NCERT Solutions for Class 12 Economics Part A Chapter 4 Determination of Income and Employment

1. What is marginal propensity to consume? How is it related to marginal propensity to save?

Ans. Marginal propensity to consume is the ratio of change in the consumer’s expenditure based on the change in disposable income (income after deducting taxes). In other words, MPC measures proportionate change in consumption with the change in income.

$$\text{So, MPC =}\frac{\varDelta C}{\varDelta Y}$$
Where, ΔC = Change in consumption
           ΔY = Change in income

For example, if income increases from ₹200 crores to ₹250 crores and consumption increases from ₹20 crores to ₹40 crores, it represents that 0.4 is the MPC or 40% increase in the income is being consumed.
This can further be explained with the help of a table.
If income and consumption are:

Income in ₹ (Y) Consumption Expenditure in ₹ (C)
200 20
250 40

$$\text{Then MPC =}\frac{\varDelta C}{\varDelta Y}=\frac{20}{50}=04$$

National Income

Also, MPC can be explained with the above mentioned diagram.
In the diagram, x-axis represents National Income and y-axis represents Consumption Level.

$$\text{So, MPC =}\frac{BC}{AC}$$

The relationship between MPC and MPS can be explained as:

Y = C + S
(Assuming that the income earned is either consumed or saved)

ΔY = ΔC + ΔS
Dividing both sides by ΔY

$$\frac{\varDelta Y}{\varDelta Y}=\frac{\varDelta C}{\varDelta Y}=\frac{\varDelta S}{\varDelta Y} \begin{bmatrix*}[r]\frac{\varDelta S}{\varDelta Y}=MPS \end{bmatrix*}$$

Or 1 = MPC + MPS
Or MPC = 1 – MPS
Or MPS = 1 – MPC
Or MPS + MPC = 1
So, the sum of MPC and MPS is always equal to unity.

2. What is the difference between ex-ante investment and ex-post investment?


S. No. Ex-ante Investment Ex-post Investment
(i) It refers to the planned or intended investment during a particular period of time. It refers to the actual level of investment during a particular period of time.
(ii) It is only imaginary (intended), in which a firm usually assumes the level of investment on its own. It is factual or original that represents the existing investment of a particular time.
(iii) It is projected on the basis of future expectations. It is the actual result of variables.

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?

Ans. Change in the cosumption curve that occurs due to the change in its slope termed as parametric shift in the curve.
Let C = C + by be the consumption function
b represents MPC
y represents Income
(i) When slope decreases: The consumption curve will shift downwards. This is known as parametric shift in the curve.

slope decreases

(ii) When its intercept increases: Intercept is the autonomous parts of consumption function, so when intercept increases there will be a parallel shift in the consumption curve.

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?

Ans. Effective demand is a situation wherein the equilibrium output is determined solely by the level of aggregate demand. This is mainly because of the assumption that the supply is infinitely elastic and if there is any inequality between the Aggregate Demand (AD) and the Aggregate Supply (AS), then the equilibrium output will be influenced by AD. This concept of effective demand can be explained with the help of the diagram.

Income Output Level

The x-axis represents income/output level and y-axis shows the level of aggregate demand. E is the equilibrium point where the two curves AS and AD are intersecting each other. EG is the effective demand and output level is represented by AD (assuming the elasticity of supply to be perfectly elastic).
Autonomous expenditure multiplier is derived as

Y = AD (at equilibrium)
Y = A + cY [Where AD = A + cY]
Y – cY = A
Y(1 – c) = A

A = Autonomous expenditure
c = MPC
Y = level of income
$$\frac{1}{1-C}=\text{autonomous expenditure multiplier}$$
Hence, we can say that the autonomous expenditure multiplier is dependent on the income and MPC.

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).

Ans. Consumption expenditure (A) = ₹50 Crores
MPS = 0.2
Level of income (Y) = ₹4000
So, MPC = 1 – MPS
= 1 – 0.2
= 0.8
Y = 4000 Crores
We know that
AD = A + cY
Putting the values in equation (1)
AD = 50 + 0.8 × 4000
= 50 + 3200
= ₹3250 Crores
But, ₹3250 < ₹4000
Implies that AD < Y
Hence, the economy is not in equilibrium.

6. Explain ‘Paradox of Thrift’.

Ans. Paradox of thrift is a situation wherein people tend to save more money, which further leads to a fall in the savings of the economy as a whole. In other words, when everyone increases his/her saving-income proportion i.e., MPS (s), then, the aggregate demand falls, because consumption decreases. This will lead to a decrease in employment and income level and eventually this will reduce the total savings for the economy. This concept was suggested by Keynes, where he stated that increased saving at individual levels will gradually lead to the slowdown of economy in terms of circular flow of income.

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