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The document discusses the concepts of Aggregate Demand and its components, contrasting Classical and Keynesian theories of income and employment. It covers topics such as consumption, savings, and investment functions, along with their derivations and implications for national income. The document also includes numerical examples and illustrations to explain these economic principles.
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0% found this document useful (0 votes)
50 views47 pagesAggregate Demand
The document discusses the concepts of Aggregate Demand and its components, contrasting Classical and Keynesian theories of income and employment. It covers topics such as consumption, savings, and investment functions, along with their derivations and implications for national income. The document also includes numerical examples and illustrations to explain these economic principles.
Uploaded by
SanchithaaCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
/ 47
Determination of Inco
6. Aggregate Demand and Its component
Ss
7. Income Determination
8. Excess Demand and Defice Ree
me and Employment
ficient Demand: Meadihg and Correction
Aggregate Demand and
Its Components
nt
Topics to be Covered
« Introduction
+ Classical Theory vs. Keynesian Theory of Income & Employment
+ Aggregate Demand and its components
« Aggregate Supply
+ Consumption: Meaning and derivation
+ Savings: Meaning and derivation
« Investments: Meaning and components
+ Concept of propensity to consume
* Concept of propensity to save
«+ Numerical Questions
INTRODUCTION
We have studied in class XI that Macroeconomics is a s
economy as a whole. In this subject matter, aggregate cot
national ingome and employment. It is because of this reason
National Income and employment Theory,
There are different schools of it_ who have resea
national income and employment. The most prominent one
and Keynesian Si ought. This chapter discusses
Employment and related approaches.
CLASSICAL THEORY Vs. KEYNESIAN THEORY or 100 Q Mentor in Beonomies-XI1
CLASSICAL APPROACH
full employment.
. ;
According to this approach, economy always operates on, f2_ OT
* Neither there is underutilisation nor overutilisation of resources. iit
. a aE Wai fi its own
Supply is the driving force'in the economy and it the supply which creates OS Ow demang
;
(PSay, termed as Say’s Law) Says law *
KEYNESIAN APPROACH
a3. * Beonomy may or may not operate at the level of full employment: im
He.4* There ig a possibility of underemployment or overemployment in the economy:
>_> Demanil'is the driving foree in the economy.
This the demand which creates its own supply. E does
Keynesian Approach seems to be mor€ re Therefore, this chapter discusses in detay
concepts that revolve around Keynesian School of Thought Be
According to Keynesian Theory, igate Demand and AE Tate tools of
determining nétional income and émployment=Let us discuss the concept Demand
AGGREGATE DEMAND AND ITS COMPONENTS
D)*| Ae he total vali 1 goods and services that all the sectors
y | Aggregate Demand refers to the total value of fina ll ine
“of the economy are willing and able to buy at a parti
period of one accounting year:
© There are four sectors in the economy namely:
= Households: Expenditure done by households is called as Consumption
_ Firms: Expenditure done by firms is called as Investment.
~ Government: Expenditure done by government is called as Government Expenditure
— Rest of the World: Expenditure done by rest of the world
‘Total value of final
goods and services that
‘ALL THE FIRMS are
willing and able to
invest at given ineome
during a given period
{Total Value of final
| mods and serves
that ALL THE
| HOUSEHOLDS are
willing and able to
buy at a given income
{aoiee. a given period
of time,
Aggregate Demand is the
economy, Aautregate Demand and tts Components © 101 ,
AD =
Cay
G
for detailed underst a |
yer Jone) of
fo" qgsumptions: the Keynesian School of thought, we will make
cind "gro dnly two sectors j
We roa ECT etthe econo ;
re ‘efore, AD = C41 omy: Households and Firina,
eral price 1
to
UPPLY
nding «
vel in the econon
MY remaing
constant
nt 1 value of final
A 9 total value of final goods aid seq
pis . producers in the economy ary ‘bua that
a" sell at @ given income during q Biot and
ane ocounting year) Period,
fy crcular flow of income
, per ‘ model, valu
+ san eal 1 income generated, Thera,
re of production is AS and income generated Ke
a a by Y. Thus, AS = Y,
een ly Cr is oi
ate Supply ‘urve is a 45° line which
+ AB origin. It implies that each and every ae
e is equidistant from horizontal and vertical
National
Income (Y)
sso
ae
_gsSUMPTION
» uneferst0 the total value of final goods and services that ALL THE HOUSEHOLDS in the
onary are willing and able to buy at a Siven income during a given period of time.
. Astmomous Consumption
-Itis the basic or minimum level of consumption
zero level of Income. rm z
-Itis denoted by “Ca”.
+ Induced Consumption
-This component is dependent on the income in
-As income increases, consumption also increase
"nes Paychologeal Law of Consumption
-Itis denoted ano"
Where, ve
\
— ey 102 Q Mentor in Keonomies-XII fy
This is called as Consumption Fun It is the functional relationship etieg,
consumption and various factors affecting WwW
ILLUSTRATION
State the Consumption Function
consumption at zero level of inco:
‘income is consumed.
Solution:
In the given Question,
2.500 Crores is the value of Autonomous Consumption and MPC is 0.70.
Therefore, C = 500 + 0.70 Y
ES ae
DIAGRAMMATIC REPRESENTATION OF CONSUMPTION FUNCTION
cc
of an economy when the minimum level 4
me is ¢ 600 Crores and 70 percent of increase!
‘* At zero level of income, there is some minimum level
of consumption that is required for basic survival
called as autonomous consumption. Therefore,
consumption curve starts from a positive point on
Y axis,
* As income increases, consumption also increases.
Therefore, consumption is an upward sloping curve,
* Since the slope of consumption curve is “b” which is 7
assumed to be constant, therefore, itis a straight line,
Note: When consumption curve shifts parallel upwards or downwards,
of consumption curve remains the same,
y
SAVINGS AND SAVINGS FUNCTION
* Savings is the residual income after consumption.
* Savings Function is the functional relationship between Savings
* Derivation of Savings Function
As we know, that Income of consumer is either(Gonsumed or &
+ This means, ¥=0'+8 Brak
+C=Ca+ bY (Consumption function/equation) ~
SS =%~ Oe
>S8=Y-(Ca+5Y)
3s Y
» IP
7S=-Ca+(1-b)¥ (Savings Equati
* Where, (1-Dyis« calls as Marginal Propensity to Save (MPS)
* MPS is assumed to be constant
[Ries_* mpc =]
\ °
a ‘Aggregate Demand and Its Components 2 103
20| we
jLLUSTRATION
ed on the information given below, answer the following parts:
‘autonomous Consumption is ¥ 1000 Crores, ratio of change in consumption to change in income
js 0.50
(a) Derive the Consumption Funetion
) Calculate the value of MPS
(o Derive the Savings Function '
solution:
(a C= 1000 +05 ¥
(b) MPS = 1-MPC = 1 - 0.50 = 0.50
= (-) 1000 + 0.50 Y
)S
| @
DERIVATION OF SAVINGS FUNCTION FROM CONSUMPTION FUNCTION
is s eae a is some minimum level of consumption that is required for
51, basi autonomous consumption. This is done out of past savings. Therefore,
os curve starts from a negative point on Y axis. -
.
. A c
ame ieee DERIVATION OF CONSUMPTION FUNCTION FROM SAVINGS FUNCTION
At zero level of income, there is some
minimum level of consumption which is
required to be done from the past savings.
This consumption is meant for basic survival
Therefore, consumption curve starts from a
positive point on Y axis,
C=Ca+by
‘National
A
As income increases, consumption also caf
Y Income (Y)
increases, Therefore, consumption is an
upwards sloping curve.
Since the slope of consumption function is $=-Ca+ (Loy
& (MPC) which is assumed to be constant.
Therefore, it is a straight line. B
As long as $< 0,C >Y -ca{|
* When, $ = 0, C= ¥. This is called as Break-
Even Point.
* As long asS>0,C i8 assumed to be constant,
qherefore, AD is a straight line,
AD and consumption curves are parallel
to each other. The gap between them is
jnvestments which by assumption are Ca+ Ia ed
constant or autonomous in nature,
National
MP to Income (¥)
propENsITY TO CONSUME
nsity Means proportion. Propensity to consume refers to the proportion of income that
ies into consumption.
«+ Ttis of two types: ,
_ Average Propensity to Consume (APC)
eitis = ratio of consumption to income at a-pazticular point of time.
+ APC = ; 7
_ Marginal Propensity to Consume (MPC)
+ tis the ratio of change in consumption to change in income over a period of time.
Ac
po = 42
aya ar moras f: aa
Fat, Nalues ot APG Sug 7 Ea
apc=l ‘When consumption is equal to Income or at break-even point
APC>1 When consumption is greater than income or when there is dissavings
ape<1 ‘When consumption is less than income or when there are savings
APC can never be This is because consumption, can never be zero. There is positive level
equal to zero of consumption even at zero level of
APC is equal to This happens at zero level of income
infinity minimum level of consumption
‘This is because consumption is alv
iris taaienanen chatire
é Phausetia nie foes iatoanc
| MPC<0 z ‘This is not possible because
‘income can never be negative AN8-O Mentor in Reonomice-X11 ; Vv
PROPENSITY TO SAVE
* Propensity means proportion. Propensity to save refers to the proportion of income that gy,
into savings
* Tt is of two types
~ Average Propensity to Save (APS)
* It is the ratio of savings to income at a particular point of time.
+ APS
~ Marginal Propensity to Save (MPS)
i riod of time.
* Tt is the ratio of change in savings to change in income over a Pe
+ ups - SS
ay
APS = 1 Dee. Lae a
income or consumption can never be zero.
APS >1 ‘This is not possible because savings can never be greater t
income ‘ IY oan
APS <1 This is possible when eee “a
APS <0 consumer is dissaving. ;
APS can be equal to Th hg teh en pt we Savin =e
zero consumption is equal to income. res
Values of MPS
MPS = 1 //, This happens when change in savings is equal to change
income or change in consumption is zero.
MPS =0 This happens when entire change in income goes into
a GENS
MPS <0
—=REEATIONSHIP BETWEEN APC AND APS
_—_a———E—E—E Nae AND APS
* As we all know, Income is either consumed or saved,
* Therefore, Y=C +8 c
* Dividing both the sides by Y
RELATIONSHIP BETWEEN! N IPC AND MPS
* As we all know, Income is either consumed or saved.
* Therefore, Y=C +S Ricci: ue eminent iF 2)
Agaregate Demand and ft Components Q 107
et initial situation be, Y, =, g
inal situation be, Yy= 0, 4g)
k gubtracting Final and Thitial Valueg y c,+3,
¥)- = (y= 0) 418, 8)
1
+ Oo
faye dc +a8 : te
siding both the sides by AY " :
o pire | as :
eta (! y, £ eee
1* MPC + MPS: ‘ % ‘ ‘
_- tea pre x bt +
° -
1. Assuming that income where APC = (BY
crores, answer the following aah 1 is & 5500 Crores and autonomous consumption as % 500
ions:
{@) Derive the savings function
(b) Value of MPC er 2
(0) Derive Aggregate Demand Function,
2, IFMPC : MPS in the economy is 2; 3, total i
£1550, answer the following cua vestments are € 1000 andl autonomous consumption i
(a) Write the Savings Function
(b) Write the consumption function.
(0) Estimate the income level at break-even point
(@) Write the Aggregate Demand Function,
3. If an economy 30% of the increased income is saved, minimum level of consumption required for
basic survival is € 100 Crores, total investments are % 500 Crores, answer the following questions:
(2) Value of MPC
(b) Write the consumption Function
(©) Write the Savings Function
(@ Estimate the equation for Aggregate Demand.
4, If consumption function in the economy is C = 40 + 0.
the following questions:
(a) Value of MPS
| () Wile the Savings Function
(0) Write the Aggregate Demand Function,
5. If C= 150 + 0.6 Y, estimate the value of income at a
6. Determine the level of ex-ante aggregate deman:
component is % 1250 Crores and level of income is
7. Complete the following table:
4 108 Q Mentor in Beonomics-XIT
|
8. Complete the following table if
(a) Dissavings at zero level of income is © 1000 Crores
| (b) Break-even level of income is © 2500 Crores:
Income Consumption Savings APS
0 z ? i
> ? 375
2500 e ?
4000 2 2
9. Complete the table as follows:
Income Consumption savings MPC
2 40 cae ee
50 2
100 2 Ineo Determinati
multip Itiphier on and
—peante and Bx-Post Variables
+ Approaches to determine Equilibrium f
- AD-AS Approach ies
- IS Approach |
«Investment Multiplier
me and Employment
INTRODUCTION /
y now, we have understood that
» Agreste Demand is an upward sloping straight line which starts from a positive point on
ei Sy Sua ene eg
+ aagregate Supply Supply is an upward sloping straight line starting from m origin and makes an
angle of 45°
« Both AD and AS will be used to determine the equilibrium income and employment.
But before we begin, we need to understand the nature
discussed.
bee
EX-ANTE AND EX-POST VARIABLES
ean TN reed
ExAnte means Planned « Ex-Post,
Ex-ante savings refers to the savings planned by Ex-post
the household for the given year. Itis also called made
planned savings.
Exante investment refers to the amount of me
investment planned by the producers in the
Fe he ee eee Weis
‘ggregate Demand at equilibrium level of income is called 110 Q Mentor in Reonomics:X11 my
APPROACHES TO DETERMINE EQUILIBRIUM INCOME AND EMPLOYMENT
HI jod that
In order to determine equilibrium income and employment, it must be understo vat all the
variables in analysis are Ex-Ante (planned) in nature.
‘There are two approaches of determining equilibrium
* AD-AS Approach, A ie
* 1S Approach,
AD-AS APPROACH [AD 3
shere Ex-Ante AD and Ex-ante AS are equal to each they
According to this approach, the point wl
it gives us equilibrium income and employment.
* Case 1: If AD > AS. me
— Tt refers fo a situation where planned spending by all sectors is more than the pl
level of output produced. ;
— There will be decrease in planned level of inventories
~— Producers will therefore, react by increasing the prodi
En tors of production. 4
They will employ more factors of pro put and income till the time AD =AS,
juction process.
— ‘Thus, there will be increase in employment, out
* Case 1fAD § (that is, AD > AS)
cor oat that planned spending by all sectors is more than the
Jt me will be decrease in planned level of inventories
_ THe ors Will react by inereasing the production process
Proll employ more factors of production
qs; there will be increase in employment, output a
- TN 11 <8 (that is, AD < AS)
+ C+ ors to. situation when planned spending by all sectors is Tess
planned level of output
ind income till the time 1=8(AD =AS).
than the planned level
ofoutput Ons
ore will be increase in planned level of inventories |
~ Ther cers will react by decreasing the production process. ;
Pr will employ less factors of produetion/remave some factors of production: | 5, _ se
~ qqrus, there will be decrease in employment, output and income till the time I= S
5 A EN
MENT MULTIPLIER Py) (Zz
sis the ratio of change in income due to change in investments in the economy.
* jpis denoted by K ‘
three formula: o? F
gett peecades 73)
s 1 eeu Pe “a
ei a Ay!
a SRA aS 5
-K- 5S Mes ee
DZ
« There exists an inverse relation between MPS and K
| there exists a direct relation between K and MPC
{since value of MPC ranges from 0 to 1, therefore, value of K ranges from 1 to infinity. (Put
the values of MPC and check for the values of K)
WORKING OF INVESTMENT MULTIPLIER
ee
« Assumptions
Zone person's expenditure is another person's income in the economy.
“_ MPC is assumed to be constant and is equal to 0.5
{If some value of MPC is given in the question, then use that parti
«+ Process
-let us assume that government has done some initial investm:
£1,000 Crores,
~ Investment done by the government is somebody's income. Ther
change in income is also 1000, The person will consume a part of
save the rest,
Person will consume (AC) MPC of AY that is 0.5 of 1000 which.
rest, i
~ Consumption done in the first round is someone's expenditure
become someone's income, ~ The part of changed income will again be consumed and saved.
— This process goes on till the time Sum of Change in savings becomes equal to initia
in Investment,
Rounds AL (Change in. AY (Change in
Investment) Tneome)
rt
2
3
| 4
‘ ‘Total A,
=2)
Thus, change in income = € 2,000 crores, Excess Demand and
Deficient Demand:
Meaning and Correction
Topics to be Covered )
De neroduction
«Types of Unemployment
+ Concept of Full employment
«+ Full employment Equilibrium
«+ Underemployment Equilibrium
+ Overemployment Equilibrium
+ Correction of Excess Demand and Dench Demand using Monetary and Fiscal policy
INTRODUCTION /
Jn the previous chapter of this unit, we have studied how tools of aggregate demand and
aggregate supply are used to determine the equilibrium national i
According to Keynesian school of thought, full emplovment of
and every econo! to achieve the same. However, in actual,
economy may or may not operate at full employment
This chapter will therefore, discuss in detail the situations
at fall employment level and what steps are initiated by the
correct such situation. ee 77
‘TYPES OF UNEMPLOYMENT
Each and every economy aims to provide employment to all i
ensure optimum and full utilisation of resources.
FULL EMPLOYMENT.
It refers to a situation where a
ets the job. Income at this level is
Unemployment can be defined in two ways:
* Voluntary Unemployment: It refers to a situation
Yee not willing oS 5S
ss caiee fii 114 Mentor in Bconomies-XIt
.
Invotuntary Unemployment: It refers to a situation where a person is willing ang
to work but fails to get a job at a given wage rate. “
Full Employment in an economy does not mean that there es rere Cymer Mt
‘economy is in a state of full employment, there will still be people who are.vol
According to Keynesian School of Thought, each and every economy tries to achieve the
of full employment. But there is always a possibility that an economy may or may not ‘
operate at full employment. \
As a result, following possibilities may exist: BS Yai
* Yf-= Ye (Full Employment Equilibrium) i % : ze
* Yf> Ye (Underemployment Equilibrium) es
* Yf< Ye (Overemployment Equilibrium) 4
Note: Ye refers to the level of equilibrium income prevailing in the economy. Which oceuy
at a point where AD = AS or1=S.
FULL EMPLOYMENT EQUILIBRIUM
+ Full_-Employment equilibrium refers to aD, AS
that level of income where AD = AS at full
employment. ie
@ In such a situation, there is complete absence
of involuntary unemployment.
« IAD further rises, it will then lead to increase
in price level because output cannot be
increased beyond this point.
Full employment equilibrium is shown as point
E in the diagram where Ye = YE
UNDEREMPLOYMENT EQUILIBRIUM
«© It refers to a level of income where AD = AS at income level which lies before
employment level. ’ ae
© That is, Ye < YE
+ Underemployment equilibrium leads to AEFG in the diagram.
National
Yo) sx Income (¥)
+ In this AEFG, AD < AS corresponding to full employment level.
* This leads to a situation called as DEFICIENT DEMAND.
* The gap (FG) which emerges due to deficient demand is called as DEFLATIONARY GAP. OSS Demand and Deficient Demand: Meaning and Correction (115
Reasons for Deficient Demand
potdient Demand occurs due to Various fhctors like:
‘ ase in propensity to consume
Impact of Deficient Demand
+ It will lond to decrease in planned level of
output
increase in rate of taxes
. * Tt causes involuntary unemployment
ise in govern "
» Decrea: ment expenditure © It leads to deflation that is, fall in general
iis price level. =
. Fallin investment expendi saa
Frespected rate of retumna cue Of
«Rise in imports
ine in exports
ovEREMPLOYMENT EQUILIBRIUM
| Ie refers to a level of income
employment level,
« That is, Ye > YE.
« Overemployment equilibrium leads to AEFG in the diagram. vy x Hi
where AD = AS at income level which lies after the full
« In this AEFG, AD > AS corresponding to full employment level.
« This leads to a situation ealled as EXCESS DEMAND.
eae
« The gap (FG) which emerges due to excess demand is called as INF
rise in expected rate of returns
* Palin imports ise in exports al
ae ~ 6 O Mentor in Bconomics-XIt
DIFFERENCE BETWEEN EXC
S DEMAND AND DEFICIENT DEMAND
Excess Demand Deficient Demand %
Tt refers to the situation where AD is more than Tt refers to the situation where AD is less thag
AS corresponding to full employment level. [AS eorrespondling to full employment evel,”
Tt leads to Inflationary Gap Tt leads to Deflationary Gap
Tt indicates Over employment equilibrium It indicates Underemployment equilibr
Tt occurs due to excess of anticipated Tt occurs due to shortage of anticipated
expenditure like rise in consumption, coxpenditure like rise in consumption, ©
; investments eto. investments ete.
Tt does not affect the output and employment It Jeads to fall in output fa employment ¢
as economy is already operating at full to shortage of aggregate demand. —
employment level.
Tt leads to inflation, that is rise in general price
level
DIFFERENCE BETWEEN INFLATIONARY GAP AND DEFLATIONARY GAP
Inflationary Gap Deflationary Gap ee |
: 2
It refers to th which actual aggregate __It refers to the gap by which actual agere
aesale Set fall employment level demand falls short of AS at full employment
level.
Tt does not affect the output and employment __It leads to fall in output. and employment 4 4
as economy is already operating at full to shortage of aggregate demand.
employment level. 3
It leads to inflation, that is rise in general price It leads to deflation, that is, fall in general
level level.
CORRECTION OF EXCESS DEMAND AND DEFICIENT DEMAND.
Economic scholars have always been of the view that if economy deviates from the 1
full employment, some policy measures should be initiated to correct the situations of
demand and deficient demand.
Now, since according to Keynesian School of thought, Aggregate Demand is the driving
in the economy becauss eat i the-dasnand which creates _its own supply. Therefore, in o1
correct the deviations{ policy instruments Will be used to target aggregate demand.
Lika a
AD, oA : AS=Y
AD, AS
FW Me National
Bedewe Income (¥) Yo Yf= Ye
Correction of Excess Demand Correction of Deficient Demand
(Reduce Aggregate Demand) (Increase Aggregate Demand) Excess Demand and Dofelont Demand: Meaning and Correction 117
economy formulates two types of policies namely:
etary. Yan ‘
+h ypis formulated by (
prod
Central Bank of the country.
~ objective of monetary policy is to correct the deviation by making changes in Money
supply
yiscal Policy
+t jp formulated by Central Government of the country.
_-onjective isto bring changes in purchasing power in the economy by{altering the Revenue
and Expenditure components of the government,
_gNONENTS OF MONETARY POLICY
a Instruments of Money oly aed it
(uaitative Instruments of Monetary despre
1. Repo Rate and Bank Rate
« Repo Rate is the rate at which commercial bank
term period.
« Bank Rate is the rate at which commercial bank takes loans from ct
riod.
Repo Rate/Bank Rate
Central Bank | >
‘To decrease Money Supply (Correct Excess
Demand)
+ RBI increases Repo Rate/Bank Rate
| + Reduces ability of commercial banks to take
loans
| + Also, they will increase the lending rate
| * Public will take less loan
+ Reduees the Money Supply and so thus, AD | | + Increases the Money S
2.Reverse Repo Rate
b 4 the rate at which commercial banks-park their excess savi
nk, “~
118 Q Mentor in Beonomics-XI1
* The rate of interest received by commercial bank is called as reverse-repo.rate,
‘Ty increase Money Supply:
(Correct Defieiont Demand)
‘+ RBI decreases Reverse Repo Rate
Decreases ability of commercial banks to
rive loans to central bank
‘To decrease Money Supply
(Correct Excess Demand)
* RBI increases Reverse Repo Rate
* Tnerenbes ability of commercial banks to
« Klos they wl ve eas eure thule || ¢ Alt her il ana a ES ay
hands to give as loans to general public hhands to give a8 bes " Sea
* Reduces the Money Supply and eo thus, | | * Inereases the Money Supr! iy
AD oo
3. Open Market Operations
* Tt refers to buying and selling of government securities
public and commercial banks. penal
* To increase the money supply or to correct Deficient Deman y
— Central bank will “ the securities from general public and commercial banks.
~ This will increase the cash balances and money supply in the economy.
— It will increase deposits with banks and so thus, AD.
* To decrease the money supply or to correct Excess Demand
— Central bank will sell the securities to general public.
~This will decrease the cash balances in the economy
— It will decrease deposits with banks and so thus, AD.
to/from central bank by g
4, Reserve Requirements
« All the commercial banks are required to keep certain amount of their deposits as
* Types of reserves are: Cash Reserve Ratio (ORR) and Statutary Liquidity Ratio (SLR). §
of the two makes LRR (Legal Reserve Ratio)
* To Increase the money Supply or to correct Deficient Demand
— Central Banks will decrease the reserve-requirements
~ This will leave more deposits with banks to be given as loans
~This will increase money supply in economy and thus, increases AD
* To decrease the money supply or to correct Excess Demand
— Central bank will increase the reserve requirements
~ This will leave less deposits with banks to be given as loans
~ This will decrease money supply in economy and thus, decreases AD
5. Margin Requirements
* It is the difference between value of loan taken and amount of collateral deposited.
ae rane
f
To increase the money supply: ‘To decrease the money supply:
(Correct Deficient Demand) (Correct Excess Demand)
| + RBI will decrease the margin + RBI will increase the margin
requirements requirements
* This will encourage public t take more * This will discourage public to take more
an Joan
* This will increase money supply and * This will decrease the supply
a monk and
therefore, AD therefore, AD "I mxcess Demand and Deficient Demand: Meaning and Correction Q 119
«, selective Credit Control
« Selective credit control implies conte
_ Amount of credit to be given
_ Purpose for which it is to be
‘al bank specifies the following for commercial banks:
given
« In order to correct the situation of excoss
credit rationing) on the
purposes for which the
demand, central bank put restrictions (introduces
credit extension capability of the commercial banks. It specifies the
creditfoan will be extended
In order to correct the situation of
extension capability of the commercial
the loan will be extended.
deficient demand, central bank relaxes the credit
I banks, It eases out the list of purposes for which
+ Moral Suasion
« Moral Suasion means central bank
follow the strategies and guidelines
supply.
¢ Itis the combination of persuasion and pressure that central bank applies on other banks
io get them act, in a manner wl ne with their policy. >
+ To correct the situation of excess demand, central bank advises, requests or persuades the
commercial banks not to advance credit for non-essential activities.
+ To correct the situation of Deficient Demand, central bank advises, requests and persuades
the commercial banks to advance credit for all types of essential and non-essential activities.
guides and issues guidelines for commercial banks to
issued by central bank regarding the control of money
cOMPONENTS OF FISCAL POLICY
+ Government controls the purchasing power in the economy through its fiscal policy
instruments,
+ These instruments alter the revenue and expenditure of the government which in turn,
affects the purchasing power and aggregate demand in the economy.
1. Taxes
+ It is the compulsory payment made by general public to the
* Taxes are of two types:
~ Direct Taxes
~ Indirect Taxes
| To increase the AD (Correct Deficient
Demand) 1
* Government will decrease the tax rate
* This will increase disposable income of
| general public
* Increase their purchasing power
| * Increase the AD 2. Government Expenditure
* Government incurs a lot of expenditure on various social welfare activities in the gg
* These activities involve health expenditure, education facilities, maintenance Of Lay,
order ete,
*AD=C+14+G4NX
‘To inerease the AD (Correct Deficient Demand) | | To decrease the AD (Correct Excess Demand)
* Government will increase the expenditure + Government will decrease the expenditure
|* Increase general purchasing power * Decrease general purchasing power
|» Increases the AD * Decreases the AD
3. Public Borrowings
* In order to cover its expenditure, government also borrows the amount from general
| To inerease the AD (Correct Deficient Demand) | "To decrease the AD (Correct Excess Demand)
| * Government repays back the borrowed + Government borrows more amount from the |
amount general public 8
* This increases the disposable income + This decrease the disposable income
| { This in tur, increases the purchasing power | | + This in turn, decreases the purchasing power
| + Increases AD + Decreases the AD
4. Deficit Financing
* It refers to the process of financing the deficits of the government.
* This is usually done by printing up of more currency in the economy.
| To increase AD (Correst Deficient Demand) ‘To decrease AD (Correct Excess Demand)
| * Government asks the RBI to print more * Government asks the RBI to withdraw
currency curreney from circulation
| + This increases the Money Supply * This decreases the Money Supply
| + Increases AD * Decreases AD
(Hints/Solutions to NCERT questions that are related to CBSE Class XII
1. What is marginal propensity to consume? How is it related margin:
save? 2 _
Ans. * MPC refers to the ratio of change in consumption to change in i
ge in income oy:
* MPC + MPS =1 er
* Ex-post Investment refers to the actual level of inves
3. Measure the level of ex.
‘tment in the economy. iS” Sa a aS
ent Dead ott Damian Menbing and Caren 772
50 + 0.8 (4,000)
250 crores INR
tn equilibrium
p =AS
3,250 # 4,000
‘Thus, economy is not in equilibrium
short Questions
Read the following news report and answer Questions on the basis of the same:
the Reserve Bank of India (RBD), eut Repo Rate to 4.4%, the lowest in at least 15 years. Also,
jx reduced the Cash Reserve Ratio (CRR) maintained by the banks for the first time in over
coven years, CRR for all banks was cut by 100 basis points to release © 1.97 laleh erores acrot
the banking system. RBI governor Dr. Shaktikanta Das predicted a big global recession and
