Determination of Income and Employment Class 12 Economics

Aggregate Demand and Its Components

Consumption

• The demand for goods and services that are utilized by individuals for day-to-day consumption in an economy is referred to as consumption.
• Household income plays a crucial role in determining consumption. Generally, an increase in income results in an increase in consumption expenditure, while a decrease in income leads to a decrease in consumption.
• A consumption function is used to describe the relationship between consumption and income. The simplest form of a consumption function assumes that consumption changes at a constant rate in response to changes in income.
• Several significant terms are associated with the Consumption Function:
• Autonomous Consumption: This represents a certain level of consumption that takes place even when income is zero. This level of consumption is independent of income and is thus referred to as autonomous consumption.
• Induced Consumption: This refers to the portion of consumption that changes with disposable income.
• Consumer Demand is the sum of Autonomous Consumption and Induced Consumption.
• Marginal Propensity to Consume (MPC): This refers to the change in consumption per unit change in income. The MPC ranges between 0 and 1, which means that either the consumer does not increase consumption at all (MPC = 0) or uses the entire change in income on consumption (MPC = 1) or uses part of the change in income for changing consumption (0 < MPC < 1).
• Marginal Propensity to Save (MPS): This refers to the change in savings per unit change in income.
• Average Propensity to Consume (APC): This refers to consumption per unit of income.
• Average Propensity to Save (APS): This refers to savings per unit change in income.

Investment

• Investment refers to the increase in the stock of physical capital (such as machines, buildings, roads, etc.) that enhances the future productive capacity of the economy, and also includes changes in the inventory (stock of finished goods) of a producer.
• Investment goods, such as machines, are considered final goods, unlike intermediate goods like raw materials that are utilized in the production process.
• Producers are responsible for making investment decisions, which are predominantly influenced by prevailing market interest rates.

Determination of Income

• Income refers to the money earned or received by individuals or businesses, typically on a regular basis, from work, investments, or production activities.
• National income can be calculated by adding up all the income earned by individuals, firms, and governments from various economic activities. The term "output" can be used interchangeably with income.
• Aggregate demand plays a crucial role in determining income. It is calculated as the sum of consumption expenditure and investment expenditure on goods.
• However, government economic activities, such as taxation (T) and government expenditure (G), also affect the aggregate demand for final goods and services.
• Like households and firms, the government adds to aggregate demand through its expenditure on final goods and services.
• Conversely, taxes imposed by the government reduce households' disposable income, decreasing their induced consumption expenditure.
• Therefore, income can be determined by adding autonomous consumption, autonomous investment, government expenditure, and induced consumption after taxes (Income – taxes).

Equilibrium 

• Market equilibrium occurs when the aggregate demand is equal to the aggregate supply, resulting in a balanced situation in the market.
• Aggregate demand refers to the demand for all finished goods and services produced in an economy, while aggregate supply refers to the total supply of finished goods and services available in an economy.

Investment Multiplier

• The investment multiplier is the ratio of the change in national income to the initial change in planned investment expenditure.
• The investment multiplier of the economy is also defined as the ratio of the total increment in the equilibrium value of final goods output to the initial increment in autonomous expenditure.
• For example, if a change in investment of Rs 2000 results in a change in national income of Rs 8000, then the multiplier (8000/2000) is 4.