Chapter 6 National Income Determination and Multiplier Solutions
Question - 1 : - Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure (A) is Rs 50 crores, and MPS is 0.2 and level of income (Y) is Rs 4000 crores. State whether the economy is in equilibrium or not (cite reasons).
Answer - 1 : - As given in the examination problem, Equilibrium Income (Y) = Rs 4000 crore Autonomous Investment + Autonomous Consumption
= Rs 50 crore MPS = 0.2
So, MPC(b) = 1 – 0.2 = 0.8
(MPC = 1 – MPS)
AD = C + I
As we know, the equilibrium level of national income in two-sector model is determined where,
AS = AD
Y = 50 + 0.8Y
4000 = 50 + 0.8(4000)
4000 = 50 + 3200
4000 =3250
Hence, the economy is not in equilibrium.
Question - 2 : - Explain ‘Paradox of Thrift’.
Answer - 2 : -
- The term thrift means savings and the paradox of thrift shows how an attempt by the economy as a whole to save more out of its current income will ultimately result in lower savings for the economy.
- If all the people in the economy make an effort to save more, then the total savings of the community will not increase, on the contrary they will decrease. This is called the paradox of thrift.
- Reasons for “Paradox of thrift” to operate:
(a) As we know that one person’s expenditure is another person’s income.
(b) If individual ‘A’ decides to save more by reducing his consumption expenditure, the income of individual ‘B’ will be less and individual ‘B’ in turn will spend less.
(c) Thus, if all individuals in the economy decide to save more, the income received by each individual will be less and overall income will fall and also lower will be the total savings.
4. Diagram Representation:
In the above figure , we have induced investment function which makes the investment curve upward positively sloping. With the increase in savings, not only the equilibrium income falls, but also savings decline.
Question - 3 : - What is Effective Demand? How will you derive the autonomous expenditure multiplier when price of final goods and the rate of interest are given?
Answer - 3 : -
- The level at which the economy is in equilibrium, i.e., where aggregate demand = aggregate supply, is called effective demand.
- Under fixed price model, the value of planned (ex-ante) aggregate demand for final goods AD is equal to ex-ante consumption plus ex-ante investment expenditure.
3. As we know that the equilibrium level of national income in two sector model is determined where,
AS = AD
4. Diagrammatical representation,
and at the same level of national income, i.e., OY, aggregate demand is greater than aggregate supply. Production will have to be increase to meet the excess demand. Consequently, national income will increase from OY to O { Y }_{ 1 }
As, we know positive relationship exists between national income and consumption, so consumption will increase which will, increase the new aggregate demand A { D }_{ 1 }
, till we reach the new equilibrium level of output i.e.,