2Y C= 100 + 0.8Y
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 Derivation of savings curve from
consumption curve
Figure 3.2 shows the derivation of savings curve from
consumption curve.

Step 1: Draw a 45° line from origin. Given

consumption curve ̅ C intersects it at B (Break-even
point). Corresponding to the Break-even point is the
level of income at which consumption equals income
(C = Y). Therefore, savings is zero (S = 0).

Step 2: Take OS1 equal to O ̅ because at zero income,

negative savings is exactly equal to the autonomous
consumption.

Step 3: From the break-even point B, we draw a

perpendicular on X-axis which cuts the X-axis at B₁. At
OB1 level of income, savings must be zero because at
this level of income consumption equals income.

Step 4: Join S₁ and B₁ and extend it by a straight line

to get the savings curve S₁S.

Top tip:
Derivation of consumption curve from savings curve
Since income equals consumption plus savings, therefore, consumption and
savings curves can be called complementary curves. Consumption curve can be
derived from savings curve.
Fig. 3.2 shows the derivation of consumption curve from savings curve.
Step 1: Draw a 45O line from origin.

Step 2: Given the savings curve S1S, take O ̅ equal to OS1 because in the
economy the autonomous consumption is exactly equal to negative savings at
zero income.
Step 3: At point B1, savings = 0. We draw a perpendicular from B1 till it intersects
the 45O line at B. B is the break-even point where consumption equals income.

Step 4: Join ̅ and B and extend it by a straight line to get the consumption curve
̅ .
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Unsolved practices
1. Calculate APC and APS from the following schedule:

Income (Y) 100 200 300

Consumption (C) 80 120 150
(APC: 0.80, 0.60, 0.50; APS: 0.20, 0.40, 0.50)
2. At income level of ` 5,000 crores, total savings is ` 1,000 crores. Calculate
APC.{0.80}

3. Calculate MPC and MPS from the following schedule:

Income (Y) 100 200 300 400 500

Consumption 85 160 235 310 400
(C)
(MPC: -−,0.75, 0.75, 0.75;MPS: −, 0.25, 0.25, 0.25, 0.10)
4. If households save `500 crores out of an additional income of ` 5,000 crores,
then calculate MPC. (0.90)
5. If the total income increases from ` 5,000 crores to ` 6,000 crores and saving
increases from ` 1,000 crores to ` 1,500 crores, calculate MPC. (0.50)
6. If MPS is 0.3 and the income increases from ` 6,000 crores to ` 9,000 crores,
what will be the additional consumption in the economy? (`2,100 crores)
7. From the following schedule, compute APC, APS, MPC and MPS:

Income 200 250 300 350 400

Saving - 5 15 20 50
{APC: 1, 0.98, 0.943, 0.875: APC: 0, 0.02, 0.05, 0.057, 0.125:
MPC: -, 0.90, 0.80, 0.40: MPS: -, 0.10, 0.20, 0.10, 0.60}
8. Complete the following table: {CBSE All India 2009(II)}

Income Consumption Marginal Average

Propensity to save Propensity to
Consume
0 15 - -
50 50 - -
100 85 - -
150 120 - -
{Marginal Propensity to save: -, 0.30, 0.30, 0.30; Average Propensity to
Consume: -, 1.00, 0.85, 0.80}
9. Complete the following table: {CBSE All India 2009(III)}

Income Marginal Saving Average

Propensity to Propensity to
consume Consume
0 -30 -
100 0.75 - -
200 0.75 - -
300 0.75 - -
{Saving: -30, -5, 20, 45; Average propensity to Consume= -, 1.05, 0.90, 0.85}
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10.Complete the following table: {CBSE Sample Paper 2012}

Income Saving Marginal Average

Propensity to Propensity to
Consume Consume
0 -20 - -
50 -10 - -
100 0 - -
150 30 - -
200 0 - -
{Marginal Propensity to Consume: -, 0.80, 0.80, 0.40, 0.40; Average Propensity
to Consume: -, 1.20, 1, 0.0, 0.70}
11.Complete the following table: {CBSE, Delhi 2013(I)}

Income Consumption Marginal Average

Expenditure Propensity to save Propensity to save
0 80
100 140 0.4 -
200 - - 0
- 240 - 0.20
- 260 0.8 0.35
{Income: 0, 100, 200, 300, 400: Consumption Expenditure: 80, 140, 200, 240,
260}
12.Complete the following table: {CBSE, Delhi 2013(II)}

Income (`) Saving (`) Average Marginal

Propensity to Propensity to
Consume Consume
0 -40 …. ….
50 -20 …. ….
100 0 …. 0.6
150 30 0.8 ….
200 50 …. ….
{Average propensity to consume: -, 1.4, 1, 0.8, 0.75: Marginal Propensity to
consume: -, 0.6, 0.6, 0.4, 0.6}
13.Complete the following table: {CBSE, Delhi 2013(III)}

Consumption Saving (`) Income (`) Marginal

Expenditure(`) Propensity to
Consume
100 50 150 -
175 75 - -
250 100 - -
325 125 - -
{Income: 150, 250, 350, 450; Marginal propensity to consume: -, 0.75, 0.75,
0.75}
14.If National Income is ` 50 crore and Saving ` 5 crore, find out average
propensity to consume. When income increases to ` 60 crore and saving to `
9 crore, what will be the average propensity to consume and the marginal
propensity to save? {CBSE, Delhi 2011 (II)}
(0.90; 0.85; 0.40}
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15. Using the consumption function: C= ̅ + b(Y), calculate saving income of
` 2,000 crore, if autonomous consumption is ` 150 crores and 40% of
additional income is consumed. {Saving= ` 1,050 crores}
16. The saving function is given as: S= -120 + 0-.4(Y). Determine:
(i) Consumption function
(ii) Consumption at income level of ` 600 crores
(iii) Break-even level of income
{(i) C= 120 + 0.60 (Y); (ii) `480 crores; (iii) ` 300 crores}
17. The consumption function for an economy is given as: C= 200 + 0.8Y.
(i) Determine the value of MPC and MPS; (ii) Autonomous Consumption;
(iii) Derive the corresponding saving function; (iv) Calculate consumption
at the income levels of ` 3,000 crores and ` 5,000 crores; (v) Determine
the break-even level of income.
{(i) MPC= 0.8; MPS= 0.2; (ii) Autonomous consumption= `200 crores; (iii)
S= -200 + 0.20Y; (iv) ` 2,600 crores and ` 4,200 crores; (v) ` 1,000
crores}
18. If MPC is four times MPS and consumption at zero level of income is `
0 crores, derive the consumption function. {C= 70 + 0.80Y}
19. The consumption curve makes an intercept of ` 60 crores on the Y-
axis. If MPC: MPS can be expressed as 1:3, the derive the saving and
consumption function. Also determine the level of income, when saving
becomes zero.
{Saving Function: S= -60 + 0.75 (Y); Consumption Function: C= 60 +
0.25(Y); Saving will become zero at income of ` 80 crore}
20. The break-even point for an economy occurs at the income level of `
500 crores. If marginal propensity to consume is 0.6, determine:
(i) Autonomous consumption
(ii) Saving function
(iii) Level of Income when saving is ` 600 crores.
{(i) ` 200 crores; (ii) -200 + 0.4 (Y); (iii) ` 2,000 crores}
21.The consumption function of an economy is given as:
C=40+0.7Y.Calculate the saving at the income level of ` 2,200 crores.
{Saving ` 620 crores}
22. The saving curve makes an intercept of` 40 crores on the negative Y-
axis. If consumers spend 60%of additional income, then determine: (i)
Saving Function: (ii) Consumption Function: (iii) Break-evenlevel of
income.
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 {(i) S= -40 + 0.40Y; (ii) C= 40 + 0.60Y; (iii) ` 100 crores}
23. If national income is `90 crore and Consumption expenditure` 81
crore, find out average propensity to save. When income rises to `100
crore and consumption expenditure to` 88 crore. What will be the
marginal propensity to consume and marginal propensity to save?
{CBSE, Delhi 2011 (III)}
{0.10; 0.70; 0.30}
24. The saving function is given as: S=-120+ 0.5Y. Draw a diagram
showing saving corresponding to income levels of 0, 200, 400, 600 and
800.
25. It Consumption Function is given by: C = 30+0.4Y, then determine: (i)
Savings at zero level of income; (ii) MPC, (ii) MPS; (iv) Break-even level of
Income; (v) Saving Function.
{(i) -30; (ii) 0.4; (iii) 0.6; (iv) 50; (v) S = -30 + 0.6Y}
18. Complete the following table:
Level of income Consumption Marginal Marginal
(`) Expenditure (`) Propensity to Propensity to Save
Consume
240 - -
500 320 - -
600 395 - -
700 465 - -
Ans: MPC= -, 0.8, 0.75, 0.7; MPS= -, 0.2, 0.25, 0.3}

19. Complete the following table: (CBSE Sample Paper 2016)

Income(`) Saving(`) Marginal Average
Propensity to Propensity to
Consume Consume
0 -20 - -
50 -10 - -
100 0 - -
150 30 - -
200 60 - -
Ans: MPC= -, 0.8, 0.8, 0.4, 0.4; APC= -, 1.2, 1, 0.88, 0.7}
20. Marginal propensity to consume is 4 times the marginal propensity to save.
At an income level of ` 20,000 crore, APC is 0.6. Find out APC at income level of `
30,000. {Ans: APC = 0.67}
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21. Complete the following table: (CBSE Delhi 2006)
Income(`) Saving(`) Marginal Average
Propensity to Propensity to
Consume save
0 -6 - -
20 -3 - -
40 0 - -
60 3 - -
Ans: MPC= -, 0.85, 0.85, 0.85; APS= -, (-)0.15, 0.00, 0.05
22. Complete the following table: (CBSE Foreign 2009)
Income(`) Saving(`) Average Marginal
Propensity to Propensity to
Consume Consume
0 -30 - -
50 -15 - -
100 0 - -
150 15 - -
Ans: APC= -, 1.3, 1.0, 0.9; MPC= -, 0.7, 0.7, 0.7

23. Complete the following table: (CBSE All India 2009)

Income (`) Marginal Saving (`) Average
Propensity to Propensity to
Consume Consume
0 - -30 -
100 0.75 - -
200 0.75 - -
300 0.75 - -
Ans: Saving= -5, 20, 45; APC = -, 1.05, 0.9, 0.85

Type 4: Location of Missing Values

24. Complete the following table: (CBSE Delhi 2012 (C))

Y (`) MPC S APC
100 40 0.60
200 - 90 -
- - 125 0.50
Ans: Y= 250; MPC = 0.5, 0.3; APC = 0.55

25. Complete the following table: (CBSE All India 2012C)

Y (`) MPS APS C
200 0.4 120
400 - - 220
- - 0.48 260
Ans: Y= 500; MPS = 0.5, 0.6; APS = 0.45
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26. Complete the following table: (CBSE Delhi 2013)
Income(`) Saving(`) Average Marginal
Propensity to Propensity to
Consume Consume
0 -40
50 -20 - -
100 0 - 0.6
150 30 0.8 -
200 50 - -
Ans: APC= -, 1.4, 1, 0.75; MPC= -, 0.6, 0.4, 0.6

27. Complete the following table: (CBSE Delhi 2013)

Consumption Savings (`) Income (`) Marginal
Expenditure (`) Propensity to
Consume
100 50 150 -
175 75 - -
250 100 - -
325 125 - -
Ans: Income= 250, 350, 450; Marginal Propensity to Consume = -, 0.75, 0.75,
0.75

Types of Investment
 Investment means expenditure made on purchases of new capital assets like
machines, tools, equipment, etc.
 It implies an addition to the existing stock of assets. It increases the
productive capacity of an economy.

“Types of Investment”

Induced Investment Autonomous Investment

 It is the investment which is  It is the investment which is

made to earn profit. independent of the level of
 It is directly influenced by income.
level of income. It is increased  It depends upon the Social
with increase in income and Economic and political
Vice Versa. Conditions of the Country.
 Such investment changes
when there is Change in
Technology or discovery of
New Resources, replacement
of worn out Machinery etc.
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 Induced Investment Autonomous Investment
1.) It changes with change in income. 1.) It is independent of change in
income.
2.) It is made to earn profit. 2.) It is made for social welfare.
3.) It is generally made by private 3.) It is generally made by
sector. government sector
4.) It slopes upwards as it is income 4.) It is parallel to X-axis as it is
elastic. income inelastic.

Aggregate Supply (AS)

 It is the value of total Quantity of final goods and services produced in the
Economy during period of One year.
 In the absence Indirect Taxes and subsidies the value total final goods is
distributed among the factors of production (wages to labour, interest to
capital and Rent to land) and whatever is left is taken over by Entrepreneur
and is called profit.
 Thus the sum of total of Aggregate factor income in the Economy i.e.
“National Income” is Equal to the Aggregate value of o/p of final goods i.e.
“Aggregate Supply”

[AS = C + S]
AS = Y

** AS is represented by 45⁰ line from the Origin has the feature that every point
on it has the same horizontal and vertical coordinates. Therefore, corresponding
to every point on 45⁰ line.
AS = Y
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 Ex- Ante and Ex- Post Saving and Investment

a) Ex-Ante Saving (Planned Saving) refers to the amount of saving which

household plan to save at different levels of income in the economy. This
amount is given by saving function.
b) Ex-Post Investment (Planned Investment): refers to the amount which firms
plan to invest at different levels of income in the economy. It is determined
by the relation between investment demand and rate of interest.
c) Ex-Post Savings refers to the actual amount of saving in the economy.
d) Ex-Post Investment refers to the actual investment made in the economy
during the year.
** Ex-Ante and Ex-Post variable may or may not be equal.

“The Concept of Full Employment and Involuntary

Unemployment”

Full Employment:
 It is defined as a situation when all the persons who are willing and able to
work get work at a given wage rate.
 So in full employment demand for labour is equal to available supply of labour
at a given wage rate.
 ** However, full employment doesn’t refer to “Zero Employment”. In a
situation of full employment some natural unemployment can exist and which
can’t be permanently reduced.

Structural Unemployment
Frictional Unemployment
 It is associated with the structure
 It is a temporary phenomenon. of the economy. It generally
It occurs when workers are occurs when there is change in
temporarily out of work while technology, change in the
changing jobs. production method in the
economy.

INVOLUNTARY UNEMPLOYMENT
It is a situation where people are willing and able to work do not get work at an
existing wage rate.
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 QUESTION BANK
I. Multiple Choice Questions

1. Which one is a component of aggregate demand?

(a) Consumption expenditure
(b) Investment expenditure
(c) Both (a) & (b)
(d) Neither (a) nor (b)
2. Aggregate consumption in an economy is:
(a) Positive throughout
(b) Positive in the beginning and then negative
(c) Negative throughout
(d) Negative initially and then positive
3. The saving function curve is:
(a) Upward sloping (b) Downward sloping
(c) Parallel to the X-axis (d) Parallel to the Y-axis
4. Which of the following is not a component of aggregate demand in two-sector
economy?
(a) Net Exports (b) Investment
(c) Consumption (d) All of the above
5. Aggregate supply is same as:
(a) National output (b) National income
(c) Both (a) and (b) (d) None of the above
6. At break-even point:

(a) S = I (b) ̅ = I
(c) C = Y (d) ΔC = ΔY
7. Which of the following statements is true?
(a) APC can never be greater than one
(b) APS can never be zero
(c) APC can be zero
(d) APS can be negative
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8. If APC = 0.8, then APS will be:
(a) 1.0 (b) 0.2
(c) -0.2 (d) 1.2
9. The value of the following can be greater than one:
(a) MPC (b) APC
(c) APS (d) MPS

10. __________________ =

(a) APC (b) MPC

(c) APS (d) MPS
11. The value MPC can be zero when:
(a) The entire increase in income is consumed
(b) The entire increase in income is saved
(c) Consumption = income
(d) None of these
12. MPS is equal to:

(a) (b)

(c) 1 − (d)
13. MPS is equal to:

(a) 1 – MPC (b)

(c) Both (a) and (b) (d) Neither (a) nor (b)
14. APC + APS = ________________.
(a) 0 (b) 1
(c) ∞ (d) None of these
15. MPC + MPS = ______________.

(a) ∞ (b) 2
(c) 1 (d) 0
16. Which one is true?
(a) MPC + MPS = 0 (b) MPC + MPS < 1
(c) MPC – 1 = MPS (d) MPS = 1 – APC
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17. Unemployment caused by change in production technology is known as:
(a) Structural Unemployment
(b) Frictional Unemployment
(c) Voluntary Unemployment
(d) Disguised Unemployment
18. Following is the assumption of the Keynesian theory of income and
employment:
(a) Full Employment
(b) Supply creates its own demand
(c) Short run
(d) None of these
19. The consumption of an economy is given as C = 40 + 0.80Y, find out the value
of MPS.
(a) 0.80 (b) 0.20
(c) 0.40 (d) 1.00
20. Which of the following statements is true?
(a) The value of APS can never be less than Zero
(b) The sum of APC and MPC is always equal to 1
(c) Full employment implies absence of involuntary unemployment ‘
(d) All of the above
21. Full employment can exist even when there is ______________ in an economy.
(a) Structural unemployment
(b) Frictional unemployment
(c) Both (a) & (b)
(d) Neither (a) nor (b)
22. Which of the following is an ex-post variable?
(a) Aggregate Demand (b) Aggregate supply
(c) Both (a) & (b) (d) Neither (a) nor (b)
23. The Saving function of an economy given as:
S = -100 + 0.3Y
Find out the value of MPC.
(a) 0.3 (b) 0.4
(c) 0.7 (d) 0.6
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24. Choose the correct statement:
(a) Aggregate Supply = Consumption + Saving
(b) Aggregate demand = Consumption + Investment
(c) Both (a) & (b)
(d) Neither (a) nor (b)
25. Which kind of Unemployment can exist in a situation of full employment?
(a) Structural unemployment
(b) Functional Unemployment
(c) Voluntary Unemployment
(d) All of the above
26. If savings are ` 2,000 at the income level of 10,000, then APC will be:
(a) 0.8 (b) 0.2
(c) 0.5 (d) 1.2
27. If = 0, then will be:
(a) equal to ΔY (b) greater than ΔY
(c) equal to ΔC (d) None of these
28. The level of induced consumption an economy depends on:
(a) APC
(b) MPC
(c) Level of National Income’
(d) Both (a) & (b)

Answers: 1. (c), 2. (a) 3. (a) 4. (a) 5. (c) 6. (c) 7. (d) 8. (b)

9. (b) 10. (b) 11. (b) 12. (d) 13. (c) 14. (b) 15. (c) 16. (c)

17. (a) 18. (c) 19. (b) 20. (c) 21. (c) 22. (d) 23. (c) 24. (c)

25. (d) 26. (a) 27. (a) 28. (d)

II. Important Question:

Q.1. What is aggregate demand?(CBSE Delhi 05C, 06, 10; All India 07, 10, 15;
Foreign 08)
Ans. Aggregate demand refers to total planned expenditure on the purchase of
domestically produced goods and services during a year.
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Q.2. What is aggregate supply in macroeconomics? (CBSE All India 2007, 08, 09,
Delhi 2014, 15)
Or
Define aggregate supply. (CBSE Delhi 2018)
Ans. Aggregate supply refers to the total value of planned output of final goods
and services by all the producers in an economy during a year.
Q.3. What are the main components of aggregate demand?
Ans. The main components of aggregate demand are:
(i) Consumption demand
(ii) Investment demand
(iii) Government purchases and’
(iv) Net exports
Q.4. What determines the level of consumption expenditure?
Ans. The level of disposable income determines the level of consumption
expenditure.
Q.5. State the components of aggregate supply. (CBSE Delhi 2005C, 06)
Ans. Consumption and savings are the two main components of aggregate
supply.
Q.6. Define propensity to consume.
Or
Define consumption function.
Ans. Propensity to consume is defined as a schedule showing amounts of
consumption at different levels of income.
Q.7. Define average propensity to consume.
Ans. The ratio between total consumption and total income to any particular
level of income is called average propensity to consume.
Q.8. What is meant by break-even point? (or income)
Ans. It refers to the point at which consumption is equal to national income. That
is C = Y.
Q.9. Define Marginal propensity to consume.
Ans. The ratio between change in consumption and change in income is called
Marginal propensity to consume.
Q.10. Define propensity to save.
Ans. Propensity to save may be defined as a schedule showing amounts of
saving at different levels of income.
Q.11. What is average propensity to save? (CBSE Delhi 2004C)
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Ans. It is the ratio between total savings and total income at a particular level of
income.
Q.12. Give the meaning of marginal propensity to save. (CBSE Delhi; All India
2008C)
Ans. It is the ratio of change in savings to change in income.
Q.13. What is the relationship between APC and APS?
Ans: APC + APS = 1
Q.14. What is the relationship between marginal propensity to consume and
marginal propensity to save? (CBSE Sample Paper 2012)
Ans: MPC + MPS = 1
Q.15. If APS is 0.4, how much will be the APC?
Ans: APC = 1 – APS
= 1 – 0.4
= 0.6
Q.16. If the value of Average Propensity to save is (-) 0.6, what will be the value of
Average Propensity to consume? (CBSE All India 2008)
Ans: Average Propensity to save (APS) = (-) 0.6
We know that,
APC + APS = 1
APC + (-) 0.6 = 1
APC = 1 + 0.6
Average Propensity to consume (APC) = 1.6
Q.17. If the value of Average Propensity to Consume is 1.5, what will be the value
of Average Propensity to Save? (CBSE All India 2008C)
Ans: Average Propensity to consume (APC) = 1.5
We know that,
APC + APS = 1
1.5 + APS = 1
APS = 1 – 1.5 = APS = (-) 0.5
Q.18. If the value of Average Propensity to consume is given 0.75, the value of
Average Propensity to save would be? (CBSE All India 2018)
Ans: 0.25
Q.19. If MPC is 0.8, what will be the MPS?
Ans: MPC + MPS = 1
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 0.8 + MPS = 1
MPS = 1 – 0.8
= 0.2
Q.20. How much is the marginal propensity to consume in an economy in which
MPS is 0.3? (CBSE All India 2008)
Ans: MPC + MPS = 1
MPC + 0.3 = 1
MPC = 1 – 0.3
= 0.7
Q.21. What is ex-ante consumption? (CBSE Delhi 2018)
Ans. Ex-ante consumption means planned consumption by households in an
economy in an accounting year.
Q.22. Give the meaning of autonomous consumption. (CBSE Delhi 2009)
Ans: Autonomous Consumption refers to the minimum level of consumption
which is required for survival. It is independent of income.
Q.23. What is induced consumption?
Ans: The consumption, which is determined by the level of income, is called
induced consumption.
Q.24. What is autonomous investment?
Ans: Investment, which is independent of income levels, is called autonomous
investment.
Q.25. What is meant by planned or ex-ante saving? (CBSE Delhi 2010)
Ans: The savings which are planned to be made by all the households in the
economy during an accounting year in the beginning of the period are called
planned (or ex-ante) savings.
Q.26. What is meant by planned or ex-ante investment? (CBSE Delhi 2010)
Ans: The investment which is planned (desired) to be made by all the firms or
entrepreneurs in the economy during an accounting year in the beginning of the
period is called planned (or ex-ante) investment.
Q.27. What is ex-post saving?
Ans: It refers to the actual savings in an economy in a year.
Q.28. What is ex-post investment?
Ans: It refers to the actual amount of investment in an economy during a year.
Q.29. Define Full employment. (CBSE All India 2001, 08, 14; Delhi 20088, 14)

Or
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Define full employment in economy. (CBSE Delhi 2018)
Ans: Full employment refers to a situation where in all able and willing persons
find work at the existing wage rate.
Q.30. Give the meaning of involuntary unemployment.
Ans: It refers to a situation when some people are not getting a job even when
they are able and willing to work at the existing wage rate.
Q.31. What is break-even?
Ans: When consumption expenditure becomes equal to income and there is no
saving, this is called break-even point.
Q.32. Outline the steps taken in deriving saving function from consumption
function. Use diagram. (CBSE Delhi 2012; All India 2017)
Ans: We can find savings at different income levels by taking the vertical
difference between the consumption curve and the 45o line.
(i) At point E, income and consumption expenditure are equal. Therefore,
saving at OY income is zero.
(ii) Draw perpendicular from point E on the consumption curve,
intersecting the X-axis at point M. This point M must be on the X-axis
because saving is zero. (refer Fig. 7.16)

(iii) Take OS equal to OC on the Y-axis. This gives point S from where the
saving curve will start.
(iv) Joining points S and M and extending the straight line upwards we get
the saving curve.
Q.33. Draw on a diagram a straight line saving curve for an economy. From it
derive the consumption curve, explaining the method of derivation. Show a point
on the consumption curve at which average propensity to consume is equal to 1.
(CBSE Sample Paper 2014)
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Ans.In Fig. 7.17, SS is the saving curve which shows negative savings equal to OS
at zero level of income.

(i) At zero level of income, consumption expenditure is equal to OC which

is equal to negative saving of OS.
(ii) So, C is the starting point of consumption curve.
(iii) Savings are zero at OM level of income as the entire income is spent.
So at OM level of income, consumption expenditure is equal to income.
This gives us point E on the consumption curve.
(iv) By joining C and E and extending it further, we get consumption curve.
At point E on the consumption curve, C = Y. Therefore, APC = 1.

III. High Order Thinking Skills (HOTS) Questions

Q.1. State the psychological law of consumption.
Ans. According to this law, as income increases, consumption also increases but
by less amount than the increase in income.
Q.2. Why does consumption curve not start from the origin?
Ans. Consumption curve does not start form the origin because there is some
minimum consumption, even at zero level of national income.
Q.3. What does consumption function equation indicate?
Ans. Consumption function equation C = ̅ + b(Y) indicates that consumption
(C) at a given level of income (Y) is equal to autonomous consumption
̅ plus b times of given level of income.

Q.4. If total consumption expenditure in an economy is ` 8,600 crore and

autonomous consumption is ` 140 crore, what will be the induced consumption.
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Ans. Total consumption expenditure = Autonomous consumption + Induced
consumption
8600 = 140 + Induced consumption
Induced consumption = 8600 – 140
= ` 8,460 crore
Q.5. If national income is ` 16,000 crore and marginal propensity to consume is
0.8, find out induced consumption.
Ans. Induced consumption = bY
Whereas, b represents marginal propensity to consume and Y represents
national income
Putting given values
Induced consumption = 0.8 X 16,000
= ` 12,800 crore
Q.6. Can consumption exceed income? If yes, what is the saving then?
Ans.

 Yes, when income is zero or less than subsistence level of

consumption, consumption will exceed income.
 Then, there is negative saving (dissaving).
Q.7. Can value of APS be negative? If yes, when?
Ans. Yes, value of APS can be negative when saving is negative.
Q.8. If the saving function S = -Y + 0.2Y, then what will be the value of MPC?
Ans. 0.2 in saving function indicates that MPS = 0.2
We know that,
MPC + MPS = 1
MPC + 0.2 = 1
MPC = 1 – 0.2
= 0.8
Q.9. Can MPC and MPS be negative? Give reasons to support your answer.
Ans. No. The values of MPC and MPS can never be negative.
Reason: Consumption and saving both are the functions of income. Because of
positive relationship between consumption (C) and Income (Y) and also between
saving (S) and Income (Y), MPC and MPS can never be negative.
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Q.10. Under what situations (a) APC > 1 (b) APC < 1 ?
Ans. (a) APC > 1, when consumption is more than income.
(b) APC < 1, when consumption is less than income.
Q.11. The value of which of the two – APC and MPC can be greater than 1 and
when?
Ans.

 The value of MPC always lies between o and 1. Hence, it can never be
greater than 1.
 The value of APC can be greater than 1. It happens when the level of
income is low and consumption exceeds income. (C > Y)
Q.12. How does MPC affect the level of income?
Ans. Since MPC is always greater than zero, higher MPC implies greater increase
in consumption demand. Thus, higher MPC will lead to increase in production and
level of income, whereas, lower MPC will bring down the level of income and
output.
Q.13. What is the significance of 45o AS line in macroeconomics?
Ans. This significance of 45o line lies in the following:

 The equilibrium level of income will be determined somewhere on this

line.’
 Every point on AS line represents equality between total income and
consumption (C) plus saving (S) i.e. Y = C + S.
 AS line states that whether consumption is more or equal to or less than
income AS line is also a guideline or reference line.
Q.14. Distinguish between induced Investment and autonomous investment.
Ans. (i) Induced investment is related to income. It increases with increase in
income and vice versa, whereas autonomous investment is not influenced by
income.
(ii) Induced investment is made with a view to earn profit, whereas autonomous
investments made to promote social welfare.
Q.15. What is the difference between ex-ante investment and ex-post investment?
Ans.

 Ex-ante Investment: The level of investment, which the entrepreneurs in

an economy desire to achieve, is called ex-ante investment.
 Ex-post Investment: Ex-post investment refers to the level of investment
actually attained by the entrepreneurs.
Q.16. Distinguish between voluntary unemployment and involuntary
unemployment. What is the significance of this distinction? (CBSE Delhi 2011C)
Ans.
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  Voluntary unemployment: Voluntary unemployment refers to a situation
when physically fit workers are unemployed because they are not willing
to work at the existing wage rate.
 Involuntary unemployment: Involuntary unemployment refers to an
unemployment in which all those people, who are willing and able to work
at the existing wage rate, do not find work.
Significance: Voluntarily unemployed people are not counted while estimating
the magnitude of unemployment.
Q.17. What is Keynesian unemployment? How can it be reduced?
Ans.

 Keynesian unemployment refers to the unemployment that arise due to

lack of demand for goods and services which people could have been
employed to produce.
 Keynesian unemployment can be reduced by the use of monetary or fiscal
policy to increase the level of aggregate demand.
Q.18. Show that at zero level of national income.

S=-
Ans. We know that,
S=Y–C
Where,
S = saving
Y = national income
C = consumption

We also know that at zero level of national income, consumption = ̅

By replacing Y with 0 and C with ̅ in the above equation, we get

S=0– ̅
S=– ̅

Q.19. Giving reasons, state whether the following statement are true or false:
(i) Average propensity to save is always greater than zero.(CBSE Delhi 2010)
(ii) Value of average propensity to save can never be less than zero. (CBSE All
India 2010)
(iii) When the value of average propensity to save is negative the value of
marginal propensity to save will also be negative. (CBSE All India 2010)
(iv) Average propensity to save can be negative.(CBSE Delhi 2016C)
Ans.
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(i) False. Because at very low level of income, when consumption exceeds
income, then saving becomes negative and APS < 0.
(ii) False. The value of APS can be less than zero (i.e., negative). When
consumption expenditure exceeds income, then the volume of savings becomes
negative.
(iii) False. Value of APS has no relationship with MPS. APS is closely related with
APC, i.e., APS + APC = 1. MPS is always positive, as there is direct relationship
between saving and income.
(iv) True. Average propensity to save can be negative. It will be negative when
consumption exceeds income.
Q.20. Giving reasons, state whether the following statements are true or false:
(a) The value of marginal propensity to save can never be negative. (CBSE Delhi
2010)
(b) The value of average propensity to save can never be greater than 1. (CBSE
Foreign 2010)
(c) Sum of average propensity to consume and marginal propensity to consume
is always equal to 1.
(CBSE All India 2010)
(d) As income increases, APC falls.
Ans.
(a) True. Because there is direct relationship between saving and income, value
of MPS is always positive.
(b) True. Because total saving can never be greater than total income. The value
of APS is generally less than 1.
(c) False. The value of APC has no relationship with MPC. Either APC + APS = 1 or
MPC + MPS =- 1.
(d) True. Because people begin to save a larger proportion of their income with
rise in income. In other words, proportion of income spent on consumption keeps
on falling.
Q.21. Giving reason, state whether the following statement are true or false:
(i) Average propensity to save cannot be negative. (CBSE 2018C)
(ii) Value of marginal propensity to consume can be greater than one. (CBSE
2018C)
(iii) Average propensity to consume can be greater than one. (CBSE 2018C)
Ans. (i) False. Average propensity to save will be negative when consumption
exceeds income at lower levels of income.
(ii) False. Value of marginal propensity to consume is greater than zero but less
than 1. 0 < MPC < 1
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Reason: People do not spend their entire increased income on consumption.
They save a part of their increased income.
(iii) True. Average propensity to consume will be greater than one when
consumption exceeds income at lower level of national income.

IV. NCERT Textbook Questions

Q.1. What is the marginal propensity to consume? How is it related to marginal
propensity to save?
Ans.
 Marginal Propensity to Consume (MPC): The ratio of change in consumption
(ΔC) to change in an income (ΔY) is termed as marginal propensity to
consume.

Symbolically, MPC =
 The sum of marginal propensity to consume and marginal propensity to save
is equal to 1.
MPC + MPS = 1
Q.2. What is the difference between ex-ante investment and ex-post investment?
Ans. See HOTS Questions: Q. No. 15.
Q.3. Explain ‘Paradox of Thrift’.
Ans. Keynes showed that if the people of the country begin to save a larger
proportion of their income, total savings in the economy will not increase. It will
either decline or remain the same. This is called 'paradox of thrift'.

 An increase in MPS means fall in MPC. When MPC falls, aggregate

consumption expenditure in the economy falls. It leads to rise in inventory
level of producers. To clear this undesired increase in inventory, they would
plan to reduce the output in the next round of production. It will, then, reduce
the demand for factors of production and factor incomes. As a result, the total
volume of saving generated in the economy would fall (or remain
unchanged).

V. Value Based & Multi-disciplinary Questions

Q.1. Do you think Indian economy is facing the problem of involuntary
unemployment? Suggest any two ways to remove this problem from the economy.
Ans. Yes. India is facing problem of involuntary unemployment. In this regard,
following measures are suggested:
(i) Education system needs to be made according to economy's requirements.
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(ii) The establishment of micro enterprises needs to be encouraged on a large
scale.
Q.2. Write any three steps to enhance the level of aggregate demand in India.
Ans. (i) An increase in government spending would raise the level of aggregate
demand.
(ii) Government through its budgetary policy can take steps to reduce the gap
between the rich and poor. This will also help raising the level of AD.
(iii) The level of AD in India can also be raised by expanding credit facilities to
people at lower interest rates.

VI. Numerical Questions

Formulae Used:
(i) C = C + bY

(ii) S = – C + ( 1 – b )Y

(iii) APC =

(iv) MPC =

(v) APS =

(vi) MPS =

(vii) APC + APS = 1

Or 1 – APC = APS
Or 1 – APS = APC

(viii) MPC + MPS = 1

Or 1 – MPC = MPS
Or 1 – MPS = MPC
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 EXERCISES
Short Answer Type Questions (Carrying 3 / 4 marks each)
1. State the meaning and components of aggregate demand. (CBSE Delhi
2005C, 06; All India 2014C)
OR
What is aggregate demand? State its components. (CBSE All India 2016, 2018)
2. State the meaning and components of aggregate supply.
3. Define average propensity to consume. How is it calculated?
4. What is marginal propensity to consume? How is it calculated?
5. Distinguish between average propensity to consume and marginal propensity
to consume. The value of which of these two can be greater than one and
when? (CBSE Delhi 2004; Foreign 2004)
Or
Distinguish between marginal propensity to consume and average propensity
to consume. Give a numerical example.
(CBSE Delhi 2016; Foreign 2016)
6. Between APS and MPS whose value can be negative? Explain your answer.
7. Explain the relationship between marginal propensity to consume and
marginal propensity to save.
8. (a) What is the value of marginal propensity to consume, when marginal
propensity to save is zero?
(CBSE Delhi 1998)
(b) What can be the minimum value of marginal propensity to save? (CBSE
Delhi 1998)
(c) Why can the value of marginal propensity to consume not be greater than
one? (CBSE All India 1998)
9. Distinguish between propensity to consume and propensity to save with the
help of numerical examples. (CBSE All India 2012)
10. Distinguish between average propensity to save and marginal propensity to
save. The value of which of these two can be negative and when? (CBSE Delhi
2004)
11. Distinguish between autonomous consumption and induced consumption.
12. Explain the distinction between ‘autonomous investment’ and ‘induced
investment’. (CBSE Delhi 2013C; 14)
13. Draw consumption curve and saving curve in a single diagram and mark the
‘break-even point’. (CBSE Foreign 2012; Delhi 2014)
14. Outline the steps taken in deriving consumption curve from the saving curve.
Use a diagram. (CBSE All India 2011C, 12, 14)
15. Give consumption curve, derive saving curve and state the steps taken in the
process of derivation. Use a diagram. (CBSE Delhi 2016)
16. Give the meaning of aggregate demand and full employment. (CBSE Delhi
2015C)
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17. Give the meaning of: (a) Autonomous consumption; (b) Full employment
(CBSE Delhi 2015C)
18. Which of the following cannot have a negative value? Give reasons.(CBSE All
India 2015C)
(i) Average propensity to save
(ii) Marginal propensity to save
19. Define full employment. Does it refer to a situation of zero unemployment?
20. What is ex-ante consumption? Distinguish between autonomous consumption
and induced consumption. (CBSE Delhi 2018)

Long Answer Type Questions (Carrying 6 marks each)

1. Define aggregate demand. What are its main components?
2. What do you understand by full employment? Can there be unemployment
under the situation of employment?
3. Draw on a diagram a straight line savings curve for an economy. From it
derive the consumption curve explaining methods of derivation. Show a point on
the consumption curve at which average propensity consume is equal to 1.
(CBSE 2006; All India 2012, 14)
4. Draw a straight line consumption curve. From it derive a saving curve
explaining the process. Show on this diagram:
(CBSE Delhi 2012; 14)
(a) The level of income at which average propensity to consume is equal
to one.
(b) A level of income at which average propensity to save is negative.
(CBSE Sample Paper 2010)
5. Explain ‘consumption function’ with the help of a schedule and diagram. (CBSE
All India 2008)
6. Explain ‘saving function’ with the help of a schedule and diagram.(CBSE All
India 2008)
7. Given consumption curve, derive saving curve and state the steps taken in the
process of derivation. Use diagram. (CBSE Delhi 2016; All India 2017)
8. Given saving curve, derive consumption curve and state the steps in doing so.
Use diagram. (CBSE All India 2016)
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Numerical Questions
Type 1: Calculation of Consumption and Saving
1. Find S when ̅ = 200, MPS = 0.4 and Y = 1000
Hint: S = – ̅ + MPS (Y) Ans. 200
2. (a) If APS = 0.25Y, find the value of APC.
(b) If disposable income is ` 500 and saving ` 100, find out APC.
Ans. (a) 0.75 (b) 0.8

3. Find the value of C, when ̅ = 50, MPC = 0.75 and Y = 300

Ans. C = 275

4. Find S, when ̅ = 100, MPC = 0.6 and Y = 500.

Hint: S = – ̅ + MPS (Y) Ans. S = 100

Objective Type Questions 3.1

1. The ratio of change in consumption to change in income is called

_____________________. (Choose the correct alternative)
(a) Marginal propensity to consume (b) Marginal propensity to save
(c) Average propensity to consume (d) Average propensity to save
2. Average propensity to consume can never be zero. (True/False)
3. Average propensity to consume can be greater than one. (True/False)
4. The minimum level of consumption for survival even if income is zero is called
__________ because ________________. (Fill in the blanks)
5. The value of MPC can exceed one. True/False? Give valid reason.
6. Which of the following is not true for MPC in an economy? (Choose the
correct alternative)
(a) MPC can be zero.
(b) MPC lies between zero and one.
(c) MPC can exceed one
(d) None of these
7. The consumption function of an imaginary country is: C =` 80 crore + 0.7Y.
Which of the following is true for his economy?(Choose the correct alternative)
(a) Even if the country does not have any income, its citizens still consume `80
crore.
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(b) People spend 70% of rise in income on consumption.
(c) Both (a) and (b)
(d) Autonomous consumption is `80 crore and people spend 70% of income on
consumption.
8. When the consumption curve in an economy lies above the 45° line from
origin, the value of APC is: (Choose the correct alternative)
(a) Greater than one (b) Zero
(c) One (d) Less than one
9. APC can be zero at a particular level of income. True/False? Give reasons.
10. The planned values of the variables are their ____________ (ex-ante/ex-post)
measures. (Fill in the blank with correct option)
11. In order to understand the determination of national income, we need to
know the ____________ (ex-ante/ex-post) values of the components of aggregate
demand. (Fill in the blank with correct option)
12. _______________ describes the relation between consumption and income. (Fill
in the Blank)
13. Even if income is zero, some consumption still takes place. Since this level of
consumption is independent of income, it is called _____________________. (Fill in
the Blank)
14. If consumption takes place even when income is zero, it is because of
________________. (Fill in the Blank)
15. Given the consumption function of an economy: C= a +bY
The autonomous consumption and induced consumption are respectively
denoted by ____________. (Fill in the Blank)
16. The maximum value of MPC can be ___________ when __________. (Fill in the
Blank)
17. The minimum value of MPC can be ___________ when __________. (Fill in the
Blank)
18. The range of MPC is: (Choose the correct alternative)
(a) between 0 and 1 (b) from 0 to 1
(c) between 1 and ∞ (d) from 1 to ∞
19. When consumers consume part of change in income, which of the following is
true?(Choose the correct alternative)
(a) MPC>1 (b) MPC 1
(c) MPC=0 (d) 0<MPC <1
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20. At zero level of income, consumption is (Choose the correct alternative)
(a) zero (b) positive
(c) negative (d) zero or negative
21. In consumption function C= a + b(Y), b represents
(Choose the correct alternative)
(a) Autonomous consumption (b) savings
(c) MPC (d) MPS
22. If MPC is 0.5, what will be change in consumption, if income increases by
`100 crore? (Choose the correct alternative)
(a) `60 crore (b) `50 crore
(c) `40 crore (d) `70 crore
23. APC can never be equal to 1. True/False? Give reasons.

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 Chapter 2
“Income Determination and Multiplier”
After knowing the Basic Concepts related to income determination, we now
proceed to the Analysis of income determination.
By income determination, we mean the determination of Equilibrium level of
national income.
In this Chapter we will see what How the Equilibrium level of income is
determined in a Country.

“Meaning of Equilibrium Income”

Equilibrium level of income is defined as that level of income where Aggregate

demand for goods and services in the Economy is equal to their Aggregate
supply.
Thus at the Equilibrium Point

AD = AS [** Also known as Effective Demand]

We know that
AD = C + I
AS = C + S
So equilibrium is stuck where,
C + I = C + S ------------ (1)
Further C is a common factor in equation (1). So we can say that at equilibrium
point:

S=I

Thus, S = I condition of equilibrium is identical with AD = AS condition. This gives

two approaches.’
(i) AD = AS
(ii) S=I
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 [A] AD – AS Approach
According to Keynes, an economy will be in equilibrium when AD is Equal to AS.
Thus in equilibrium:

AD = AS

AD – AS Schedule
Y C S I AD = C AS = C REMARKS
+I +S
0 40 – 40 40 80 0 AD > AS
100 120 – 20 40 160 100 AD > AS
200 200 0 40 240 200 AD > AS
300 280 20 40 320 300 AD > AS
400 360 40 40 400 400 AD = AS
Equilibrium
500 440 60 40 480 500 AD < AS
600 520 80 40 560 600 AD < AS

In the table we can see that the economy attains equilibrium at an income level
of ` 400 cr. Where AD = AS
The determination of equilibrium level of income can be shown graphically also.

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 Saving and Investment Approach

To see How an Economy attains equilibrium under S-I Approach, we can take the
help of table and diagram.
Under S-I Approach, the Economy will be in Equilibrium when Planned saving is
equal to the Planned Investment.

“S – I Schedule”
Income (Y) Consumption Saving (S) Investment Remarks
(C) (I)
0 40 – 40 40 S < I
100 120 – 20 40 S < I
200 200 0 40 S < I
300 280 20 40 S < I
** 400 360 40 40 S=I
500 440 60 40 S>I
600 520 80 40 S>I

On X-axis = Income
On Y-axis = Saving and Investment
E is the point of Equilibrium where S = I
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 “Adjustment Mechanism”
(1.) When S > I :
 When Planned saving is more than Planned Investment it means that
Households are not consuming as much as firms expected them to do so. As a
result inventory would rise above the desired level. To clear the undesired
inventory, firms will reduce the production. This process will continue till
planned savings and Planned Investment become Equal.
(2.) When S < I :
 When planned saving is less than Planned investment it means that
Households are saving less than what firms expected from them. Or we can
say that households are Consuming more than firms’ expectation. As a result
the Planned Inventory would fall below the desired level. To Bring the
Inventory up, firms will increase their production. This process will continue
till S = I.

8.2 EQUILIBRIUM LEVEL

According to the classical economists, equilibrium level of income is attained
always at full employment level, i.e. there is absence of involuntary
unemployment. However, as per the Keynesian theory, equilibrium level can be
achieved at:
(i) Full Employment level; or
(ii) Underemployment level, i.e. less than full employment level; or
(iii) Over full employment level, i.e. more than full employment level.
Let us discuss the three possibilities of equilibrium level.

Full Employment Equilibrium

It refers to a situation when the aggregate demand is equal to the aggregate
supply at full employment level.

 In Fig. 8.3, E is the full employment equilibrium because aggregate demand

‘EQ’ is equal to full employment level of output ‘OQ’.
 At OQ level of output, all those who are willing to work at the prevailing wage
rate, are able to find employment, i.e. there is no involuntary unemployment.
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 Underemployment
Equilibrium
It refers to a situation when aggregate
demand is equal to the aggregate
supply when the resources are not fully
employed. It occurs prior to the full
employment level.
 In Fig. 8.4, AD1 = AS at point ‘F’
which is lower than full employment
level.
 As OQ1 is less than OQ, point ‘F’ Fig. 8.4
signifies the under employment
equilibrium. Fig. 8.4

Over Full Employment

Equilibrium
It refers to a situation when AD is
equal to AS beyond the full
employment level. It occurs after
the full employment level.
 In Fig. 8.5, AD1 = AS at point ‘G’
which is higher than the full
employment level.
 Point ‘G’ signifies the over full
employment equilibrium.

Over Full Employment Equilibrium creates Inflationary Pressure

 Over Full Employment Equilibrium signifies that planned expenditure (AD) is
equal to planned output (AS) at a level higher than full employment level.
 However, in reality, actual output cannot increase beyond this level as
economy is already at full employment and there is no idle capacity.
 So, any increase in AD beyond the full employment output, will lead to
increase in general price level (i.e. inflation) and there will be no real increase
in output.
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 Objective Type Questions 3.4
1. AD curve starts: (Choose the correct alternative)
(a) From the origin (b) point below to the origin ‘
(c) Point above the origin (d) none of these
2. In determination of equilibrium level of income by AD – AS approach, AD is
represented by: (Choose the correct alternative)
(a) C + S (b) C + I
(c) S + I (d) C + Y
3. Which of the following is the equilibrium condition in a two sector economy?
(Choose the correct alternative)

(a) Y = (b) Y =

̅ ̅
(c) Y = (d) Y =

4. When Aggregate Demand is more than Aggregate Supply, this will lead to
___________________. (Choose the correct alternative)
(a) a planned inventories accumulation
(b) a planned inventories decumulation
(c) an unplanned inventories accumulation
(d) an unplanned inventories decumulation
5. When Planned Savings is more than Planned Investment, then
__________________. (Choose the correct alternative)
(a) National income is likely to fall
(b) There will be no change in national income
(c) National income is likely to rise
(d) None of these
6. When aggregate demand is greater than aggregate supply, inventories
________________. (Choose the correct alternative)
(a) Fall (b) rise
(c) Do not change (d) first fall, then rise
7. The equilibrium level of income changes if there is ______________________.
(Choose the correct alternative)
(a) Change in autonomous consumption
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(b) Change in MPC
(c) Change in autonomous investment
(d) All of the above
8. In the Keynesian analysis of determination of equilibrium income in the short
run, the justification for taking the price level as fixed is: (Choose the correct
alternative)
(a) We are assuming an economy with unused resources: machineries, buildings
and labours.
(b) In such a situation, the law of diminishing returns will not apply.
(c) Additional output can be produced without increasing marginal cost.
(d) All of the above

Working / Mechanism of Investment Multiplier (6 Marks)

 Multiplier is based on a fact that one person’s expenditure is other person’s
income.
 Or we can say that more the consumption expenditure, more will be the
income generation.
 The multiplier process works on the basis:
a) Investment generates income
b) Additional income causes change in consumption
c) Change in consumption depends upon MPC

Working of Multiplier
{Suppose ΔI = 100 cr; MPC = 0.9}

Round ΔI ΔY ΔC ΔS
Increase in Increase in Increase in Increase in
investment Income Consumption Saving
I 100 cr. 100 cr. 90 cr. 10 cr.
II - 90 cr. 81 cr. 9 cr.
III - 81 cr. 72.9 cr. 8.1 cr.
. . . . .
. . . . .
. . . . .
. . . . .
. . . . .
1000 cr. 900 cr. 100 cr.

R= = = 10 times ΔY = 100 X 10 = 1000 cr.

.
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STEPS
1. Suppose there is An Initial Increase in investment of & 100 cr. in the
Economy.
2. This Increase in investment worth `100 cr. resulted in Increase in
income worth `100 cr. of people involved in the production of these
goods. They will together spend `90 cr. (100x0.9) on Consumption of
goods.
3. This Increase in Consumption of 90 cr. will ↑ in Income by 90 cr. in the
Second Round.
4. This process will continue with Each Round of income Being Times
the previous level.
Thus, the initial increase in investment of ` 100 cr. has resulted in an
increase of `1000 cr.

Multiplier = = = 10 Times

Explanation:
On X-axis Income OR Output
On Y-axis AD (C + I)
The initial Equilibrium is achieved at point E, where AD curve intersects AS
Curve. Here the Equilibrium level of income is OY. Now the investment
increases by ΔI. So that the New AD Curve (AD1) intersects the AS at Point
F. Thus the new Equilibrium level of income also Increases to OY1.

It is clear from the figure that Increase in Income (ΔY) is greater than
increase in investment (ΔI).
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 R=

***Forward and Backward Working of Multiplier

Forward Working Backward Working

Multiple increase in Multiple decrease in
income due to increase income due to decrease
in investment
in investment.

*** Minimum and maximum value of multiplier

As we know that the value of multiplier depends upon MPC and value of
MPC varies from 0 to 1.

Maximum value Minimum value

R= R=

R= =∞ R= =1
Max. Value of multiplier Minimum value of
can be infinity. multiplier can be 1.
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 Objective Type Questions 3.5

1. If MPC = 1, value of multiplier is: (CBSE 2015) (Choose the correct

alternative)
(a) 0 (b) 1
(c) Between 0 and 1 (d) Infinity
2. 2. If MPC = 0, the value of multiplier is: (CBSE 2015) (Choose the correct
alternative)
(a) 0 (b) 1
(c) Between 0 and 1 (d) Infinity
3. The maximum value of investment multiplier can be ________________ when
MPC is assumed to ______________. (Choose the correct alternative)
(a) Infinity, zero (b) Infinity, one
(c) One, infinity (d) none of these
4. National income will rise with the rise in investment. True/False? Give reasons
5. If the value of MPC is 0.75, the value of multiplier is _____________. (Fill in the
blank)
6. Value of investment multiplier varies between zero and infinity. (True/False)
7. When marginal propensity to consume is zero, the value of investment
multiplier will also been
(True/False)
8. The ratio of the total increment in equilibrium value of final goods output to
the initial increment in autonomous expenditure is called _____________ of the
economy. (Fill in the blank)
9. What is the value of multiplier, when S = –100 + 0.4Y? (Choose the correct
alternative)
(a) 1.5 (b) 1.05
(c) 2.5 (d) 2.05
10. In an economy, when investment decreases national income decreases at
least by an amount equal to decrease in investment. (True/False)
11. MPS= 1, change in national income will be exactly equal to change in
investment. (True/False)
12. If MPC is double the MPS, value of investment multiplier will be 2.
(True/False)
13. When MPC is equal to MPS, increase in national income will be twice the
initial increase in investment. (True/False)
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14. When investment multiplier is 1, the value of marginal propensity to
consume is zero. (True/False)
15. A change initial investment causes a change in final income by an amplified
amount, which is a multiple of the change in initial investment and depends upon
the value of ________________. (Fill in the Blank)
16. As MPC rises, value of multiplier increases. True/False? Give reasons

HOTS
Analysing, Evaluating & Creating Type Questions
1. When an economy decides to save the whole of its additional income, what will
be the value of investment multiplier? (1 mark)
Ans. When an economy decides to save the whole of its additional income, i.e.
MPS =1, the value of investment multiplier will be:
k= 1/MPS = 1/1 = 1
2. State giving reasons whether the following statements are true or false.
(4 marks)
(a) When marginal propensity to consume is greater than marginal propensity to
save, the value of investment multiplier will be greater than 5.
(b) If the ratio of marginal propensity to consume and marginal propensity to save
is 4:1, the value of investment multiplier will be 4.
Ans. (a) False
Reason: Value of investment multiplier will be greater than 2.
Explanation:
MPC >MPS
1 - MPS<MPS
1>2 MPS
1/MPS > 2
k> 2
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Numerical 9
If in an economy consumption function is given by C = 100 + 0.75Y, and
autonomous investment is ` 150 crore. Estimate
(i) Equilibrium level of income by C+I approach and
(ii) Consumption and savings at the equilibrium level of income. (6 marks)
Solution:
C = 100 + 0.75Y; I =` 150 crore
(i) At equilibrium level of income:
Y=C+I
Y = 100 + 0.75Y + 150
Y – 0.75Y = 250
0.25Y = 250
Y = 250/0.25 = 1,000
The equilibrium level of income in the economy Y = ` 1,000 crore
(ii) Consumption at the equilibrium level of income:
C = 100 + 0.75Y

Do it yourself 9
Find equilibrium level of national income from the following: (3 Marks)

Sr. No. Items (` crore)

(i) Autonomous consumption 100
(ii) Marginal propensity to consume 0.8
(iii) Investment 50
[Ans.` 750 crore]
Numerical 10
In an economy, C = 100 + 4Y is the consumption function, where C is
consumption and Y is National income. If investment expenditure is ` 1,100
crore, calculate:
(i) Equilibrium level of national income using savings and investment approach
(ii) Consumption expenditure at equilibrium level of national income
Solution:
Consumption function C = 100 + 4Y. Therefore savings function
S=Y–C
S = Y – (100 + 0.4Y)
S = – 100 + 0.6Y
Investment expenditure I = ` 1,100 crore
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At equilibrium level of national income, S = I
– 100 + 0.6Y = 1,100
0.6Y = 1,100 + 100 = 1,200
Y = 1,200/0.6 = 2,000
(i) Equilibrium level of national income = `2,000 crore
(ii) At equilibrium level of national income, savings (S) = Investment (I) = `1,100
crore
Consumption expenditure at equilibrium level of national income, C = Y – S =
2,000 – 1,100 = `900 crore
Do it yourself 10
In an economy, S = – 100 + 0.6Y is the saving function, where S is saving and Y
is national income. If investment expenditure is 1,100, calculate:
(i) Equilibrium level of national income
(ii) Consumption expenditure at equilibrium level of national income. (6
marks)
[Ans. (i) 2,000 (ii) 900]
Numerical 11
The savings function of an economy is S = –200 + 0.25Y. The economy is in
equilibrium when income is equal to `2,000 crore. Calculate: (i) Investment
expenditure at equilibrium level of income and (ii) Autonomous consumption. (3
marks)
Solution:
(i) Equilibrium level of income Y = `2,000 crore, saving function S = –200
+ 0.25Y
Savings at equilibrium level of income S = –200 + 0.25(2,000)
S = –200 + 500 = `300 crore
At equilibrium, planned savings and panned investment expenditure
are equal. Therefore, investment expenditure at equilibrium level of
income I = `300 crore
(ii) From the savings function S = –200 + 0.25Y, we get dissavings at zero
income = `200 crore, which is equal to autonomous consumption.
Therefore, autonomous consumption = `200 crore
Do it yourself 11
If in an economy consumption function is given C = 100 + 0.75Y, and
autonomous investment is `150 crore. Estimate (i) Equilibrium level of income
and (ii) Consumption and Savings at the equilibrium level of income. (3 marks)
[Ans. (i) `1000 crore (ii) `150 crore]
Numerical 12
Measure the level of ex-ante aggregate demand when autonomous investment
and consumption expenditure( ̅) is `50 crore, and MPC is 0.8 and level of income
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(Y) is `4,000 crore. State whether the economy is in equilibrium or not (cite
reasons) (3 Marks)
Solution:

Sum of autonomous investment (I)̅ and autonomous consumption C = (A) = ` 50

crore, MPC = b = 0.8 and national income (Y) = `4,000 crore
Ex-ante aggregate demand,AD = C + I

AD = C + bY + I̅

AD = (C + I)̅ + bY = A+ bY
AD = 50 + 0.8 X 4000 = ` 3,250 crore
Since, AD = ` 3,250 crore is less than national income (Y = ` 4,000 crore),
herefore, the economy is not equilibrium. The economy is in equilibrium when AD
= Y.
Do it yourself 12
In an economy the autonomous investment is ` 100 crore and the consumption is
C = 80 + 0.4Y. Is the economy in equilibrium at an income level `400 crore?
Justify your answer.
[Ans. No, equilibrium level of income = ` 300 crore]
Numerical 13
In an economy the autonomous investment is `60 crore and the marginal
propensity to consume is 0.8. If the equilibrium level of income is `400 crore,
then the autonomous consumption is `30 crore. True or false? Justify your
answer. (3 marks)
Solution:
At equilibrium, Y = C + I (since at equilibrium AD = Y C+I=Y

Y = C + bY + I̅

400 = C+ 0.8 X 400 + 60 (since Y= 400, MPC = b = 0.8 and I̅ = 60)

400 = C + 320 + 60

C = 400 – 320 – 60 = 20

Autonomous consumption C= `20 crore

The given value of autonomous consumption (`30 crore) is incorrect.
Do it yourself 13
In an economy, C= 50 +0.5Y is the consumption function, where C is
consumption expenditure and Y is national income. If investment expenditure is
2,000, calculate:
(i) Equilibrium level of national income.
(ii) Consumption expenditure at equilibrium level of national income.
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 (iii) Savings at equilibrium level of income.
[Ans. (i) 4,100 (ii) 2,100 (iii) 2,000]
Numerical 14
From the data given below about an economy, calculate investment expenditure
and consumption expenditure: (3 marks)
Equilibrium level of income = ` 5,000 crore
Autonomous consumption = ` 500 crore
Marginal propensity to consume = 0.4
Solution:

Equilibrium income Y= ` 5,000 crore, Autonomous consumption C = ` 500 crore,

MPC = b = 0.4

Consumption expenditure C = C + bY
C = 500 +0.4(5,000)
C = 500 + 2,000
C = `2,500 crore
At equilibrium income Y = C + I (since at equilibrium AD = Y => C + I = Y)
5,000 = 2,500 + I
I = 5,000 – 2,500
I = 2,500
Investment expenditure I = `2,500 crore
Do it yourself
Calculate investment expenditure from the following data about an economy
which is in equilibrium:
National income = `1,000 crore
Marginal propensity to save = 0.25
Autonomous consumption expenditure = `200 crore (3 marks)
[Ans. `50 crore]
Numerical 15
An economy is in equilibrium. Calculate marginal propensity to save from the
following:
National income = `1,000 crore
Autonomous Consumption = `100
Investment expenditure = `200 (4 marks)
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Solution: at equilibrium, Y = C + I

Y = C + bY + I̅
1,000 = 100 + b (1,000) + 200
b (1,000) = 1,000 – 100 – 200 = 700
b = 700/1,000 = 0.7 = MPC
Therefore, MPS = 1 – MPC = 1 – 0.7 = 0.3
Do it yourself 15
An economy is in equilibrium. From the following data, calculate the marginal
propensity to save:
(a) Income = 10,000
(b) Autonomous consumption = 500
(c) Consumption expenditure = 8,000 (4 marks)
[Ans. 0.25]
Numerical 16
Calculate autonomous consumption expenditure from the following data about
an economy which is in equilibrium:
National Income = ` 1,200 crore
Marginal propensity to save= 0.20
Investment expenditure = ` 100 crore (3 marks)
Solution: since MPS = 0.20, therefore, MPC = b = 1 – MPS = 1 – 0.20 = 0.80

Consumption function equation C = C + bY = C + 0.80Y

At equilibrium level of national income
Y = C + I (since t equilibrium AD = Y => C + I = Y)

Y = C + 0.80Y + I̅

1,200 = C + 0.80Y X 1,200 + 100 (since Y=1200, I̅ =100)

1,200 = C + 960 + 100

C= 1,200 – 960 – 100 = 140

Autonomous consumption expenditure = ` 140 crore
Do it yourself 16
Calculate marginal propensity to consume from the following:
Equilibrium income = ` 350 crore
Consumption expenditure at zero = ` 20 crore
Investment = ` 50 crore [Ans. 0.8]
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Numerical 17
If in an economy savings function is given by S= (-) 50+ 0.2 Y and Y= `2,000
crore; consumption expenditure for the economy would be `1650 crore and the
autonomous investment is `350 crore and the marginal propensity to consume is
0.8. True or False? Justify your answer with t proper calculations.
(3 marks)
Solution: Level of income Y = `2,000 crore
Savings S=-50+ 0.2Y
S=-50+ 0.2(2,000) = -50 + 400 =` 350 crore
Consumption expenditure C=Y-S= 2,000 - 350 = `1,650 crore (Which is true.)
From the savings function equation S = (-) 50+ 0.2 Y, we have MPS = 0.2
Since MPC + MPS= 1, therefore, MPC = 1 - MPS = 1-0.2= 0.8 (Which is true.)
At equilibrium level of income, Savings = Investment = `350 crore (Which is also
true.)
Thus, all the given values are correct.
Do it yourself 17
In an economy C = 200+ 0.5 Y is the consumption function where C is the
consumption expenditure and Y is the national income. Investment expenditure
is `400 crore. Is the economy in equilibrium at an income level `1,500 crore?
Justify your answer. (3 marks)
(Ans. No, the equilibrium level of income is `1,200 crore]
Numerical 18
The saving function of an economy is given as: S = -250 +0.25Y
If the planned investment is`2,000 crore, calculate the following:
(a) Equilibrium level of income in the economy.
(b) Aggregate demand at income of `5,000 crore.(CBSE 2019) (6 marks)
Solution:
S-250+ 0.25Y (Given) (a) Equilibrium level of income in the economy exist when
S = I Substitute the values of saving and investment, we get
-250+ 0.25Y = 2,000
0.25Y= 2,000+ 250
0.25Y = 2,250
Y = 2,250/0.25
Equilibrium level of income Y = `9,000 crore
(b) C=Y-S-Y-(-250 +0.25Y)
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C=250 +0.75Y Given that Y= 5,000
C=250 +0.75 (5,000) = 250+ 3,750 = 4,000
AD=C+I = 4,000 + 2,000 = 6,000
Aggregate demand at income of `5,000 crore = `6,000 crore
Do it yourself 18
The saving function of an economy is given as: S = -10 + 0.20Y
If the planned investment is `100 crore, calculate the following: (a) Equilibrium
level of income in the economy. (b) Aggregate demand at income of `300 crore.
(Ans. (a) `550 crore (b) ` 350 crore)
Numerical 19
In an economy 75% of the increase is spent on consumption. Investment is
increased by `1,000 crore. Calculate:
(i) Total increase in income
(ii) Total increase in consumption expenditure
(iii) Change in savings (3 marks)
Solution:
In the economy 75% of the increase in income is spent on consumption, i.e. MPC
= 75% = 0.75

Increase in investment ΔI = `1,000 crore

k= 1/ (1-MPC) = 1/(1-0.75) = 1/0.25= 4

k= ΔY/ΔI =>4 = ΔY/1,000 =>ΔY= 4,000

MPC = ΔC/AY => 0.75 = ΔC/4,000 =>ΔC = 0.75 X 4,000 = 3,000

ΔS = AY – AC = 4,000 – 3,000 = 1,000

(i) Total increase in income = `4,000 crore

(ii) Total increase in consumption expenditure= `3,000 crore
(iii) Change in savings = `1,000 crore
Do it yourself 19
In an economy, with every increase in income 10% of the rise in income is saved.
Suppose a fresh investment of `120 crore takes place in the economy. Calculate:
(i) Change in consumption
(ii) Change in savings
[Ans. (i) Total increase in consumption expenditure = `1,080 crore (ii) Increase in
savings =`120 crore]

Numerical 20
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An increase of `250 crore in investment in an economy results in income
increasing by three times more than the increase in investment. Calculate.
(i) Marginal propensity to save
(ii) Change in savings
(iii) Change in consumption
(iv) Value of multiplier (4 marks)
Solution:

Increase in investment ΔI = 250, Increase in income ΔY = 250 + 3 X 250 = 1,000

Therefore, Investment multiplier k= ΔY/ΔI = I = 1,000/250 = 4

k= 1/(1 – MPC) =4 = 1/(1 – MPC)

1 – MPC = 1/4 =MPC = 1 – (1/4) = 3/4

MPC = ΔC/ΔY =3/4 = ΔC/1,000 => 3/4 X 1,000 = 750

ΔS = ΔY – ΔC = 1,000 – 750 = 250

(i) Marginal propensity to consume = 3/4 = 0.75

(v) Change in savings = `250 crore
(vi) Change in consumption expenditure = `750 crore
(ii) Value of multiplier = 4
Do it yourself 20
In an economy an increase in investment leads to increase in national income
which is three times more than the increase in investment. Calculate marginal
propensity to consume. (3 Marks)
[Ans. MPC = 0.75]
Numerical 21
In an economy, the marginal propensity to save is 0.4. National Income in the
economy decreases by `200 crore as a result of change in investment. Calculate
the change in investment. (3 marks)
Solution: MPS = 0.4, therefore, value of multiplier, k= 1/MPS = 1/0.4 = 5/2

National income decreases by `200 crore, i.e., ΔY = –200

k= ΔY/ΔI => 5/2 = –200/ΔI

ΔI = (–200 X2)/5 = –80

 The investment decreases by `80 crore.

Do it yourself 21
Investment in an economy decreases by `400 crore. Marginal propensity to
consume is zero. Calculate the change in national income. (3 marks)
[Ans. `400 crore]
Numerical 22
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In an economy, 60% of the additional income is spent on consumption. Assuming
that the investment increases by `900 crore, explain the working of multiplier.
(CBSE 2017) (6 marks)
Solution:
Working of multiplier (with increase in investment `900 crore and MPC = 0.6)

Rounds Increase in Increase in Additional savings

income (ΔY) induced leakages (ΔS)
consumption (ΔC)
I ` 1,000 crore `800 crore `200 crore
II ` 800 crore `640 crore ` 160 crore
III ` 640 crore ` 512 crore ` 128 crore
…. ….. ….. …..
Total 5,000 4,000 1,000

 Increase in investment will generate an extra income of ` 1,000 crore in first

round, as expenditure of one is income for another.
 Since MPC is 0.6, the nationals who are receiving this additional income will
spend ` 540 crore (0.6 X 900), which in return becomes additional income
during second round.
 Similarly. In third round ` 324 crore of income is generated.
 This process will go on infinitely and total increase in income will be:
ΔY = ΔI X 1/(1 – MPC)

= 900 X 1/(1 – 0.6)

= 900 X 1/0.4 = 900 X 2.5
= `2,250 crore

As a result, value of investment multiplier, k= ΔY/ΔI = 2,250/900 = 2.5

Do it yourself 22
In an economy, 75% of the additional income is spent on consumption. Assuming
that the investment increases by `800 crore, explain the working of multiplier.
[Ans. ΔY= `3,200 crore]

Numerical 23
An economy, C= 100+ 0.75Y is the consumption function, where C is
consumption expenditure and Y is National income. If investment expenditure is
1,000. (6 marks)
(i) Derive the savings function Income
(ii) Calculate equilibrium level of National Income
(iii) Calculate additional investment needed to reach the new equilibrium level of
income 6,000.
Solution: Consumption function C= 100+ 0.75Y, Investment expenditure I =
1,000
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 (i) Savings function S = Y – C
S = Y – (100 + 0.75Y)
S = Y – 100 – 0.75Y
S = – 100 + o.25Y
(ii) At equilibrium level of income Y = C +1
Y = 100 + 0.75Y + 1000
Y – 0.75Y = 1,100
0.25Y = 1,100
Y = 1,100/0.25
Therefore, Equilibrium level of national income = 4,400
(iii) From the consumption function C = 100+ 0.75Y, we get MPC = 0.75
Value of multiplier k = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4
To reach the new equilibrium level of income 6000, required increase
in income, ΔY = 6000 - 4400 = 1600
k = ΔΥ/ΔΙ = 4 = 1,600/ΔΙ = ΔΙ = 1,600/4 = 400

Therefore, Additional investment needed = 400

Do it yourself 23
In an economy C = 500+ 0.9Y and I = `1000 crore (Where C= Consumption
expenditure, Y = National income, I = Investment) (3 marks)
Calculate the following:
(i) equilibrium level of income
(ii) (ii) value of investment multiplier
[Ans. (i) `15000 crore (ii) 10]

Numerical 24
There is increase in investment of `100 crore in an economy. Marginal propensity
to consume is 1. What can you say about total increase in income? Calculate.
(3 marks)
Solution: increase in investment ΔΙ = 100, MPC = 1

Value of multiplier k= 1/(1 – MPC) = 1/(1 – 1) = 1/0 = ∞

k= ΔY/ΔΙ

∞ = ΔY/ΔΙ

ΔY = ΔΙ X ∞

Therefore, there will be an infinite increase in income in the economy due to an

increase in investment of `100 crore.
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Do it yourself 24
There is increase in investment of `1,000 crore in an economy. Marginal
propensity to consume is zero.What is the total increase in income? Calculate.
(3 marks)
[Ans. `1,000 crore]
Numerical 25
In economy the equilibrium level of income `12,000. The ratio marginal
propensity to 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. (3 marks)
Solution:

Required increase in income ΔY = 20,000 – 12,000 = 8,000

MPC: MPS = 3:1. Therefore, MPC = 3MPS

Since MPC + MPS = 1. Therefore, 3MPS + MPS = 1 => 4MPS = 1 => MPS = 1/4
Value of multiplier k=1/MPS= 4
k= ΔY/ΔΙ => 4 = 8,000/ΔΙ = 8,000/4 = 2,000

Therefore, additional investment needed = `2,000 crore

Do it yourself 25
Investment in an economy increases by ` 1000 crore. Suppose marginal
propensity to save is zero. What can you say about an increase in national
income? Calculate (3 marks)
[Ans. `1,000 crore]
Numerical 26
In economy investment increases from 300 to 500. As result of equilibrium level
of income increases 2,000. Calculate marginal propensity consume. (CBSE 2015)
(3 Marks)
Solution: Increase in Investment ΔΙ = 500 – 300 = 200

Increase in income ΔY = 2,000

Therefore, value of investment multiplier k=ΔY/ΔΙ = 2,000/200 = 10

Since k= 1/MPS, therefore, 10 = 1/MPS => MPS = 1/10

Hence, MPC = 1 – MPS = 9/10 = 0.9
Do it yourself 26
In an economy, a 20% increase in investment results in a 100% increase in
income. Calculate the marginal propensity to consume. (3 marks)
[Ans. MPC = 0.8]
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Numerical 27
Calculate Multiplier when MPC is 4/5 and 1/2. From the calculations establish the
relations between size of multiplier and size of MPC. (4 marks)
Solution: Multiplier k= 1/ (1 – MPC)

MPC Value of Multiplier, k

4/5 = 0.8 k= 1/(1 – 0.8) = 1/0.2 = 5
1/2 = 0.5 k= 1/(1 – 0.5) = 1/0.5 = 2
Observing the same we may conclude that there exists positive or direct relation
between MPC and Investment Multiplier. Investment multiplier coefficient
measures the change in final income with respect to given change in the initial
investment in the economy. It carries direct relation with rate of growth in an
economy, i.e., higher the MPC more chance of growth exists in an economy. But,
it is a two sided sword hence if investment falls in an economy the income may
also fall.
Do it yourself 27
In an economy, investment increased by `1,100 crore and as a result of it income
increased by `5,500 crore. Calculate the value of multiplier and MPS. (4 marks)
Had the marginal propensity to save been 25%, what would have been the
increase in income?
[Ans. 5, 0.2, `4,400 crore]

Numerical 28
If in an economy, income increases from `5,000 crore to`8,000 crore as a result
of 20% increase in investment, calculate the value of multiplier. (3 Marks)
Solution: increase in income ΔY = (8,000 – 5,000)/5,000 X 100

= 3,000/5,000 X 100
= 60%
Increase in investment ΔI = 20%

Therefore, value of investment multiplier k= ΔY/ΔI

= 60% / 20%
= 0.6 / 0.2 = 3
Do it yourself 28
If in an economy C = 500 + 0.9Y and I = `1,000 crore
(where C = Consumption expenditure, Y = National income, I = Investment)
Calculate the following:
(i) Equilibrium level of income
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 (ii) Value of investment multiplier (CBSE 2018) (4
Marks)
[Ans. (i) `15,000 crore (ii) 10]
Numerical 29
The consumption function of an economy is given by C= `100 crore + 0.8Y
As a result of increase in autonomous expenditure in this economy, national
income increases by `500 crore. Calculate the increase in autonomous
expenditure in the economy. (3 marks)
Solution: from the consumption function C= `100 crore + 0.8Y, we have MPC =
0.8
Value of investment multiplier k= 1/(1 – MPC) = 1/(1 – 0.8) = 1/0.2 = 5
Now, investment multiplier k= ΔY/ΔI

ΔY = `500 crore (given) and k= 5

Therefore, 5 = 500/ ΔI = ΔI = 100

Since ΔA = ΔI, therefore increase in autonomous expenditure ΔA = `100 crore

Do it yourself 29
Suppose in a hypothetical economy, the savings increase by `20 crore when
national income increases by `100 crore. Compute the increment expenditure in
the economy to attain an increase in national income by `6,000 crore. (3 marks)
[Ans. `1,200 crore]
Numerical 30
The saving function of economy is given as:
S = (– )10 + 0.20Y
If the ex-ante investments are `240 crore, calculate the following:
(i) Equilibrium level of income In the economy
(ii) Additional investments which will be needed to double the present
level of equilibrium income. (CBSE 2019) (6 marks)
Solution:
(i) We know that the equilibrium level of income in an economy is
determined when S = I
Substituting S = (– )10 + 0.20Y and I = 240, we have,
(– )10 + 0.20Y = 240
0.20Y = 250
Y = 250/0.20 = 1,250
Equilibrium level of income in the economy = ` 1,250 crore
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 (ii) From the savings function S = (– )10 + 0.20Y, MPS = 0.20
Value of investment multiplier, k= 1/MPS= 1/0.2 = 5

To double of the existing income level (ΔY = 1,250 crore), suppose additional
investments needed = ΔI

k= ΔY/ΔI

5 = 1250/ΔI

ΔI = 1,250/5 = 250

Additional investments needed = `250 crore

Do it yourself 30
The saving function of an economy is given as (– )50 + 0.10Y
If the ex-ante investments are `450 crore, calculate the following:
(i) Equilibrium level of income in the economy
(ii) Additional investments which will be needed to gain an additional income
level of `3,000 crore (CBSE 2019) (6 marks)
[Ans. (i) `5,000 crore (ii) `300 crore]
Numerical 31
If marginal propensity to consume (MPC) is 0.8 and increase in autonomous
investment is `1,000 crore, calculate the increase in induced consumption and
the leakages in the economy. (6 marks)
Solution: Investment multiplier k= 1/(1 – MPC)
= 1/(1 – 0.8) = 1/0.2 = 5

Also, k= ΔY/ΔI

5 = ΔY/1,000

ΔY= 5,000

Thus, increase in final income (ΔY) = `5,000 crore

MPC = 0.8

 ΔC/ΔY = 0.8
 ΔC/5,000 = 0.8
 ΔC = 0.8 X 5,000 = 4,000

Thus, increase in induced consumption (ΔC) = `4,000 crore

Leakages in the economy means the additional savings in the economy i.e. ΔS =
ΔY – ΔC = 5,000 – 4,000 = `1,000 crore
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 QUESTION BANK
I. Multiple Choice Questions
1. Following is the assumption of the Keynesian theory of income:
(a) Assumption of long run
(b) The economy is an open economy
(c) Assumption of full employment.
(d) The general price level is fixed in the short run.
2. Equilibrium level of income is determined when:
(a) AS = AD (b) S=1
(c) Both (a) and (b) (d) Neither (a) nor (b)
3. At break-even point:
(a) National income = Consumption
(b) Saving = Investment
(c) Consumption = Investment
(d) Consumption = Saving
4. If the value of MPS = 0.25, then the value of multiplier:
(a) 4 (b) 5
(c) 3 (d) 2.5
5. As a result of increase in investment by `125 crore national income increases by
`500 crore.
Then the value of MPC will be:
(a) 0.70 (b) 0.25
(c) 0.75 (d) 0.80
6. Which of the following statements is true?
(a) The maximum value of multiplier can be unity
(b) The minimum of multiplier is one.
(c) When AD > AS, inventory with producers increases.
(d) The value of multiplier varies between zero to infinity.
7. When MPC = 1, the value of multiplier is: (CBSE All India 2015)
(a) 0 (b) 1
(c) Between 0 and 1 (d) Infinity
8. The value of multiplier is: (CBSE Delhi 2013)
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(a) K = (b) K =

(c) K= (d) K =

9. If MPC = 0, the value of multiplier is: (CBSE Foreign 2013)

(a) 0 (b) 1
(c) Between 0 and 1 (d) Infinity
10. Value of multiplier is determined by:
(a) MPC (b) MPS
(c) Both (a) and (b) (d) Neither (a) nor (b)
11. If MPC MPS, the value of multiplier is:
(a) 0 (b) 1
(c) 2 (d) Infinity
12. If an economy decides to spend the entire additional income on consumption,
then value of multiplier will be:
(a) 1 (b) Between 0 and I

(c) 0 (d) ∞
13. If MPC = 0, the multiplier will be: (CBSE Foreign 2015)
(a) 0 (b) 1
(c) ∞ (d) None of these
14. The maximum value of multiplier is ____________ when the value of MPC is
_______________.
(a) Infinity, zero (b) Infinity, one
(c) One, infinity (d) None of these
15. If MPC=0.8, what will be the value of Investment Multiplier (K)?
(a) 5 (b) 3
(c) 4 (d) 2
16. If the marginal propensity to consume is greater than margin propensity to
save, the value of the multiplier will be: (Choose the correct alternative) (CBSE All
India 2017)
(a) Greater than 2 (b) Less than 2
(c) Equal to 2 (d) Equal to 5
17. Select from the following the correct pairs on values on which the size of
multiplier depend:
(a) APC, MPC
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(b) APS, MPS
(c) MPC, MPS
(d) APC, APS
18. When aggregate demand is greater than aggregate supply, inventories:(CBSE
Foreign 2017)
(a) Fall (b) Rise
(c) Do not change (d) First fall, then rise
19. The ratio between MPC and MPS is 3: 1. Find the value of multiplier from the
following:
(a) 2 (b) 3
(c) 4 (d) 5

Ans. 1(d), 2(c), 3(a), 4(a), 5(c), 6(b), 7(d), 8(b), 9(b), 10(c), 11(c), 12(d),
13(b), 14(b), 15(a), 16(a), 17(c), 18(a), 19(c).

II. Important Questions

Q.1. What do you mean by equilibrium income?
Ans. Equilibrium income refers to that level of income where AD = AS.
Q.2. What is effective demand? (CBSE Delhi 2005C, 06C, 09C)
Ans. The particular level of AD, which is equal to AS, is called effective demand.
The economy is in equilibrium at this level of AD.
Q.3. What are the two approaches for determining the equilibrium level of output?
Ans. Two approaches to the determination of equilibrium level of income are:

(i) AD – AS approach and

(ii) S–I approach
Q.4. How in the equilibrium level of income determined according to AD and AS
approach?
Ans. According to AD and AS approach, equilibrium level of income is determined
at the point where aggregate demand is equal to aggregate supply. That is, AD =
AS.
Q.5. How is the equilibrium level of income determined according to saving and
investment approach?
Ans. According to saving and investment approach, equilibrium level of income is
determined at the level of income when planned saving (S) is equal to planned
investment (I), i.e., when S = I
Q.6. Define full employment equilibrium.
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Ans. Full employment equilibrium is a state of equilibrium where AD equals AS at
full employment level.
Q.7. Give the meaning of under-employment equilibrium. (CBSE
Foreign 2017)
Ans. It refers to a situation of equilibrium where all resources of the economy are
not fully employed. Some resources are unemployed.
Q.8.Explain the meanings of (a) desired stocks and (b) actual stocks with the
producers.
Ans.

 Desired Stocks: Desired stocks refer to the level of stock of goods with the
producers where AS= AD.
 Actual Stocks: Actual stocks refer to the level of stock of goods which is
actually left with the producers. It includes desired stock plus undesired
stock.
Q.9. What is the relationship between marginal propensity to save and multiplier?
(CBSE Foreign 2009)
Ans. Multiplier is inversely related to MPS

i.e., Multiplier (k) =

Q.10. If MPC and MPS are equal, what is the value of the multiplier? (CBSE Sample
paper 2008)
Ans. We know, MPC + MPS = 1. If both are equal, it means, MPS = 0.5.

Multiplier (k) = = =2
.
Q.11. if Marginal propensity to save is 0.1, calculate the value of multiplier. (CBSE
Delhi 2003)

Ans. Multiplier (k) = = = 10

.
Q.12. IF the value of marginal propensity to consume is 0.8, calculate the value of
multiplier.

Ans. Multiplier (k) =

=
.

=
.

= =5
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Q.13. Define the term multiplier. How do we measure it?
Ans. Multiplier (k) refers to the ratio of change in income (ΔY) to change in
investment (ΔI).

Formula for measuring multiplier : k= ΔY /ΔI

Q.14. What is investment multiplier? Explain the relationship between marginal

propensity to consume and investment multiplier.(CBSE Delhi 2005, 06, 07, 08,
09, 18; All India 2004, 07, 08)
Ans. Meaning of Multiplier : Multiplier is defined as the ratio of change in income
to change in investment.
Relationship of K with MPC : The value of multiplier (K) depends on value of
marginal propensity to consume (MPC). There is direct relationship between K
and MPC. If MPC is high, K will also be high and if MPC is low, K will also be small.
Relationship between K and MPC is expressed as under:

k=

Q.15. Explain the concept of investment multiplier. Use diagram.

Ans. Investment multiplier shows relationship between initial increase in
investment and the resulting increase in national income.
Diagrammatic Representation:

In Fig. 8.7:

 National income is shown on the x-axis and saving & investment on the y-
axis. .
 II and SS denote investment curve and saving curve saving respectively.
 Equilibrium level of income is OY0, where Il curve intersects the SS curve
at point E0.
 If investment increases by ΔI, and the new investment is being
represented by I'I' curve, the equilibrium will shift to point E1 from point E,
and the corresponding equilibrium level of income will be OY₁.
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  As a result of II' increase in investment, income increases by YoY₁ (YoY₁ >
II’).
Q.16. Explain national income determination through the two alternative
approaches. Use diagram.
(CBSE Foreign 2014)
Or
What are the two alternative ways of determining equilibrium level of income?
How are these related?
(CBSE Delhi 2018)
Ans. Two Alternative ways of Income Determination: The national income
determination through two alternative approaches can be explained with the
help of diagram (Fig. 8.8).

III. High Order Thinking Skills (HOTS) Questions

Q.1. What is the difference between aggregate demand and effective demand?
Ans.

 Aggregate demand refers to the total of goods and services that

households and firms taken together plan to buy during a year.
 There are different levels of AD at different levels of income. Only that
level of AD is effective which is equal to AS.
Q.2. Distinguish between ex-ante measure and ex-post measure of a variable.
Which of two the forms the basis of the theory of national income determination?
(CBSE Delhi 2017C)
Ans.
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  Ex-ante measure refers to planned measure of a variable in the beginning
of an accounting year.
 Ex-post measure implies actual measure of a variable in a year.
 Ex-ante measures form the basis of the theory f national income
determination.

Q.3. Explain how the level of effective demand is attained in an economy if,
aggregate demand is more than the aggregate supply. (CBSE
Sample Question Paper 2018-19)
Ans.

 Effective demand refers to that level of output where aggregate demand is

equal to the aggregate supply.
 If aggregate demand exceeds aggregate supply it means buyers are
planning to buy more goods and services than firms are planning to
produce.
 Thus, the inventories in hand with the firms will start falling.
 As a result, firms will plan to raise the production.
 This will increase the level of income up to the level aggregate demand is
equal to aggregate supply.
Q.4. Under fixed price analysis, the equilibrium level of income is solely
determined by aggregate demand. Write true or false. Give reason.
Ans. True.
Reason: Under fixed price analysis, aggregate supply is assumed to be perfectly
elastic with respect to price. Aggregate supply can be changed according to
change in aggregate demand for goods and services. Hence, the equilibrium
level of income is solely determined by the level of aggregate demand.
Q.5. Explain the meaning of under-employment equilibrium clearly.
Or
Can an economy be in equilibrium, when there is unemployment in the economy?
Explain.(CBSE Sample Paper 2010)
Ans.Under-employment equilibrium denotes a situation where an economy
attains equilibrium at less than full employment output. When aggregate
demand falls short of full employment level of output, under-employment
equilibrium occurs. An economy attains under-employment equilibrium when AD
curve intersects the aggregate supply curve before full employment level of
output. Thus, AD and AS can become equal at less than full employment level.
Q.6. What is the value of multiplier (K) if entire additional income is used into
additional consumption?
Or
What is the value of multiplier when Marginal Propensity to save is zero?(CBSE
Sample Paper 2014)
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Ans. When ΔC = ΔY, then MPC = ΔC / ΔY = 1

k= = = = ∞ (inifinity)
Alternative method:
When MPC = 1, MPS= 0. This is shown as under:
MPC + MPS = 1
1 + MPS = 1
MPS = 1 – 1 = 0

K= = =∞

Q.7. What can be the minimum value of multiplier? Explain.

Ans. The minimum value of multiplier is one when the value of MPC is zero. It can
be proved as under:

We know, k=

When, MPC = 0, then k= = =1

Numerical Questions
Type I : Calculation of Equilibrium Level of Income
1. In an economy the consumption function is C = 500+ 0.8Y where C is
consumption expenditure and Y is income. Calculate (i) equilibrium level of
national income and (ii) consumption expenditure when investment
expenditure is 500.
Ans. Y = 5,000; C= 4,500 (CBSE Foreign 2010)
2. In an economy the consumption function is C = 600+ 0.9Y where C is
consumption expenditure and Y is income. Calculate (i) equilibrium level of
national income and (ii) consumption expenditure when investment
expenditure is 500.
Ans. Y = 11,000; C = 10,500 (CBSE Foreign 2010)
3. In an economy C = 200+ 0.75Y is the consumption function where C is
consumption expenditure and Y is national income. Investment expenditure is
4,000. Calculate equilibrium level of income and consumption expenditure.
(CBSE All India 2013)
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Ans. Equilibrium level of Income = 16,800; Consumption Expenditure = 12,800
4. From the following data about an economy, calculate: (a) Equilibrium level of
national income; (b) Total consumption expenditure at equilibrium level of
national income. (CBSE All India 2013)
(i) C = 200 + 0.5Y is the consumption function where C is the
consumption expenditure and Y is the national income
(ii) Investment expenditure is 1,500
Ans. (i) 3,400 (ii) 1,900
5. C = 100 + 0.4Y is the consumption function of an economy, where C is the
Consumption expenditure and Y is national income. Investment expenditure is
1,100. Calculate: (i) Equilibrium level of national income (ii) Consumption
expenditure at equilibrium level of national income. (CBSE Delhi 2013)
Ans. (i) 2,000, (ii) 900
6. C = 50 + 0.5Y is the consumption function of an economy, where C is the
Consumption expenditure and Y is national income. Investment expenditure is
2,000. Calculate: (i) Equilibrium level of national income (ii) Consumption
expenditure at equilibrium level of national income. (CBSE Delhi 2013)
Ans. (i) 4,100, (ii) 2,100
7. The savings function of an economy is S = – 200 + 0.25Y. The economy is in
equilibrium when income is equal to 2000. Calculate:
(a) Investment expenditure at equilibrium level of income
(b) Autonomous consumption
(c) Investment multiplier (CBSE Sample Paper 2010)

Hint: (i) at equilibrium level S = I (ii) at zero level of income C = S

[Ans. (a) 300, (b) 200, (c) 4]
8. Given consumption function C = 100 + 0.75Y (when C = Consumption
expenditure and Y = national income) and investment expenditure `1,000,
calculate: (CBSE Delhi 2009)
(i) equilibrium level of national income
(ii) consumption expenditure at equilibrium level of national income
Ans. (i) ` 4,400 (ii) `3,400
9. In an economy S = –50 + 0.5Y is the savings function (where S= saving and
Y= national income) and investment expenditure is 7000. Calculate:
(i) equilibrium level of national income
(ii) consumption expenditure at equilibrium level of national income
Ans. (i) 14,100 (ii) 7,100 (CBSE All India2009)
10.Calculate equilibrium level of income from the following: (CBSE 2013C)
(i) Consumption expenditure at zero income = `40
(ii) Marginal propensity to consume = 0.8
(iii) Investment = `80
[Ans. `600]
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11.Calculate equilibrium level of income from the following: (CBSE All India
2013C)
(i) Consumption expenditure at zero income = `60
(ii) Marginal propensity to consume = 0.9
(iv) Investment = `100 [Ans. `1600]
12.An economy is in equilibrium. Calculate national income from the following:
(CBSE Delhi 2015)
(i) Autonomous consumption = 100
(ii) Marginal propensity to save = 0.2
(v) Investment expenditure = 200 [Ans. 1500]
13.An economy is in equilibrium. Calculate national income from the following:
(CBSE All India 2015)
(i) Autonomous consumption = 120
(ii) Marginal propensity to save = 0.2
(vi) Investment expenditure = 150 [Ans. 1350]
14.Calculate equilibrium level of income: (CBSE Delhi 2015C)
(a) Autonomous consumption = 200
(b) Marginal propensity to consume = 0.9
(c) Investment expenditure = 1,000 [Ans. 12,000]
15.S = –100 + 0.2Y is the saving function in an economy. Investment
expenditure is 5,000. Calculate equilibrium level of income.
[Ans. 25,500] (CBSE Delhi 2015C)
16.Find equilibrium national income: (CBSE Foreign 2016)
(i) Autonomous consumption = 120
(ii) Marginal propensity to consume = 0.9
(iii) Investment expenditure = 1,100
[Ans. 12,200]
17.Calculate equilibrium level of income in the economy: (CBSE Delhi 2015C)
C = 500 + (0.9Y)
Investment expenditure = 3,000
18.If in an economy: (a) Consumption function is given by C = 100 + 0.75Y, and
(b) Autonomous investment is `150 crores. Estimate (i) Equilibrium level of
income and (ii) Consumption and savings at the equilibrium level of income.
[Ans. (i) `1,000 crores; (ii) Consumption = `850 crores, Savings = `150
crores] (CBSE Sample Paper 2017)

Type 2: Calculation of , C, I, MPC and MPS, when national

income is given
19.Find investment from the following: (CBSE Delhi 2013C)
(i) Equilibrium income = `500
(ii) Consumption expenditure at zero income = `50
(iii) Marginal propensity to consume = 0.7
[Ans. `100]
20.Calculate marginal propensity to consume from the following: (CBSE All India
2013C)
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 (i) Consumption expenditure = `70
(ii) Equilibrium income = `700
(iii) Investment = `140
[Ans. MPC = 0.7]
21.Calculate marginal propensity to consume from the following data about an
economy which is in equilibrium: (CBSE Delhi 2014)
(i) National income = `1,500
(ii) Autonomous consumption expenditure = `300
(iii) Investment expenditure = `300
[Ans. MPC = 0.6]
22.Calculate autonomous consumption expenditure from the following data
about an economy which is in equilibrium: (CBSE All India 2014)
(i) National income = `500
(ii) Marginal propensity to save = 0.30
(iii) Investment expenditure =`100
[Ans. C = ` 50]
23.Calculate investment expenditure from the following data about an economy
which is in equilibrium: (CBSE All India 2014)
(i) National income =` 1,000
(ii) Marginal propensity to save =0.20
(iii) Autonomous consumption expenditure = `100
[Ans. `100]
24.Calculate marginal propensity to consume from the following data about an
economy which is in equilibrium:(CBSE All India 2014)
(i) National income =`2000
(ii) Autonomous consumption expenditure =`200
(iii) Investment expenditure =`100 [Ans. MPC
0.85]
25.Calculate marginal propensity to consume from the following data about an
economy which is in equilibrium: (CBSE Foreign 2014)
(i) National income = 800
(ii) Autonomous consumption expenditure = 100
(iii) Investment expenditure = 70
[Ans. 0.75]
26.Calculate ‘investment expenditure’ from the following data about an economy
which is in equilibrium: (CBSE Foreign 2014)
(i) National Income = 700
(ii) Marginal propensity t consume = 0.8
(iii) Autonomous consumption = 70
[Ans. 70]
27.An economy is in equilibrium. Find ‘autonomous consumption’ from the
following: (CBSE Delhi 2015)
(i) National Income = 1000
(ii) Marginal propensity to consume = 0.8
(iii) Investment expenditure = 100
[Ans. 100]
28.An economy is in equilibrium. Find ‘Marginal propensity to consume’ from the
following: (CBSE Delhi 2015)
(i) National Income = 2000
(ii) Autonomous consumption = 400
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 (iii) Investment expenditure = 200
[Ans. 0.7]
29.An economy is in equilibrium. Find ‘Marginal propensity to save’ from the
following: (CBSE All India 2015)
(i) National Income = 1000
(ii) Autonomous consumption = 100
(iii) Investment = 120
[Ans. 0.22]
30.An economy is in equilibrium. Calculate investment expenditure from the
following: (CBSE All India 2015)
(i) National Income = 800
(ii) Marginal propensity to save = 0.3
(iv) Autonomous consumption = 100
[Ans. 140]
31.An economy is in equilibrium. Calculate Autonomous consumption from the
following: (CBSE Foreign 2015)
(i) National Income = 1,250
(ii) Marginal propensity to save = 0.2
(iii) Investment expenditure = 150
[Ans. 100]
32.An economy is in equilibrium. Calculate investment expenditure from the
following: (CBSE All India 2015)
(i) National Income = 750
(ii) Autonomous consumption = 200
(iii) Marginal propensity to save = 0.4
[Ans.100]
33.An economy is in equilibrium. Calculate marginal propensity to save from the
following: (CBSE Foreign 2015)
(i) National Income = 1,000
(ii) Autonomous consumption = 100
(iii) Investment expenditure = 200
[Ans. 0.3]
34.An economy is in equilibrium. Calculate marginal propensity to consume.
(CBSE Delhi 2016)
(i) National Income = 1000
(ii) Autonomous consumption expenditure = 200
(iii) Investment expenditure = 100
[Ans. 0.7]
35.An economy is in equilibrium. Find Investment expenditure. (CBSE All India
2016)
(i) National Income = 1000
(ii) Autonomous consumption = 100
(iii) Marginal propensity to consume = 0.8 [Ans. I̅ = 100]
36.An economy is in equilibrium. Find Autonomous consumption expenditure.
(CBSE Foreign 2016)
(i) National income = 1600
(ii) Investment expenditure = 300
(iii) Marginal propensity to consume = 0.8
[Ans.C = 20]
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37.An economy is in equilibrium. Find marginal propensity to consume. (CBSE
foreign 2016)
(i) Autonomous consumption expenditure = 100
(ii) Investment expenditure = 100
(iii) National Income = 200 [Ans. MPC
= 0.9]
38.From the following data, calculate marginal propensity to consume. (CBSE
Delhi 2016C)
(i) Equilibrium level of income = 2,000
(ii) Autonomous consumption = 200
(iii) Investment expenditure = 800
[Ans. MPC = 0.5]
39.Calculate investment expenditure in the economy from the following data:
(i) Equilibrium level of income = 10,000
(ii) Autonomous consumption = 500
(iii) Marginal propensity to consume = 0.75
[Ans. 2,000]
40.An economy is in equilibrium. From the following data about an economy,
calculate autonomous consumption. (CBSE Delhi 2017)
(i) Income = 5,000
(ii) Marginal propensity to save = 0.2
(iv) Investment expenditure = 800
[Ans.C = 200]
41.An economy is in equilibrium. From the following data about an economy,
calculate investment. (CBSE Delhi 2017)
(i) Income = 10,000
(ii) Marginal propensity to consume = 0.9
(iv) Autonomous consumption = 100 [Ans. I̅ = 900]
42.An economy is in equilibrium. From the following data calculate Investment
expenditure. (CBSE Foreign 2017)
(i) Marginal propensity to consume = 0.9
(ii) Autonomous consumption = 200
(v) Level of income = 10,000 [Ans. I̅ = 800]

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Type 3: Multiplier and Income

43. In an economy income increases by 10,000 as a result of a rise in investment

expenditure by 1,000 Calculate: (CBSE Sample Paper 2010)
(a) Investment multiplier
(b) Marginal propensity to consume. Ans. (a) 10; (b) 0.9
44. As a result of increase in investment by `20 crore, national income rises by
`100 crore. Find out the value of marginal propensity to consume. (CBSE Delhi
2005C) Ans. 0.8
45. (a) If the size of multiplier is 2.5, what amount of new investment will be
needed to generate an additional income of `500 crore? Ans. `200 crore
(b) If the value of MPS is 0.4, what amount of new investment will be required to
generate an additional income of `1,000 crore? Ans. `400 crore
46. (a) If an increase of `10,000 in investment in an economy results in an
increase in income of `40,000. Calculate marginal propensity to save in the
economy. Ans. 0.25
(b) In an economy, the level of income is `2,000 crore and marginal propensity to
consume is 0.75. Calculate the total increase in income if investment increases
by `200 crore. (CBSE Sample Paper 2006) Ans. `800 crore
47. In an economy marginal propensity to consume is 0.75. If investment
expenditure is increased by `500 crore calculate the total increase in income and
consumption expenditure. (CBSE Delhi 2004)
Ans. ∆Y = `2000 crore; ∆C= `1500 crore
48. If MPC is 0.9 and increase in investment is `100 crore, find out increase in
national income. (CBSE Delhi 2004C) Ans. ∆Y = `1000 crore
49. In an economy marginal propensity to save is 0.2. Investment increases by
`1,000 crore. Calculate total increase in national income. (CBSE All India 2007)
Ans. ∆Y = `5000 crore
50. If marginal propensity to save is 0.2, how much new investment is required
to make the national income rise `600 crore? Calculate. (CBSE All India 2008)
Ans. `120 crore
51. As a result of increase in investment by `125 crore, national income
increases by `500 crore. Calculate marginal propensity to consume. Ans. 0.75
(CBSE Delhi 2008)
52. In an economy, every time income rises, 75 per cent of the rise in income
spent on consumption. Now suppose in the same economy investment rises by
`750 crore. Calculate the following: (CBSE Delhi 2009C)
(i) Change in income
(ii) Change in saving Ans. (i) ∆Y = `3000 crore (ii) ∆S = `750 crore
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53. An increase in investment by `400 crore leads to increase in national income
by `1600 crore. Calculate MPC. Ans. 0.75 (CBSE Foreign 2008)
54. In an economy marginal propensity to consume is 0.75. If investment
expenditure is increased by `75 crore, calculate the total increase in national
income and consumption expenditure. (CBSE All India 2011)
Ans. (i) Increase in national income = `300; (ii) Increase in consumption
expenditure `225
55. Marginal propensity to consume is zero. Calculate change in income, if
investment falls by `1000 crore. (CBSE All India 2012C)Ans. ∆Y = (–)`1000 crore
56. Calculate the additional investment required if the equilibrium level of
income falls short of `2000. The consumption function is given by C = 200 +
0.75Y
Hint: (i) Calculate the value of k

K=

∆
(ii) Use formula: k = Ans. `500 crore
∆
57. In an economy the marginal propensity to consume is 0.75. Investment
expenditure in the economy increases by `75 crore. Calculate the total increase
in national income. Ans. `300 crore (CBSE All India 2011)
58. In an economy, investment expenditure is increased by `400 crore and
marginal propensity to consume is 0.8. Calculate total increase in income and
savings.
Ans. ∆Y = `2000 crore, ∆S = `400 crore
59. In an economy, a 40 per cent increase in investment results in a 40 per cent
increase in income. Calculate the marginal propensity to consume.
Ans. MPC = 0 (CBSE Delhi 2012C)
60. Marginal propensity to consume is zero. Calculate the change in income, if
investment falls by `1000 crores.
Ans. `1,000 (CBSE All India 2012C)
61. In an economy income increases from `5000 crore to `6000 crore as a result
of 20 per cent increase in investment. Calculate the value of investment
multiplier. Ans. K = 1 (CBSE All India 2012C)
62. In an economy, investment increases from 300 to 500. As a result of this,
equilibrium level of income increases by 2,000. Calculate the marginal
propensity to consume. Ans. 0.9 (CBSE All India 2015C)
63. In an economy, 20 percent of increase income is saved. How much will be
the increase in income, if investment increases by 10,000? Calculate.
Ans. 50,000 (CBSE All India 2015C)
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64. In an economy investment is increased by `300 crore. If marginal propensity
to consume is 2/3, calculate increase in national income.
Ans. ` 900 crore (CBSE Delhi 2016)
65. Suppose marginal propensity to consume is 0.8. How much increase in
investment is required to increase national income by `2000 crore?
Ans. `400 crore (CBSE Delhi 2016)
66. In an economy an increase in investment by `100 crore led to increase in
national income by `1000 crore.Find marginal propensity to consume.
Ans. 0.9 (CBSE Delhi 2016)
67. If MPC is 0.5, calculate value of investment multiplier. Ans. 2 (CBSE Delhi
2017C)
68. National income increases by `2500 crore when an additional investment of
`500 crore is made. Calculate the value of investment multiplier.
Ans. 5 (CBSE All India 2017C)

69. If in an economy C = 500+ 0.9Y and I = `1,000 crores.

(Where C = Consumption expenditure, Y = National income, I = Investment).
Calculate the following: (i) Equilibrium level of income.
(ii) Value of investment multiplier. Ans. (i) `15,000 crore,
(ii) 10

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 “Chapter 3”
Problems of Deficient Demand and excess Demand
According to Keynes, the Equilibrium level of income need not necessarily be at
the full Employment level. Though full Employment Equilibrium is an ideal
situation which every Economy tries to achieve but may be unable to do so.
 If AD is less than full Employment AS, the Economy will only achieve under
Employment Equilibrium. This situation is known as “Deficit Demand”.
 If AD is more than full Employment AS at full Employment Equilibrium level,
this is Called “Excess Demand”.

Problem of Excess Demand

Meaning of Excess Demand
 It refers to a situation where Aggregate Demand is more than Aggregate
supply corresponding to full Employment level of output in the Economy.
 Excess Demand gives rise to the inflationary gap.
 Inflationary gap refers to the gap by which Actual AD Exceeds the required
AD.
 It is basically inflationary in nature as it leads to rise in general price level of
the Economy.

In the above diagram, Income / o/p on X Axis and AD on Y Axis, AD & AS intersact
at print E, which indicates the full Employment Equilibrium. Due to Increase in
investment Expenditure (∆I) AD Rises from AD to AD1. It shows the situation of
Excen Demand and EF is the Inflationary gap.
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 Reasons for Excess Demand
1.)Rise in Cosnumtpion Expenditure:
Consumption expenditure is a major component of AD. Consumption expenditure
increases with rise in propensity to consume and fall in propensity to save.
2.)Increase in Investment:
Increase in Investment expenditure can also result in excess demand and it
happens due to high business expectations.
3.)Increase in Government expenditure:
Increase in govrenment expenditure for development as well as welfare
purposes in the economy may also result in excess demand.
4.)Rise in Exports:
Excess demand may also arise due to rise in export due to relatively cheaper
domestic goods or due to fall in the exchange rate.
5.)Fall in Imports:
Decrease in imports, due to higher international prices as compared to domestic
prices, may also lead to “excess demand”.
6.)Reduction in Taxes:
Cut in taxes by the government may lead to increase in disposable income with
the people and hence it increases their demand.

“Effects of Excess Demand”

In the situation of excess demand outut of goods and services remains constant,
employment also remains constant as economy is already operating at full
employment level.
So excess demand always results in rise in general price level in the economy.

Meausres to Correct Excess Demand

 In order to solve the problem of excess demand. The AD has to be reduced by
an amount equal to the inflationary gap. This will bring the economy back to
the full employment equilibrium.
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 1.) Fiscal Policy Measures 2.) Monetary Measures
 Reducing the
government expenditure
 Increasing the amount of Quantitative Qualitative
taxes Methods Methods
 Increase in  Increasing
bank rate margin
 Sale of requirement
securities
in the open
market
 Increasing
LRR

(1) Fiscal Policy Measures

(a) Reducing the Government expenditures:
During excess Demand, The government needs to reduce its spending on public
works like subsidies etc. which ultimately reduces the income of the people and
their demand for goods and services.
(b) Increasing the Amount of Taxes:
In order to reduce the level of AD, the Govt can also Increase the Tax Rates
which ultimately reduces the disposable income in the hands of Households
which ultimately reduces the Overall AD in the Economy.

(2) Monetary Measures

[A] Quantitative Methods
(i) Increase in Bank rate:
An increase in bank rate increases the rate of interest which ultimately makes
the credit (loan) expensive. So people are discouraged to borrow and spend. As a
result AD would fall.
(ii) Sale of Securities:
The Central Bank can sell government securities in the Market. As Securities sold
by central Bank, the Buyers will make the payment through Cheques. The Money
will flow out from Commercial Banks to Central banks. This will decrease
Commercial Banks deposits and their lending power. Borrowers will get less
amount of loan from banks which will ultimately reduce their Demand.
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(iii) Increasing LRR ( CRR + SLR ):
When the LRR is Raised, Commercial Banks now be able to lend less than before.
It will reduce the Borrowing By people from Banks. In this way the level of way
AD may be reduced.

[B] Qualitative Methods

(i) Margin Requirement:
To reduce the excess Demand, Central Bank raises the margin requirement. The
Borrowers are now given less money in the form of Loans against their securities.
This will have An Anti-inflationary Effect.

Difference between Excess Demand & Deficient Demand

Basis Excess Demand Deficient Demand
Meaning It refers to situation It refers to situation
when AD>AS when AD<AS
corresponding to full corresponding to full
employment level of employment level in the
output in the economy. economy.
Impact on price It leads to inflation. It It leads to deflation. It
results in rise in general results in fall in general
price level. price level.
Equilibrium It indicates over full It indicates under
employment equilibrium. unemployment
equilibrium.
Impact on o/p & It doesn’t affect the o/p It leads to fall in o/p and
employment and employment. employment due to
shortage in AD.

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HOTS Analysing, Evaluating & Creating Type Questions

1. Giving valid reasons, state whether the following statements are true or false:
(4 marks)
(a) An excess of aggregate demand over full employment level of aggregate
supply represents a situation of inflationary gap.
(b) An economy facing unintended accumulation of inventories would try to reduce
aggregate demand.
Ans. (a) The given statement is true; an excess of aggregate demand over full
employment level of aggregate supply represents a situation of inflationary gap,
production cannot be increased beyond this level. Increase in AD here onwards,
will increase only the general price level.
(b) The given statement is not correct. The situation of unintended accumulation
of inventories arises when ex-ante aggregate demand is lesser than the ex-ante
aggregate supply. This would pile up the stock with the producers, thus to tackle
this situation the economy must increase AD.

2. ‘An economy is operating at under-employment level of income’. What is meant

by the given statement? Discuss one fiscal measure and one monetary measure to
tackle the situation.(CBSE Sample Question Paper 2020) (6 marks)
Ans. An economy is said to be operating at under employment equilibrium level,
if the planned aggregate expenditure (i.e. aggregate demand) falls short of
available output in the economy, corresponding to the full employment level. It
refers to a situation of deficient demand, which gives rise to a deflationary gap.
To tackle such a situation the aggregate demand has to be increased by an
amount equal to the deflationary gap. Following measures may be taken for the
same.
(i) One fiscal measure - Decrease in taxes
The government under its fiscal policy may decrease the rate of taxes (both
direct and indirect taxes). This will ensure greater purchasing power in the hands
of general public. This will help to increase aggregate demand and remove the
deflationary gap.
(ii) One monetary measure - Increase in money supply
Central bank through its expansionary monetary policy can increase the money
supply in the economy. Central bank can use tools like bank rate, cash reserve
ratio, repo and reverse repo rates etc. to ensure greater money in the hands of
general public which would in turn increase the aggregate demand in the
economy and be helpful in reducing/removing the deflationary gap.
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3. State which of the following statements are true or false. Give valid reasons.
(CBSE 2019) (3 marks)
(a) According to Keynesian theory of employment, the state of full employment is
obtained only when the economy is in equilibrium.
(b) According to Keynesian theory of employment, a state of under-employment
can never exist in an economy.
Ans. (a) The given statement is false - as per Keynesian theory of Employment
the economy can be in equilibrium at less than or more than full employment
level also.
(b) The given statement is false, according to Keynesian theory of employment
the state of under employment can exist. This may occur at that level of income
where equilibrium between AD and AS happens at less than full employment
level.
4. State the impact of ‘Excess Demand’ under Keynesian theory on employment,
in an economy. (CBSE 2019) (3 marks)
Ans.In case of 'Excess Demand' under the Keynesian Theory, there will be no
change in the employment as economy is already working at the full
employment. Thus, there is no further scope of creation of employment.
5. What does the deflationary gap measure? (1 mark)
Ans. The deflationary gap is a measure of the amount of deficiency of aggregate
demand.
6. What is meant by demand pull inflation? (1 mark)
Ans. Demand pull inflation is an aggregate demand induced rise in the price
level.
7. Why is the inflationary gap so called?(1 mark)
Ans. The inflationary gap is so called because it sets in motion forces that will
cause inflation or a rise in the price level.
8. What is the effect of a decrease in bank rate on aggregate demand?(1 mark)
Ans. It will increase the level of aggregate demand in the economy.
9. What is the effect of a rise in cash reserve ratio on aggregate demand?(1 mark)
Ans. It will decrease the level of aggregate demand in the economy.
10. What is the effect of increase in Reverse repo rate on aggregate demand?(1
mark)
Ans. It will decrease the level of aggregate demand in the economy.
11. Give two measures taken by the government to remove deflationary gap. (1
mark)
Ans. (i) Increase in government expenditure
(ii) Reduction in the amount of taxes
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12. Give two measures taken by the Central bank to combat excess demand.
(CBSE 2009) (1 mark)
Ans. (i) Increase in Legal reserves (CRR, SLR)
(ii) Increase in Bank
13. In the situation of inflation, more credit creation by commercial banks has
negative impact on d economy, How? (3 Marks)
Ans. Credit creation by commercial banks in inflationary situation in the economy
increases the money supply and hence aggregate demand. It creates the
situation of excess demand and inflationary gap if aggregate demand exceeds
the full employment level of output/income.
14. Is equilibrium level of income and output always associated with full-
employment? Explain. (3 marks)
Ans. The economy will be in full-employment equilibrium if aggregate demand is
equal to aggregate supply at full employment. However, the equilibrium level of
income/output is not always associated with full employment.

 If aggregate demand is less than aggregate supply at full employment,

then it is a situation of deficient demand in the economy which gives rise
to deflationary gap.
 On the other hand, if aggregate demand is more than aggregate supply at
full employment, then a situation of excess demand exists in the economy
which gives rise to inflationary gap.
15. What changes will take place in the economy if (4 marks)
(i) Aggregate demand exceeds aggregate supply?
(ii) Aggregate demand exceeds aggregate supply at full employment?
Ans. (i) If aggregate demand exceeds aggregate supply (AD> AS), this means
that consumers would be buying more goods than firms were producing. This
would lead to an unplanned decrease in inventories. Firms would then increase
output and thus income would increase. This process of increase in income will
continue until the economy is in equilibrium where AD = AS.
(ii) If aggregate demand exceeds the full employment level aggregate supply,
then a situation of excess demand exists in the economy. Excess demand gives
rise to an inflationary gap; which causes a rise in the general price level or
inflation.
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 QUESTION BANK
I. Multiple Choice Questions
1. If equilibrium level of income in the economy is determined at the level before
full employment, it is known as the state of:
(a) Deficient demand (b) Excess demand
(c) Both (a) and (b) (d) None of these
2. In Keynesian economics, deficient demand results in:
(a) Full employment equilibrium
(b) Under full employment equilibrium
(c) Both (a) and (b)
(d) None of the above
3. Which of the following is true?
(a) Employment level declines due to deficient demand
(b) Price level falls due to deficient demand in the country
(c) Output level falls in times of deficient demand
(d) All of the above
4. Deflationary gap is a measure of:
(a) Aggregate demand (b) Aggregate supply
(c) Excess demand (d) Deficient demand
5. Following may be the reason for excess demand:
(a) Fall in propensity to consume
(b) Increase in taxes
(c) Increase in government expenditure
(d) Decrease in money supply
6. Following can be the reason for deficient demand:
(a) Rise in propensity
(b) Deficit financing
(c) Rise in exports
(d) Increase in taxes
7. Excess demand has the following effect:
(a) Rise in general price level
(b) Fall in output
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(c) Rise in the level of employment
(d) Fall in price level
8. Fiscal remedy for excess demand:
(a) Increase in bank rate
(b) Sale of government securities in the open market
(c) Cut in government spending
(d) Cut in tax rates
9. Monetary remedy for excess demand:
(a) Government expenditure should be reduced
(b) Increase in repo rate
(c) Cut in CRR
(d) Increasing the tax burden on the people
10. Name the monetary measure indicated in the following during deficient
demand:
(a) Purchase of government securities from the public
(b) Increase in margin requirement
(c) Raising CRR
(d) Increase in bank rate
11. Identify the correct statement from the following:
(a) To correct the situation of deficient demand, the central bank should raise the
repo rate.
(b) To correct the situation of excess demand, the availability of credit should be
made cheaper.
(c) During deficient demand, the government should increase expenditure on
public works
(d) Bank rate is a qualitative measure of credit control.
12. Following is the quantitative Instrument of monetary policy:
(a) Repo rate
(b) Open market operations
(c) CRR
(d) All of the above
13. Following is the qualitative instrument of monetary policy:
(a) Imposing margin requirement
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(b) Varying legal reserve requirement
(c) Open market operations
(d) Bank rate
14. Aggregate demand can be increased by: (Choose the correct alternative)
(CESE Delhi 2017)
(a) Increasing bank rate
(b) Selling government securities by Reserve Bank of India
(c) Increasing cash reserve ratio
(d) None of the above
15. Inflationary gap can be corrected by the central bank by:
(a) Reducing bank rate
(b) Reducing SLR
(c) Selling government securities
(d) Buying government securities
16. Deflationary gap can be corrected by the central bank by:
(a) Reducing bank rate
(b) Raising CRR
(c) Raising SLR
(d) Selling government securities
17. Excess demand indicates:
(a) Under-employment equilibrium
(b) Over full employment equilibrium
(c) Full employment equilibrium
(d) None of these
18. Which of the following results in increase in AD?
(a) Rise in exports
(b) Increase in consumption expenditure
(c) Increase in government expenditure
(d) All of the above

Answers:
1(a), 2(b), 3(d), 4(d), 5(c), 6(d), 7(a), 8(c), 9(b), 10(a), 11(c), 12(d), 13(a), 14(d),
15(c), 16(a), 17(b), 18(d).
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II. Important Questions

Q.1. Give the meaning of deficient demand. (CBSE Delhi 2008, 10; All India 2008;
Foreign 2014)
Ans. It refers to a situation in which aggregate demand falls short of aggregate
supply at full employment level in the economy.
Q.2. What is meant by excess demand in macro economics? (CBSE Delhi 2008; All
India 07, 10, 14)
Ans. It refers to a situation in which aggregate demand exceeds the aggregate
supply corresponding to full employment level in the economy.
Q.3. Define inflationary gap. (CBSE Delhi 2008, 18C; All India 2014)
Ans. It refers to the gap by which actual aggregate demand exceeds the
aggregate demand required to establish full employment equilibrium.
Q.4. Define deflationary gap. (CBSE Delhi 08, 10; All India 14; Foreign 14)
Ans. It refers to the gap by which actual aggregate demand falls short of the
aggregate demand required to establish full employment equilibrium.
Q.5. What impact does deficient demand have on output and price level?
Ans. Output decreases during deficient demand. The general price level also falls
due to shortage of demand.
Q.6. State one cause of excess demand.
Ans. An increase in money supply due to deficit financing may cause excess
demand.
Q.7. State one cause of deficient demand.
Ans. Fall in propensity to consume as a result of rise in taxes may cause the
situation of deficient demand.
Q.8. What is fiscal policy?
Ans. Fiscal policy refers to revenue and expenditure policies of the government
to correct the situations of inflation and deflation in the economy.
Q.9. What is monetary policy?
Ans. Monetary policy is the policy of the central bank relating to the regulation of
(i) Rate of interest, and (ii) Availability of credit.
Q.10. State two monetary measures to reduce the inflationary gap.
Ans. Two monetary measures to reduce the inflationary gap may be:
(i) Increase in bank rate
(ii) Sale of government securities in the open market by the Central Bank
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Q.11. State two fiscal measures to reduce the inflationary gap (or excess demand).
Ans. Inflationary gap can be reduced by undertaking following fiscal measures:
(i) Imposition of higher taxes
(ii) Cut in public expenditure.
Q.12. Differentiate between inflationary and deflationary gaps.
Ans.
(i) Inflationary gap is the amount by which the actual aggregate demand
exceeds aggregate supply at the level of full employment while deflationary gap
is the amount by which actual demand falls short of aggregate supply at full
employment level.
(ii) Inflationary gap is a measure of excess demand while deflationary gap is a
measure of deficient demand.
(iii) Inflationary gap causes a rise in price level which is called inflation while
deflationary gap causes a decline in output, income and employment along with
persistent fall in prices.
Q.13. Explain the concept of inflationary gap. Explain the role of repo rate in
reducing this gap. (CBSE Delhi 2015)
Ans.

 The inflationary gap is the amount by which the aggregate demand exceeds
aggregate supply at the full employment level. It is called inflationary
because it leads to rise in price level.
 Repo rate is the rate of interest at which central bank lends to commercial
banks for a short period. When central bank raises repo rate, the borrowings
by the commercial banks become costlier. This forces the commercial banks
to the raise their lending rates. People borrow less, and therefore spend less.
This helps in reducing inflationary gap.
Q.14. Explain the concept of deflationary gap and the role of open market
operations in reducing it.
(CBSE Delhi 2015)
Ans.

 Deflationary gap is the amount by which the aggregate demand falls short of
aggregate supply at the full employment level. It is called deflationary
because it leads to fall in price level.
 Open market operations refer to buying and selling of government securities
by the central bank in the open market. Central bank can reduce deflationary
gap by buying securities. Those who sell receive payments by cheques from
the central bank will deposit the same in their respective banks. Thus, the
money flows out from central bank into the commercial banks. This raises
lending capacity of commercial banks. Banks lend more leading to rise in
aggregate demand.
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Q.15. What is meant by margin requirement? How does the Central Bank use this
measure to control deflationary conditions in an economy?(CBSE Sample Paper
20130)
Ans.

 Marginal requirement refers to the difference between market value of the

security offered for loans and the amount of loans offered by the commercial
banks.
 The central bank fixes the margin requirements. Under deflationary
conditions, central bank reduces the margin requirement. As a result,
borrowers get more amount of loan against the same security. It increases
the level of aggregate demand.
Q.16. Explain the role of taxation in reducing excess demand. (CBSE Delhi 2016)
Ans. By raising tax rate, the government can reduce personal disposable income
of the people. This will further reduce private final consumption expenditure. This
will finally reduce aggregate demand.
Q.17. Explain the role of margin requirement in dealing with the problem of excess
demand. (CBSE 2018C)
Ans. • Excess demand refers to a situation in which aggregate demand is more
than aggregate supply corresponding to full employment in the economy.
Role of margin requirements:

 Margin requirement refers to difference between the market value of

security offered and the amount of loan.
 When the economy is suffering from the problem of excess demand,
central bank increases the margin requirement. This restricts the credit
creating power of banks. Borrowers also find it less attractive to borrow
money and it decreases the level of aggregate demand.

IV. Value Based & Multi-disciplinary Questions

Q.1. Explain the meaning of under-employment equilibrium. Explain two measures

by which full employment equilibrium can be reached. (CBSE All India 2013)
Ans. When an economy attains equilibrium at an income level less than full
employment level, it is called under employment equilibrium.
Two Measures:
(i) Aggregate demand has to be increased by an equal amount of deficient
demand through government spending.
(ii) The central bank should ensure easy availability of credit and reduce cost of
borrowing.
Q.2. Indian economy is in the grip of rising prices. Explain any two measures to
control the situation.
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Ans. (i) The central bank should raise the bank rate
(ii) Government should reduce its expenditure to the maximum possible extent.
Q.3. How does government expenditure affect the level of AD?
Ans. An increase in government expenditure on purchase of consumption goods
and capital goods increases the level of aggregate demand.

EXERCISES
Short Answer Type Questions (Carrying 3/4 marks each)

1. Explain the concept of inflationary gap. Use diagram. (CBSE Delhi 2001, 05C)
2. Explain the meaning of deflationary gap with the help of a diagram. (CBSE
Foreign 2005; All India 2008: Delhi 2012C)
Or
Explain the situation of deficient demand in an economy with the help of a
diagram. (CBSE Delhi 2005)
3. What is excess demand? Would you advocate expansion or contraction of
credit supply in a situation of excess demand? Explain.
4. Differentiate between inflationary and deflationary gaps.
5. Discuss any three measures by which deficient demand in an economy can be
corrected. (CBSE Delhi 1999C, 08C)
Or
What is meant by deficient demand? State two measures to correct it. (CBSE
Delhi 2008C)
6. Explain any two fiscal policy measures to rectify the problem of excess
demand in an economy. (CBSE Sample Paper 2006)
7. Explain the role of bank rate in dealing with the problem of deficient demand.
(CBSE 2018C)
8. Explain the meaning and impacts of deflationary gap. (CBSE All India 2011C)
9. Explain the meaning and impacts of inflationary gap.(CBSE All India 2011C)
10. What is meant by inflationary gap? State three measures to reduce this gap.
(CBSE 2018)
11. Explain the role of “open market operations” in controlling the inflationary
gap. (CBSE Sample Paper 2014)
12. Explain how controlling money supply is helpful in reducing excess demand.
(CBSE All India 2016)
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13. Explain how government spending can be helpful is removing deficient
demand. (CBSE Foreign 2016)
14. What is monetary policy? State any three instruments of monetary policy.
(CBSE Delhi 2018)
15. Define full employment in an economy. Discuss the situation when aggregate
demand is more than a supply at full employment income level. (CBSE Delhi
2018)
16. Explain the role of margin requirements in dealing with the problem of
excess demand. (CBSE 2018C)

Long Answer Type Questions (Carrying 6 marks each)

1. Explain the concept of inflationary gap with the help of a diagram. Give any
two measures of reducing it. (CBSE Delhi 2005C, Foreign 2008: CBSE Sample
Paper 2006)
2. Explain the concept of deflationary gap. Use diagram. Explain any one
monetary measure to correct it.(CBSE Foreign 2008)
3. Explain the role of the following in correcting the deflationary gap in an
economy. (CBSE All India 2011)
(i) Open market operations
(ii) Margin requirements
4. Explain the role of the following in correcting the inflationary gap in an
economy. (CBSE All India 2011)
(i) Legal reserves
(ii) Bank rate
5. Explain the role of the following in correcting the deficient demand in an
economy. (CBSE Delhi 2011)
(i) Bank rate
(ii) Open market operations
6. Explain the role of the following in correcting the deficient demand in an
economy. (CBSE Foreign 2011)
(i) Government expenditure
(ii) Legal reserves
7. Explain the role of the following in correcting the inflationary gap in an
economy.(CBSE Foreign 2011)
(i) Open market operations
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(ii) Government expenditure
8. Explain the concept of ‘excess demand’ in macroeconomics. Also explain the
role of open market operations in correcting it. (CBSE Delhi 2012)
9. Explain the concept of deflationary gap. Also explain the role of legal reserves
in correcting it. (CBSE All India 2012)
10. Explain the role of the following in correcting the excess demand in the
economy: (CBSE Delhi 2011)
(i) Open market operations
(ii) Bank rate
11. Distinguish between inflationary gap and deflationary gap. Show deflationary
gap on a diagram. Can this gap exist at equilibrium level of income? Explain.
(CBSE Delhi 2004)
12. Explain the concept of deflationary gap. Also explain the role of open market
operations in reducing it. (CBSE Foreign 2012)
13. Explain the concept of excess demand. Also explain the role of bank rate in
reducing it. (CBSE Foreign 2012)
14. Explain the meaning of under employment equilibrium. Explain two measures
by which full employment equilibrium can be reached. (CBSE All India 2013)
15. Distinguish between inflationary gap and deflationary gap. State two
measures by which these can be corrected. (CBSE All India 2013)
16. Explain the meaning of inflationary gap and deflationary gap with the help of
diagrams. (CBSE Delhi 2013C)
17. Explain the meaning of inflationary gap and deflationary gap. Explain any
one measure by which these gaps can be reduced. (CBSE Delhi 2013C)
18. Explain the concept of deflationary gap and the role of open market
operations in reducing this gap. (CBSE Delhi 2015)
19. Explain the concept of inflationary gap. Explain the role of repo rate in
reducing this gap.(CBSE Delhi 2015)
20. What is deficient demand? Explain the role of bank rate in removing it. (CBSE
All India 2015)
21. What is excess demand? Explain the role of reverse repo rate in removing it.
(CBSE All India 2015)
22. What is inflationary gap? Explain the role of cash reserve ratio in removing
this gap. (CBSE Foreign 2015)
23. What is deficient demand? Explain the role of ‘margin requirements’ in
removing this gap. (CBSE Foreign 2015)
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