# Determination of Income and Employment

This page contains the NCERT Economics class 12 chapter 4 Determination of Income and Employment from Book II Introductory Macroeconomics. You can find the solutions for the chapter 4 of NCERT class 12 Economics, for the Short Answer Questions, Long Answer Questions and Projects/Assignments Questions in this page. So is the case if you are looking for NCERT class 12 Economics related topic Determination of Income and Employment question and answers.
Exercises
1. What is marginal propensity to consume? How is it related to marginal propensity to save?
Marginal Propensity to Consume (MPC): The Marginal Propensity to Consume refers to the ratio of change in consumption to the change in income. It indicates how much of an additional unit of income will be spent on consumption. Mathematically, it is denoted as,
MPC = {\dfrac{ΔC}{ΔY}}
where
ΔC is the change in consumption, and
ΔY is the change in income.
Relationship with Marginal Propensity to Save (MPS): MPC is intrinsically linked to the Marginal Propensity to Save. The MPS measures the ratio of change in savings to the change in income, essentially showing how much of an additional unit of income will be saved rather than spent. It is calculated as
MPS = {\dfrac{ΔS}{ΔY}},
where
ΔS is the change in savings.
The key relationship between MPC and MPS lies in their sum, which always equals 1. This is because any additional income is either consumed or saved. Therefore, if MPC is 0.8 (meaning 80% of additional income is spent), MPS will be 0.2 (20% of additional income is saved). This relationship is expressed as
MPC + MPS = 1.
2. What is the difference between ex ante investment and ex post investment?
The following are the differences between ex ante investment and ex post investment:
Aspect
Ex Ante Investment
Ex Post Investment
Definition
Planned or intended investment based on future expectations.
Actual investment that occurs, regardless of initial plans.
Nature
Theoretical, based on intentions and forecasts.
Real, based on actual outcomes and events.
Usage
Used in theoretical models and economic forecasts.
Used in economic analysis to assess real economic activities.
Realization
May not necessarily be realized as planned.
Measurement
Measured before the investment takes place, based on plans.
Measured after the investment period, based on actual investment.
Example
A producer plans to add ₹ 100 worth of goods to her stock.
Due to unforeseen demand, the producer ends up adding only ₹ 70 to her stock.
3. What do you understand by ‘parametric shift of a line’? How does a line shift when its (i) slope decreases, and (ii) its intercept increases?
Understanding ‘Parametric Shift of a Line’:
A parametric shift of a line in a graph refers to changes in the line’s position or orientation due to variations in its underlying parameters. It can be represented as a straight line using “the intercept form of linear equation” as
{Y = a + bX}
where
{b = \tan θ} is the slope and
{c} is the intercept on the vertical axis.
Changes in these parameters result in shifts of the line.
Shifts in the Line:
1.
When Slope Decreases (i.e., {b} decreases):
A decrease in the slope {(b)} of a straight line means the line rotates downward around the same vertical intercept {(a)}.
In practical terms, this means for each unit increase in {(X)}, the increase in {(Y)} is less than before. The line becomes flatter, indicating a less steep relationship between {(X)} and {(Y)}.
2.
When Intercept Increases (i.e., {(a)} increases):
An increase in the intercept {(a)} of a straight line results in the line shifting parallelly upward.
This shift means that for any given value of {(X)}, the value of {(Y)} is higher than before, regardless of the slope. The entire line moves up while maintaining its angle of inclination.
These shifts are crucial in graphical analysis, especially in fields like economics, where they can represent changes in relationships between variables, such as demand and price, or income and consumption. The slope and intercept parameters define the nature of these relationships, and their changes lead to shifts in the graphical representation.
4. What is ‘effective demand’? How will you derive the autonomous expenditure multiplier when price of final goods and the rate of interest are given?
Effective Demand:
Effective demand is reached when, at a particular price level, the aggregate demand for final goods equals the aggregate supply of final goods, leading to equilibrium in the final goods or product market.
It assumes constant prices and interest rates, and includes components like ex ante consumption and investment.
Aggregate output is determined by aggregate demand under these conditions, illustrating the principle of effective demand.
Autonomous Expenditure Multiplier:
The multiplier measures the effect of a change in autonomous expenditure on equilibrium income and output.
It’s calculated as
Multiplier
{= \dfrac{ΔY}{ΔA}}
{= \dfrac{1}{1 - c}}
where
{ΔY} is the change in output and {c} is the marginal propensity to consume (MPC).
A higher MPC leads to a larger multiplier, amplifying the impact of changes in autonomous expenditure on the economy.
5. Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure (A) is ₹ 50 crores, and MPS is 0.2 and level of income (Y) is ₹ 4000 crores. State whether the economy is in equilibrium or not (cite reasons).
To calculate the level of ex-ante aggregate demand and determine if the economy is in equilibrium, we follow these steps:
1.
Calculate Marginal Propensity to Consume (MPC):
MPS (Marginal Propensity to Save) is given as 0.2.
Since MPC + MPS = 1,
MPC
= 1 – MPS
= 1 – 0.2
= 0.8.
2.
Calculate Ex-Ante Aggregate Demand:
Ex-ante aggregate demand is given by the formula:
{\text{Aggregate Demand} = C + I}
where
{C} is consumption and
{I} is investment.
Consumption {(C)} can be further broken down into autonomous consumption plus induced consumption, which is dependent on income. So,
{C = \text{Autonomous Consumption} + \text{MPC} × \text{Income}}.
Given that autonomous investment and consumption expenditure (A) is ₹ 50 crores and assuming this entire amount is the autonomous part of consumption and investment, and with an income (Y) of ₹ 4000 crores, the formula becomes:
C = 50 + 0.8 × 4000.
Therefore, C
= 50 + 3200
= ₹ 3250 crores.
Since investment is part of the autonomous expenditure, the total ex-ante aggregate demand is also ₹ 3250 crores.
3.
Determine Economic Equilibrium:
Economic equilibrium occurs when aggregate demand equals aggregate supply.
In this scenario, as the aggregate supply (or income, Y) is ₹ 4000 crores, and the aggregate demand is ₹ 3250 crores, there is a discrepancy between supply and demand.
Since aggregate demand is less than aggregate supply, the economy is not in equilibrium. There is excess supply in the economy.
Reason for Non-Equilibrium:
The reason for this disequilibrium is that the level of output (or income, Y) is higher than what is demanded at the current level of aggregate demand.
This situation typically leads to a buildup of unsold goods, prompting producers to reduce output, which could eventually move the economy towards equilibrium.
In summary, with the given parameters, the economy is not in equilibrium due to a mismatch between aggregate demand and aggregate supply, indicating excess supply in the market.
Definition: The Paradox of Thrift is an economic theory which posits that when everyone in an economy decides to increase their savings simultaneously, the overall savings in the economy may not increase as expected. Instead, this collective action can lead to a decrease in aggregate demand, resulting in reduced income and production. This paradox highlights the unintended consequences of individual saving behaviors on the broader economy.
It can be further explained as follows:
1.
Increased Savings Intention: When all people in an economy increase the proportion of income they save, the marginal propensity to save (mps) of the economy increases.
2.
Unexpected Outcome: Contrary to what might be expected, the total value of savings in the economy does not increase as a result of this collective increase in savings. Instead, it either declines or remains unchanged.
3.
Reason for the Paradox: This seemingly impossible result is actually a straightforward application of the economic model discussed in the document. The paradox arises because of the interconnected nature of income, consumption, and savings in an economy.
4.
Decrease in Aggregate Demand: As people save more, they spend less, leading to a decrease in aggregate consumption spending and hence in aggregate demand.
5.
Economic Consequences: This decrease in aggregate demand leads to an excess supply in the economy, causing producers to reduce production. This reduction in production results in a decrease in income and further reductions in consumption and aggregate demand.
6.
Convergent Process: The process of decreasing production and income continues, but it is convergent, meaning the effects become smaller in each successive round.
7.
Final Equilibrium: Despite the initial intention to save more, the total value of savings in the economy remains unchanged or even decreases, demonstrating the Paradox of Thrift.