Chapter 7 - 11 (Macro Economics) - Chapter Notes ( Part -2) - Commerce PDF Download

AGGREGATE DEMAND (AD)

MEANING :: It refers to sum total of demand for all goods and services in the economy as a whole during accounting year
It is also defined as total expenditure that the residents of country are ready to incur on consumption and investment of domestically produced goods and services in an accounting year

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SPECIAL POINT :: AD is different from market demand as market demand refers to demand for one commodity in the market                                                                                                     ____________________________

BEHAVIOUR OF AGGREGATE DEMAND

(1) For survival there must be some minimum consumption or demand, hence AD is always positive (Rs.120 cr) even if income is zero (Y=0) .AD curve starts from intercept on y-axis ( point “A”)
(2) AD curve is upward sloping that is it increases with increase in income

(3) After a particular level of income is reached rate of increase in expenditure(demand) is less than
increase in income. Income increases by 100 cr and AD by 60 cr

MEASUREMENT OR COMPONENTS OF AD

AD is defined as total expenditure on goods and services in an economy in an accounting year

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 AD = C + I + X- M + G

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It is measured by considering following components
(1) CONSUMPTION (C) :: It is generally done by household sector and depends upon personal disposable income of the consumers i.e C = f (Y).
Consumption is always positive even if income is zero (Y= 0) as for survival there is minimum consumption this makes AD also positive at zero level of income and at higher level of disposable income , higher is the private consumption expenditure
(2) INVESTMENT (I) :: Investment is part of saving which is used for further production or creation of new capital assets. It is defined as addition to the stock of physical capital ( such as machine , building, roads ) and change in inventory.Thus Investment adds to future productive capacity of the economy and is referred to as Capital Formation .

Induced invest. which is done by privates players and is related to level of income
depends upon

(i) Marginal efficiency of capital
(ii) Rate of interest

(3) NET EXPORT (X - M) ::
Export are foreign’s demand of country production. It increases AD and hence added.
On other hand import are country’s demand of foreign goods, it decreases AD of economy and hence substracted

(4) GOVERNMENT EXP. (G) :: It refers to govt. planned expenditure on purchase of consumer and capital goods to fulfill common needs of the society. These investment are not related to level of income and are called autonomous investment.
Exp. are incurred on following heads
(a) Public Welfare like health , education
(b) Public Work like roads,dams, bridges,park
(c) Subsidies like given to exporters , farmers
(d) Exp. on maintenance of Law ‘n’ Order and on defence purposes

AGGREGATE SUPPLY (AS) :: Aggregate supply refers to flow of goods and services or total value added in an economy in an year.Since we know that net value added at factor cost is equal to income generated,hence AS is measured or estimated as sum total of consumption and saving.

BEHAVIOUR OF AGGREGATE SUPPLY

(1) AS curve starts from origin which means no production at zero level of employment
(2) AS is upward sloping with 450 which means that AS increases or decreases in same
proportion to increase or decrease in income and employment
(3) AS can be increased
(a) by additional utilisation of existing resources
(b) By technological improvement.
As Keynes theory is a short period analysis, he assumed technology to be constant in short period.Thus output or AS can only be increased by increasing utilisation of existing resources mainly labour

(4)When existing resources get fully employed or in other words Full employment level is reached,output cannot be further increased and this makes AS curve a vertical line parallel to y-axis.This situation arises beyond ‘OL’ which is a Full employment level

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 SIGNIFICANCE OF 450 LINE :: the 450 line starts from the origin O. Since the vertical and horizontal axis have the same scale, the 450 line has the property that at any point on it, the distance up from the horizontal axis exactly equals the distance across from the vertical axis.

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FULL EMPLOYMENT :: It refers to a situation when every able person who are willing to work at the prevailing wage rate gets work. Thus in other words it means a situation in which at a given level of real wage, demand for labour is equal to available supply

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SPECIAL POINT :: The concept of Full Employment is explained only in the context of
‘LABOUR FORCE’, i.e. working population and not the total population { It means,
children and old persons will not be considered }

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FULL EMPLOYMENT DOESN’T MEANS ZERO UNEMPLOYMENT

REASON :: A s there is always natural rate of unemployment known as Frictional and Structural unemployment
(1) FRICTIONAL UNEMPLOYMENT :: It refers to temporarily unemployment due to

(a) Imperfection of labour market like time required by workers in shifting from one job to another
(b) Shortage of raw material
(c) Lack of information about employment opportunities.

(2) STRUCTURAL UNEMPLOYMENT :: It is temporary unemployment due to time required in adjusting to changes in the economy.It is related with structural changes like
(i) shortage in FOP(labour capital)
(ii) Change in nature of goods to be produced and change in technique of production
(iii) when labour are trained in old and decaying industries and are ill - equipped for
new emerging industries
INVOLUNTARY UNEMPLOYMENT :: It refers to a situation when every able person who are willing to accept job at prevailing wage rate does not gets work .
It may be identified as that of open unemployment
It is generally caused due to deficiency of AD and hence can be removed by
raising level of AD in an economy
Only involuntary unemployment is considered in estimation of total unemployment of
the country
VOLUNTARY UNEMPLOYMENT :: It refers to a situation when a able person is not willing to accept job at prevailing wage rate even when work is available e.g Qualified Housewife prefers to remain unemployed even they had job offers at existing wage rate.

Such type of unemployment is not considered in estimation of total unemployment of the country
 

NUMERICAL’S
(Q1) Given that national income is Rs. 80 crore and consumption expenditure Rs. 64 crore, find out average propensity to save. When income rises to Rs. 100 crore and consumption expenditure to Rs. 78 crore, what will be the average propensity to consume and the marginal propensity to consume ?

(Ans. 0.20; 0.78; 0.70)

(Q2) The consumption expenditure and investment demand are Rs. 600 crores and Rs. 300 crores respectively, when income is Rs. 1,000 crores.
Calculate : (i) AD, (ii) AS (iii) Saving.

(Ans. (i) AD = Rs. 900 cr; (ii) AS = Rs.1,000 cr; (iii) Saving = Rs. 400 cr.)

(Q3) Using the equation of consumption function : C = c + b(Y), calculate consumption expenditure at the income level of Rs. 500 crores, if autonomous consumption is Rs. 40 crores and 40% of additional income is saved.

(Ans. Consumption Expenditure (C) = Rs. 340 crores)

(Q4) The saving curve of an economy makes a negative intercept of Rs. 50 crores and 20% of additional income is saved. Derive the saving and consumption function.

(Ans. S = - 50 + 0.2 (Y) ; C = 50 + 0.8 (Y)

(Q5) On the basis of consumption function : C = 120 + 0.40 Y; answer the following questions :
(i) Derive the saving function.
(ii) Determine the saving at the income level of Rs. 250 crores.
(iii) At what level of income, saving becomes zero ?

(Ans. S = - 120 + 0.60 (Y); (ii) Rs. 30 crores; (iii) Rs. 200 crores)

(Q6) If MPC is one-third of MPS and consumption at zero level of national income is Rs. 40
crores, derive the consumption and saving function.

(Ans. C = 40 + 0.25 (Y) ; S = - 40 + 0.75 (Y)

(Q7) The consumption function for an economy is : C = 20 + 0.8Y (assuming amount in Rs. crores). Determine the level of income when average propensity to consume will be one.

(Ans. Rs. 100 crores)

(Q8) The break-even level of income for an economy is given to be Rs. 10,000 crores. If the economy saves 20 per cent of additional income, then calculate the value of autonomous consumption. (Ans. Rs. 2000 crores)

(Q9) Find change in saving when 2/3rd of income is always spent as consumption expenditure
and current income is 50% more than the initial income of Rs 50000 (Ans Rs 8333 )
 

Answer the following questions :
(i) Identify the break-even point.
(ii) Locate the equilibrium level of income.
(iii) Calculate MPS when income changes from Rs. 400 to Rs. 500.
(iv) Calculate APC at income level of Rs. 100 crores.
(v) Calculate APS at income level of Rs. 500 crores.
(Ans. 200, 400, 0.2, 1.2, 0.12)

(Q13) Find consumption and saving when C = 100 , MPC = 0.5 and Y = 2000 . Is there greater
increase in income as compared to consumption when income changes to 2500 .

( ans :: 1350 - 1100 = 250 )

DETERMINATION OF EQUILIBRIUM LEVEL OF INCOME
-- EMPLOYMENT--- OUTPUT

Equilibrium level of income /employment /output is determined where AD (level of desire spending or expenditure) is equal to AS (total output). Thus all that is produced in an economy have corresponding equal demand.
This situation is called equilibrium because
(a) Producer don’t suffer Burden of unwanted supplied that is unsold stock
(b) Producer don’t suffer Loss of unfilled demand due to lack of stock
(c) Planned Saving is equal to Planned Investment
Pt. ‘E’ is equilibrium point where

and “OY” is National income /Output / Employment which is 300 cr in our example

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CONCEPT OF AED (AGGREGATE EFFECTIVE DEMAND) :: It refers to level of output where AD = AS . Thus AED always corresponds to the equilibrium level of income / output in the economy
This is known as effective demand principle as equilibrium output is determined by the AD
( at a fixed price of final goods and constant rate of interest in the economy)

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ADJUSTMENT MECHANISM

NUMERICAL’S

(Q1) Find equilibrium S and I when Y = 4400 , MPC = 0.75 and C = 100

(Ans :: 1000 )

(Q2) S = - 25 + 0.5 Y and I = 5000 , find equilibrium Y and C at equilibrium level.

( ans :: 10050 , 5050)

(Q3) Given C = 400 + 0.9Y and I = 4000 , find equilibrium Y and S at equilibrium level.

( ans :: 44000 , 4000)

(Q4) Find national income if consumption function is 1000 + .67Y and investment is 200cr ?

(Q5) C = 50 + .8 Y and I = 50. find (a) equilibrium level of income
(b) level of consumption and saving at equilibrium

(Q6) C = 40 + .75 Y and I = 60. find(a) equilibrium level of income
(b) level of consumption and saving at equilibrium

(Q7) S = - 10 + .2Y and I = 3 + .1Y . What will be equilibrium level of income ?
(Q8) From the following find whether economy is in equilibrium or not I = 10 cr , C = 40 + .8Y
and Y = 200 cr

(Q9) Measure the level of ex-ante aggregate demand when autonomous investment and
consumption investment (A) is 50 crore and MPS = .2 and level of equilibrium is Rs 4000cr.
State whether the economy is in equilibrium or not ?

( Ans AD = 3250 , N0)

(Q10) Suppose in an economy C = 80 and I = 20 b = .8 . calculate values of Y and AD. state
whether the economy is in equilibrium or not ?

( Ans AD = 500 , Yes)

(Q11) Find out the level of ex-ante aggregate demand from the following information :
Autonomous investment = Rs. 25 crore
Autonomous consumption expenditure = Rs. 25 crore
MPS = 0.2
Level of income = Rs. 5000 crores
State, whether the economy is in equilibrium or not. Give reason for your answer.

(Ans. AD = Rs.4050 cr. , AD < AS, the economy is not in equilibrium)

(Q12) C = C0 + by and I = I0
(a) Find Equi.levelof income
(b) The change in income that result from an autonomous change in I0
(c) Value of multiplier

KEYNES VERSION

According to Keynes full employment is not a general feature of economy.There can be unemployment as it happened during great depression of 1929-1933. Keynes pointed out that Equilibrium level depends upon AD and hence there can be three situation

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(A) FULL EMPLOYMENT EQUILIBRIUM
It is a state of equilibrium where resources are fully employed .
In other words it refers to situation where AD = AS (equilibrium) is also level of full employment
In the diagram Equilibrium level (where AD = AS ) is at ‘E’ point i.e ‘OL’ level of employment and also
F.E.L = ‘OL’ level of employment

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(B) UNDER EMPLOYMENT EQUILIBRIUM It is a state of equilibrium where resources are not fully employed .
In other words It refers to situation where AD = AS (equilibrium) before level of full employment
In the diagram Equilibrium level (where AD = AS ) is at ‘U’ point i.e ‘OU’ level of employment where as F.E.L = ‘OL’ level of employment
Since ‘OU’ < ‘OL’ , there is underutilisation of resources of ‘UL’ amount.

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DEMAND MANAGEMENT POLICY :: This situation is being caused due to deficiency of AD which is less than full employment level of output .
Keynes suggested that to move economy out of this Under Employment Equilibrium to F.E.L there is need to increase government expenditure on goods and services.
This increase in expenditure will increases income of economy by multiplier effect and thus will raise AD. This increase in AD will cause increase in AS by equivalent amount without affecting price level.This process of increasing AD by government is called as Demand Management Policy

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(C)EQUILIBRIUM BEYOND FULL EMPLOYMENT :: There is possibility that of equilibrium even beyond full employment level.

It refers to a situation where AD exceed AS after F.E.L and since output / employment cannot be increased beyond F.E.L, Excess Demand put pressure on available goods and services and this makes Price to increase (inflation).

(Ques.) Does saving is equal to investment always ?
Ans. No ,saving is not equal to investment always.For this we have to understand different concept
of saving and investment.

In an economy actual saving and actual investment (ex-post saving and investment) are
always equal .Infact they are like accounting identity where S = I
But Planned saving and Planned investment are not equal always i.e may or maynot be equal
due to
(i) Savers and investors being different people in the economy
(ii)Both having different motive

Thus there can be three situation
(a) Planned Investment greater than Planned Saving (at level of income before equilibrium level
(b) Planned Investment less than Planned Saving (at level of income after equilibrium level )
(c) Planned Investment Equal to Planned Saving (at equilibrium level of income)

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Thus it can be concluded that it is only equilibrium level of income / output / employment where
Realised Saving = Realised Investment = Planned Saving = Planned Investment
Ex-post Saving = Ex-post Investment = Ex-ante Saving = Ex-ante Investment   _____________________________________