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When income increases by 10, consumption expenditure goes up by (0.8)10 since people spend 0.8 (= MPC) fraction of their additional income on consumption. Hence, in the next round, aggregate demand in the economy goes up by (0.8)10 and there again emerges an excess demand equal to (0.8)10.

Therefore, in the next production cycle, producers increase their planned output further by (0.8)10 to restore equilibrium. When this extra output is distributed among factors, the income of the economy goes up by (0.8)10 and consumption demand increases further by (0.8)210, once again creating excess demand of the same amount.

This process goes on, round after round, with producers increasing their output to clear the excess demand in each round and consumers spending a part of their additional income from this extra production on consumption items-thereby creating further excess demand in the next round.

In order to nd out the total increase in output of the nal goods, we must add up the infinite geometric series in the last column, i.e. 

10 + (0.8)10 + (0.8)210 + ……… ∝ 

= 10(1 + (0.8) + (0.8)2 + ……….. ∝} 

= 10/1 – 0.8 = 50 

The increment in equilibrium value of total output thus exceeds the initial increment in autonomous expenditure. The ratio of the total increment in equilibrium value of nal goods output to the initial increment in autonomous expenditure is called the output multiplier of the economy.

Ex-ante and Ex-post: 

Consumption, savings, and investment can be classified into Ex-ante and Ex-post variables. The terms Ex-ante and Ex-post have been derived from the Latin word. Ex - ante means planned or desired. Ex-post means actual or realized. In national income accounting, the variables such as consumption, investment and savings are considered as ex-post variables. The rate at which consumption, savings, and investment are presented in the ex-post sense.

Break-even point refers to that point in the level of income at which consumption expenditure becomes exactly equal to income and there is no saving. In other words, whole of income is spent on consumption and as a result, there is no saving.

It happens when income increases from low level to high level, it becomes equal to consumption expenditure at some level and that level is called break even point. Below this level of income, consumption is greater than income but above this level, income is greater than consumption.

This concept can be illustrated as follows. A hypothetical consumption and saving schedule is given.

From the data, 

we get, C = 400,Y = 500, ΔC = 50, ΔY = 100 

1. MPC = ΔC/ΔY = 50/100 = 0.5 

2. APC = C/Y = 400/500 = 0.8 

3. MPS = ΔS/ΔY = 50/100 = 0.5 

4. APS = S/Y = 100/500 = 0.2

(a) Multiplier of Kerala

K = \(\frac{1}{1-0.8}=\frac{1}{0.2}=5\)

Multiplier of Assam

K = \(\frac{1}{1-0.5}=\frac{1}{0.5}\)  = 2

In Kerala, ΔY = K x Δl

ΔY = 5 x 40 = 200 Crores

In Assam ΔY = 2 x 40

= 80 crores

(b) Multiplier denotes the relationship between investment and income. Increase in investment leads to increase in income.

1. False. AS curve will be still rising 

2. True 

3. True

(c) The consumption is a function of rate of interest

MPC = 3/4 = 0.75 

MPS=1/4 = 0.25 

K = 1/MPS = 1/0.25 = 4 

K=(ΔY)/(ΔI) 

→ ΔI = 8000/4 [As ΔY=20000-12000=8000] 

= 2000 

Y = C + S 

S = Y - C 

MPS = (ΔS)/(ΔY) 

APC = C/Y

K = (ΔY)/(ΔI) = 1000/250 = 4 

We know K = 1/(1 - MPC) = 4 

→ K = 1/MPS = 4 

→ MPS = 0.25 

MPS = (ΔS)/(ΔY) = 0.25 

→ ΔS = (0.25)(ΔY) 

= (0.25)(1000) = 250 

(b)  MPC + MPS = 1

That is 0.75 + 0.25 = 1

C = c^‒ +b.Y 

C = 500 + (0.4) x 5000 

= 2500 

I = Y - C 

= 5000 - 2500 

= 2500 

At Equilibrium Y = C + I 

→ Y = 500 + 0.9 Y + 1000 

→ 0.1 Y =1500 

→ Y = 15000

(a)  The value of multiplier is determined by marginal propensity to consume. Higher the MPC, greater the size of multiplier lower the MPC, smaller the size of multiplier. When income of consumer rises they spend more the value of increase in income ie. multiplier depends on ’MPC, greater the value of multiplier depends on greater size of MPC. Thus there is direct relation between multiplier and MPC.

The relation can be expressed in terms of an equation as under

K = \(\frac{ΔY}{ΔI}\)

We know ΔY = ΔC + ΔI

ΔI = ΔY + ΔC

Putting the value of in equation we get,

K = \(\frac{ΔY}{ΔY - ΔC}\) = \(\frac{1}{1-MPC}\)

Thus it is clear from the above equation that the value of MPC and multiplier are positively related

(b) MPC = 0.8

Multiplier (k) = \(\frac{1}{1-MPC}\) = \(\frac{1}{1-0.8}\) = \(\frac{1}{0.2}\) = 5

C = Y - I 

→ C = 500 - 100 = 400 

We know C = c^‒ +b.Y 

→ 400 = c + (1-0.3) x 500 

→ 400 = c + (0.7) x 500 

→ c = 400 - 350 = 50 

C = Y - I 

= 1000 - 120 = 880 

C = c^‒ + b.Y 

→ 880 = 100 + b.1000 

→ b = 780/1000 

= 0.78

MPC = 1 - MPS = 1 - 0.2 = 0.8 

At Equilibrium Y = C + I 

C = c^‒ +b.Y 

= 120 + (0.8)Y 

→ Y = 120+(0.8)Y + 150 

→ 0.2Y = 270 

→ Y = 1350

 MPC = \(\frac{ΔC}{ΔY}\)

= \(\frac{75}{100}\)

= 0.75

MPS = \(\frac{ΔS}{ΔY}\)

= \(\frac{25}{100}\)

= 0.25

1. False – MPS = 0.2. 

2. False – Autonomous consumption.

(a) Micro economics

(b) Macroeconomics

(c) Macroeconomics

(d) Microeconomics

MPC = \(\frac{ΔC}{ΔY}\) = \(\frac{75}{700}\) = 0.75

MPS = \(\frac{ΔS}{ΔY}\) = \(\frac{25}{700}\) = 0.25

At Equilibrium Y = C + I 

→ Y = c^‒ + b.Y + I 

→ 2000 = 200+b.(2000) + 100 

→ b = 1700/2000 = 0.85 

At equilibrium Y = C +I 

Y = c^‒ +b.Y + I 

=100+(0.6)Y + 200 

= 300 + (0.6)Y 

→ (0.4)Y = 300  

→Y = Rs 750

It is usually accepted that an increase in saving leads to a decrease in saving. This is because, if all the people of the economy increase the proportion of income they save (i.e. if the mps of the economy increases) the total value of savings in the economy will not increase – it will either decline or remain unchanged. This result is known as the ‘Paradox of Thrift’ – which states that as people become more thrifty they end up saving less or same as before.

When aggregate demand falls short of aggregate supply at full employment, it gives rise to deflationary gap. Thus, deficient demand = aggregate supply – aggregate demand. Measures to remove deflationary gap, 

1. Reduce the bank rate. 

2. Reduce the cash reservice ratio.

The components of aggregate demand are: 

1. Household consumption expenditure 

2. Government consumption expenditure 

3. Private Investment expenditure

(b) Paradox of thrift

Correct answer is (b) MPS

Correct answer is  (b) 210

Equilibrium level of income (Y) is attained when S= I. It means: 

-10 + 0.2Y = – 3 + 0.1Y

0.2Y – 0.1Y = – 3 +10

0.1Y = 7

Y=70

Equilibrium level of income = 70

The two approaches for determining the equilibrium are :

1. AD (or C+I) and AS approach: Equilibrium is achieved when planned expenditure of the economy (AD) is equal to the planned availability of goods and services (AS), i.e., when AD = AS

2. Saving and Investment Approach: Equilibrium level of income is determined at the level where planned saving is equal to planned investment. I.e., when S=1

(a) Multiplier (k) = \(\frac{1}{MPS}=\frac{1}{0.40}\) = 2.5

(b) If MPS = MPC, then MPS = 0.5

Multiplier (k) = \(\frac{1}{MPS}=\frac{1}{0.5}\) = 2

The two approaches to determining the equilibrium level of income are.

• AD (or C+1) and AS approach
• Saving and investment approach