Chapter 4 Determination of Income and Employment Class 12

Q1 What is Marginal Propensity to Consume? How is it related to Marginal Propensity to Save?

Marginal Propensity to Consume (MPC): It is the ratio of change in consumption expenditure ($\Delta C$) to the change in income ($\Delta Y$). It represents the proportion of additional income that is spent on consumption.

$$MPC = \frac{\Delta C}{\Delta Y}$$

Relationship with MPS: Since any change in income is either consumed or saved ($\Delta Y = \Delta C + \Delta S$), the sum of MPC and MPS is always equal to 1.

$$MPC + MPS = 1$$

Q2 What is the difference between Ex Ante Investment and Ex Post Investment?

Basis	Ex Ante Investment	Ex Post Investment
Meaning	It refers to the planned or desired investment by firms in an economy during a particular period.	It refers to the actual or realized investment that takes place in an economy during a period.
Components	Includes planned inventory accumulation.	Includes both planned and unplanned inventory accumulation (unsold stock).

Q3 What do you understand by ‘parametric shift of a line’? How does a line shift when its slope decreases and intercept increases?

Parametric Shift: It refers to the shift in the graph of a function due to a change in the value of a parameter (like the slope or intercept), while the variables on the axes remain the same.

Effects on the line:

(i) When Slope Decreases: The line becomes flatter. It rotates downwards around its intercept. (e.g., If MPC decreases, the Consumption curve becomes flatter).
(ii) When Intercept Increases: The line shifts parallelly upwards. The slope remains the same, but the starting point on the Y-axis moves up. (e.g., If Autonomous Consumption increases).

Q4 What is ‘Effective Demand’? How will you derive the autonomous expenditure multiplier?

Effective Demand: It refers to that level of Aggregate Demand ($AD$) in the economy which is equal to Aggregate Supply ($AS$). It determines the equilibrium level of income and employment.

Derivation of Multiplier:

At equilibrium: $Y = AD$

Since $AD = C + I$, and $C = \bar{C} + cY$ and $I = \bar{I}$

$$Y = \bar{C} + cY + \bar{I}$$ Let Autonomous Expenditure $\bar{A} = \bar{C} + \bar{I}$ $$Y = \bar{A} + cY$$ $$Y – cY = \bar{A}$$ $$Y(1 – c) = \bar{A}$$ $$Y = \frac{1}{1-c} \cdot \bar{A}$$

Here, the term $\frac{1}{1-c}$ is the Multiplier (K).

Q5 Measure Ex-ante Aggregate Demand and check for equilibrium.

Given:
Autonomous Expenditure ($\bar{A}$) = Rs 50 Crores
MPS = 0.2 $\Rightarrow$ MPC ($c$) = $1 – 0.2 = 0.8$
Level of Income ($Y$) = Rs 4000 Crores

Step 1: Calculate Ex-ante AD

$$AD = \bar{A} + cY$$ $$AD = 50 + 0.8(4000)$$ $$AD = 50 + 3200$$

Ex-ante AD = Rs 3250 Crores

Step 2: Check for Equilibrium
Compare Output ($Y$) and Demand ($AD$):
$Y = 4000$ and $AD = 3250$.

Conclusion: Since $Y > AD$ ($4000 > 3250$), the economy is NOT in equilibrium.

Reason: Aggregate Supply exceeds Aggregate Demand. Producers will face unplanned accumulation of inventory (unsold stock) and will cut down production in the next period.

Q6 Explain ‘Paradox of Thrift’.

The Paradox of Thrift states that if all individuals in an economy try to save more (increase MPS), the total savings in the economy may actually fall or remain unchanged, rather than increasing.

Logic:

If everyone saves more, they consume less.
Consumption expenditure decreases $\rightarrow$ Aggregate Demand falls.
Fall in AD leads to a fall in Income and Production.
As income falls, the capacity to save also falls.
Eventually, the total savings may return to the original level or drop lower, despite the intention to save more.

“Virtue for an individual becomes a vice for the economy.”