CBSE Class 12 Economics HOTs Determination of Income and Employment

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Part B Macroeconomics Chapter 4 Determination of Income and Employment Class 12 Economics HOTS

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HOTS Questions Part B Macroeconomics Chapter 4 Determination of Income and Employment Class 12 Economics with Answers

 

UNIT VII

DETERMINATION OF INCOME AND EMPLOYMENT

QUESTIONS BASED ON HOTS WITH MODEL ANSWERS

Question: Why can the value of MPC be not greater than 1?

Answer: It is because change in consumption can never be greater than change in income.

Question: Does an excess of AD over AS always imply a situation of inflationary gap?

Answer: No. Inflationary gap occurs only when AD>AS corresponding to full employment level of employment.

Question: What happens if AD>AS prior to full employment level of employment?

Answer: It is a state of disequilibrium in economics. When AD>AS , producers have to cater to demand out of their existing stock of goods , implying that the desired level of stocks will decrease. It implies greater production & therefore there is increase in AS .This process continues till equilibrium is struck between AD and AS.

Question: In poor countries like India , people spend a high percentage of their income so that  APC and MPC are high . Yet , value of multiplier is low . Why? 

 Answer: Working of the multiplier process is based on one fundamental assumption: that there exists, excess capacity in the economy , so that whenever consumption expenditure rises (implying increase in demand ) there is a corresponding increase in production (implying increase in income ) . But poor countries like India, lack in production capacity. Accordingly, whenever demand increases (in terms of increase in consumption expenditure), there is increasing pressure of demand on the existing output (implying inflation or rise in prices) rather than the increase in output or income.

Question: Show a point on the consumption curve at which APC= 1.
 
Answer: APC = C/Y =1 is possible if C=Y, i.e. Consumption is equal to Income.
 
Question: In what respect foreign trade will be useful in removing the adverse economic effects of deficient demand?
 
Answer: Export increases the demand for goods and services produced in the domestic territory and is helpful to reduce deficient demand.
 
Question: What happens in an economy, when credit availability is restricted and credit is made costlier?
 
Answer: Aggregate demands falls. 
 
 Important Questions for NCERT Class 12 Economics Determination of Income and Employment 
 
Short Answer Type Questions
 
Question: Explain the components of equation c= ‾a + by.
Answer: ‘a’ is called intercept and it represents the amount of consumption when there is a zero level of income i.e. autonomous consumption. The consumption is positive at zero level of income. The coefficient ‘b’ measures the slope of consumption. The slope gives the increase in consumption per unit increase in income. This is called as MPC. Consumption changes by ‘b’ for every one rupee change in income. Consumption changes in the same direction as income. 


Question: Which are the important elements in the determination of investment?
Answer: Following are the three elements important in the determination of investment 
(i) Expected Returns or Revenue An investment is undertaken on the basis of expected demand or expected returns to the producers.
(ii) Costs It has three components viz. cost of purchase of equipment, cost of maintenance of equipment (depreciation) and Cost of funds borrowed for investment.
(iii) Business Expectation Bullish expectations attract more investment. Bearish expectations cause low investment.

Question: Define aggregate demand. State its components.
Answer: Aggregate demand refers to the total expenditure on the goods and services in an economy during the period of one year.
The main components of aggregate demand are 
(i) Consumption expenditure
(ii) Private investment (Fixed Capital Formation + Change in Stock)
(iii) Government expenditure
(iv) Net exports or difference between exports and imports AD = C + I + G + (X –M)

Question: What is the difference between planned investment and actual investment? 
Answer:

CBSE Class 12 Economics HOTs Determination of Income and Employment

Question: Distinguish between marginal propensity to consume and average propensity to consume. Give a numerical example. 
Answer: Differences between marginal propensity to consume and average propensity to consume Basis Marginal Propensity to  Consume 


CBSE Class 12 Economics HOTs Determination of Income and Employment
The numerical example given below will help to understand the computation of MPC and APC. 

Question: State whether the following statement are true or false. Give reasons for your answer.
(i) The value of average propensity to save can never be greater than 1.
(ii) When investment multiplier is 1 the value of marginal propensity to consume is 0.
Answer: (i) True. The value of average propensity to save can never be greater than 1 because even when all the income is saved and nothing is spent on consumption, saving will be equal to income. In this case, Average Propensity to Save (APS) will be equal to 1 and not greater than 1.
(ii) The given statement is true. When investment multiplier is 1, marginal propensity to consume is 0.
We know that,
Multiplier (K) = 1/1 MPC
               
              1=/1/1-MPC

         1 –MPC = 1MPC = 0

Question: An economy is in equilibrium. From the following data, calculate the marginal propensity to save.
Income = ` R.s.10,000
Autonomous consumption = `R.s.500
Consumption expenditure = `R.s. 8,000 
Answer: We know that,
Consumption expenditure = c¯ + bY,
where C = Autonomous Consumption,
b = Marginal Propensity to Consume and
Y = Income
So, on substituting the given variables, we get
8,000 = 500 + b. (10,000)
8,000 - 500 = b. 10,000
b = = 7, 500/10, 000 =0 75. i.e.
Marginal Propensity to Consume = 0.75.

We also know that, MPC + MPS = 1, where,
MPC = Marginal Propensity to Consume, and
MPS = Marginal Propensity to Save
On substituting MPC = 0.75, we get
0.75 + MPS = 1,
MPS = 1 - 0.75 = 0.25, i.e,
Marginal Propensity to Save = 0.25

Question: If national income is `R.s. 100 crore and consumption `R.s.crore, find the average propensity to save.
When income rises to `R.s. 120 crore and consumption expenditure to `R.s. 108 crore, what will be the marginal propensity to consume and marginal propensity to save?
Answer: Given, National Income (Y) = `R.s. 100 crore
 Consumption Expenditure (C) = `R.s. 90 crore 
Saving (S) = Y–C =
100 – 90 
= ` R.s.10 crore
 Average Propensity to Save (APS) = S/ Y=10/100=0.1

Increased Income (Y1) = ` R.s.120 crore

Increased Consumption Expenditure (C1)
                             = `R.s.108 crore
Increased Saving (S1) = 120 – 108
                         = `R.s.12 crore
Change in Income (ΔY) = 120 – 100
                             = `R.s. 20 crore
Change in Consumption Expenditure (ΔC) = 108 – 90
                                              = `R.s.18 crore
Change in Saving (ΔS) = 12 – 10
                           = `R.s. 2 crore
Marginal Propensity to Consume (MPC) =  ΔC/ΔY=18/20=0.9
Marginal Propensity to Save (MPS) = ΔAS/ΔAY= 2/20=0.1

Therefore,
Average Propensity to Save (APS) = 0.1.
Marginal Propensity to Consume (MPC) = 0.9.
Marginal Propensity to Save (MPS) = 0.1
 

Question: An economy is in equilibrium. Find ‘autonomous consumption’ from the following National income = 1,000
Marginal propensity to consume = 0.8
Investment expenditure = 100
Answer: At equilibrium
                       AD = AS(Y)
                    Y = C + I
Where         C = Consumption expenditure
                  I = Investment expenditure
Further       C = c¯ + bY
Where,       C = Autonomous consumption
                 b = MPC
Hence,       Y = c¯ + bY + I
                 1,000 = c¯  + 0.8 (1,000) + 100
                1,000 = C + 800 + 100
               c¯ = `R.s. 100

Question: An economy is in equilibrium. Calculate the investment expenditure from the following.
National income = `R.s.800
Marginal propensity to save = 0. 3
Autonomous consumption = 100
Answer: As the economy is in equilibrium
∴                  Y = AD
i.e.              Y = C + I
                C = c¯ + bY
or,            Y = c¯  + bY + I ...(i)
National Income (Y) = 800
Marginal Propensity to Save (MPS) = 0.3
Marginal Propensity to Consume
                              (MPC) = 1 - MPS = 1 - 0.3 = 0.7
Autonomous Consumption, (c¯ ) = 100
From (i)              800 = 100 + 0.7(800) + I
                         700 = 560 + I
                             I = 140
 

Question: If in an economy
Marginal Propensity to Consume (MPC) = 08 .
Change in Initial Investment (DI) =`R.s. 4,000 crores
Find the value of the following. 
(i) Investment Multiplier (K)
(ii) Change in Final Income (DY)
Answer: (i) Investment Multiplier (K) = 1/1 - MPC
Here, MPC is given = 0.8
Now,
Investment Multiplier (K) = 1/1 - 0.8
Investment Multiplier (K) = 1/0.2
Investment Multiplier (K) = 5
(ii) Investment Multiplier (K)
= Change in Income (Δy )/Change in Investment (ΔI)

Putting the value of K, which is determined in above case
we get 5== ΔY/ 4 000
                = ΔY =  4,000 × 5
∴ Change in final income ΔY = `R.s.20,000 crores

Question: Giving valid reasons, state whether the following statements are true or false.
(i) Ex-post investment means fixed capital with production units during a particular period of time.
(ii) Marginal propensity to consume represents the slope of the consumption function. 
Answer: (i) The given statement is false, as ex-post investment includes both fixed as well as inventory investment with the production unit during a period of time.
(ii) The given statement is true, as it represents change in consumption due to a given change in income.
MPC = ΔC /ΔY

Question: In an economy, the autonomous investment is 360 and the marginal propensity to save is 0.3. If the equilibrium level of income is 1,400, then the autonomous consumption is 40. True or false?
Answer: False. Given, Autonomous Investment= 360
Marginal Propensity to Save (MPS) = 0.3
Equilibrium Level of Income (Y) = 1,400
Marginal Propensity to Consume (MPC) = 1–MPS
                                         = 1– 0.3 = 0.7
At the equilibrium Level, Y = C+I
or,                       Y = C+MPC (Y) +I
                         1,400 = C + MPC (Y) + I
                         1,400 = C + 0.7 (1,400) + 360
                         1,400 = C+ 980+360
                         1,400 = C+1,340
                              C = 1,400– 1,340 = 60
Thus, it is proved that the given statement is false. The autonomous consumption = 60.

Question: Give reason, state whether the following are true or false.
(i) Sum of average propensity to consume and marginal propensity is always equal to 1.
(ii) If the ratio of marginal propensity to consume and marginal propensity to save 3 : 1, the value of investment multiplier will be 5.
Answer: (i) False. Sum of average propensity to consume and average propensity to save as well as sum of marginal propensity to consume and marginal propensity to save is always equal to one. There is no fixed relationship between APC and MPC.
(ii) False, because, if the ratio of marginal propensity to consume and marginal propensity to save is 3:1, MPC will be 0.75 and investment multiplier (K) will be K =1/1-MPC=1/1-0.75=1/0.25 = 4
Assume that MPS = x, So that MPC = 3x
We know MPC+MPS=1
⇒       3x + x = 1
⇒       4x = 1
⇒       x =  1/4=0.25
⇒       MPS = 0.25
So that MPC = 3 × 0.25 = 0.75
or MPC = 1–MPS
1 - 0.25 = 0.75

Question: The saving function of an economy is given as
           S = -250 + 0.25Y
If the planned investment is `R.s. 2,000 crores, 
calculate the following.
(i) Equilibrium level of income in the economy.
(ii) Aggregate demand at income of `R.s. 5,000 crores.
Answer: (i) At the point of equilibrium,
Saving = Investment
  (S = I) - 250 + 0.25Y = 2,000
   0.25Y = 2,000 + 250
  0.25Y = 2.250
     Y = = 2 250/0.25=9 000
Equilibrium level of income = `R.s.9,000 crores
(ii) AD at income level ` 5,000 crores will be
AD= 250 + (1 - 0.25 )(5,000) + 2,000
= 250 + 0.75 × 5,000 + 2,000
= 250 + 5,750
= `R.s. 6,000 crores

Question: The value of marginal propensity to consume is 0.6 and initial income in the economy is `R.s. 100 crores.
Prepare a schedule showing income, consumption and saving. Also show the equilibrium level of income by assuming investment of `R.s. 80 crores.
Answer: MPC = 0 6 . , Let autonomous consumption = 40 

CBSE Class 12 Economics HOTs Determination of Income and Employment
When economy is in equilibrium, S = I
Y = C + I
Y = 40 + 0.6Y + 80
Y - 0.6Y = 120
0.4Y = 120
Y = `R.s.300 crores
Equilibrium level of income is `R.s.300 crores.

Question: Which of the following cannot have a negative value?
Give reasons.
(i) Average propensity to save
(ii) Marginal propensity to save 
Answer: (i) APS can have a negative value because at zero level of income there is some amount of consumption which is known autonomous consumption which shows dissaving.
(ii) MPS cannot have a negative value as there is a positive relationship between saving and income, an increase in income must cause an increase in saving. Implying that MPS must always be positive.

Question: In an economy autonomous consumption is 500,marginal propensity to save is 0.2 and investment expenditure is 2,000. Calculate its equilibrium level of income. 
Answer: When economy is in equilibrium, then Y = C + I
Given C'= 500, MPS = 0.2, I = 2,000
MPC = 1 - MPS
MPC = 1 - 0.2 = 0.8
Y = C' + MPC (Y) + I [∴ C = C' + MPC(Y)]
Y = 500 + 0.8Y + 2,000
Y - 0.8Y = 2,500
0.2Y = 2,500
Y = 12,500
Equilibrium level of income = `R.s.12,500 

Question: Derive the saving function from the consumption function c=‾a+by.
Answer: Saving is equal to income minus consumption (y=c+s).The saving function relates to the level of savings to the level of income. It is derived from the consumption which is as
follows:
Y=C+S
S=Y-C
since C=‾a+bY.
therefore,
S=Y-(a+bY)
S= -a+(1-b)Y
 
Question: Explain the components of S= -a+ (1-b) Y.
Answer: The saving function is S= -a+ (1-b) Y.-a represents the intercept term and it represents the amount of savings done when there is zero level of income. The saving is negative at zero level of income because at zero level of income consumption (a) is positive. Negative saving is nothing but dissaving, this means that at zero level of income there is dissaving of amount –a.
The coefficient (1-b) measures the slope of the saving function. The slope of the saving function gives the increase in savings per unit increase in the income. This is known as MPS. Since ‘b’, that is MPC is less than one, it follows that (1-b) i.e. MPS is positive.
Saving is an increasing function of income.
 
Question: Can the value of APS be negative? If yes then when?
Answer: The value of APS can be negative when the value of consumption exceeds the value of income. At low level of income saving is negative.
e.g.: if income is Rs 1000 and consumption expenditure is Rs 1200
Y=C+S S=Y-C
1000-12000=-200
APS=-200/1000=0.2 APS=S/Y.
APS=-0.2.
 
Question: Can the average propensity to consume be greater than one? Give the reason for
your answer.
Answer: APC can be greater than one when the consumption exceeds the income. At that level APS will be negative .when the APS is negative APC will be greater than one.
e.g.: if the income is 1000 and the consumption is 1200, APC =1200/1000=1.20.
 
Question: When can the APC be equal to one? Give reason for your answer.
Answer:APC can be equal to one when APS =0, i.e when consumption = income.
E.g: y=1000, c=1000.
APC=C/Y 1000/1000=1
APC=1
APC+APS=1
1-APC=APS
1-1=0
 
Question: Explain the meaning of investment multiplier? What can be its minimum value and
why?
Answer: Defined as the ratio of change in the income to the change in the investment.
K=ΔY/ΔI.
The value of the multiplier is determined by the MPC. It is directly related to MPC.
K=1/1-mpc = 1/1-0 =1
K=1
Minimum value of K is when minimum value of MPC=0, the minimum value of K will be unit one.
 

Long Answer Type Questions


Question: In an economy, if initial investments are increased by `R.s.100 crores, discuss the working of investment multiplier presuming marginal propensity to consume is 0×8. 
Answer: Investment multiplier is the ratio between change in income and the corresponding change in investment.
There is a direct or positive relationship between Marginal Propensity to Consume (MPC) and Multiplier (K). Higher the MPC, higher will be the value of multiplier and vice-versa. 
Working of Investment Multiplier

CBSE Class 12 Economics HOTs Determination of Income and Employment

As shown in the table, there is additional investment of ` R.s.100 crores and 80% of which is spent on consumption i.e, `R.s. 80 crores and `R.s. 20 crores is saved. `R.s. 80 crores is reinvested of which 80% is consumed and if goes on like
this.
Marginal propensity to consume is 0.8
Change in investment = `R.s. 100 crores
K = 1/1 MPC=1/1- 0 8 .
K = = 1/0. 2=5.
Change in investment = ΔI = `R.s. 100 crores
Investment multiplier = K = 5
Change in income ΔY = K × ΔI
                          = 5 × 100
                       = `R.s. 500 crores

Question: Explain consumption function, with the help of a schedule and diagram. 
Answer: The relationship between the consumption expenditure and the income is known as consumption function.
                     C = F (Y)
When we write consumption function in terms of an
algebraic expression, we write, C = c¯+ bY
Where, C = Consumption expenditure,
c¯ = Autonomous consumption i.e. consumption at zero level of income,b = Marginal Propensity to Consume,Y = Income Let us understand consumption function with the help of an imaginary schedule and diagram 
CBSE Class 12 Economics HOTs Determination of Income and Employment

The point B in the diagram below represents the break-even point where the consumption expenditure equals to the income.
CBSE Class 12 Economics HOTs Determination of Income and Employment

Question: When is an economy in equilibrium ? Explain with the help of saving and investment functions. Also explain the changes that take place in an economy when the economy is not in equilibrium. Use diagram.
Answer: Equilibrium level of income is determined at a point where ex-ante or planned saving is equal to planned investment.  
CBSE Class 12 Economics HOTs Determination of Income and Employment
This is because, in equilibrium
AS = AD or C+S=C+I or S= I
E is the point where S = I, hence, the point at which the economy is in equilibrium.OY is the equilibrium level of national income.
What happens when S> I?
When savings are greater than investment in an economy,it refers to AD< AS. There will be a rise in inventory stock and prices will start to fall. To clear their stocks, the producers will now plan lesser output.
Income This will mean lesser income in the economy. Lesser income implies lesser saving. The process will continue till S = I.
What Happens if S < I? In case S< I, it implies a situation when withdrawal of expenditure (S) is lesser than injection of expenditure (I) into the circular flow of income. Accordingly, overall expenditure in the economy would exceed than what is required to buy the planned output. It is a situation of higher AD than AS.
To cope with the situation, the producers would now plan higher output. Higher output would mean higher income and higher saving. The process will continue till S = I.

Question: Answer the following questions based on the data given below.
Planned investment =`R.s.100 crore
                             C = 50 + 0.5Y
(i) Determine the equilibrium level of income.
(ii) Calculate the saving and consumption expenditure at equilibrium level of national income.
Answer: (i) At equilibrium level of income,
                            Y = C + I
Here, Y = Equilibrium level of income
C = Consumption expenditure at equilibrium level of income
I = Investment expenditure at equilibrium level of income
             Y = (50 + 0.5Y) + 100
          Y - 0.5Y = 150
          0.5Y = 150
Equilibrium level of income = `R.s. 300 crores
(ii) C = 50 + 0.5Y
Substituting the value of Y in the above equation
                   C = 50 + 0.5 × 300
                  C = 50 + 150
                  C = 200
Consumption expenditure at equilibrium level of income
            = `R.s. 200 crores
               Y = C + S
            300 = 200 + S
            S = 300 - 200 ; S = 100
 Saving at equilibrium level of income = `R.s. 100 crores.

Question: Explain the theory of determination of income and employment with the help of aggregate demand and aggregate supply curves.
                                                                                         Or
Why must aggregate demand be equal to Aggregate supply at the equilibrium level of income and output? Explain with the help of a diagram.

Answer: In an economy, equilibrium level of income and employment is determined when AD (Aggregate Demand) is equal to AS (Aggregate Supply). According to Keynes, AS may be assumed to be elastic in an economy
where full employment (of resources) is yet to be achieved. Accordingly, AD becomes the principal determinant of equilibrium level of income. 
CBSE Class 12 Economics HOTs Determination of Income and Employment
In the above figure, AD represents aggregate demand curve and 45° line is the line of reference, where AS =Y.
Equilibrium level of income Y is determined at point E, where AD = AS. Prior to point E, aggregate demand exceeds aggregate supply, leading to an increase in level of income upto point E. Beyond point E, Aggregate Supply
exceeds Aggregate Demand leading to a fall in income back towards point E.
It is only when AS = AD, that the equilibrium is struck,because the equality between AS and AD implies that the desired level of output in the economy (as indicated by AS) is exactly equal to the desired level of expenditure (indicated
by AD) in the economy. So, the entire output as planned by the producers (during an accounting year) is purchased by the buyers. There are no undesired or unwanted inventories (stock of goods) with the producers.

 
Question: Explain the working of a multiplier with an example.
Answer: Multiplier tells us what will be the final change in the income, as a result of change in investment. Change in investment results in the change in income. Symbolically:
ΔI→ΔY→ΔC→ΔY
The working of a multiplier can be explained with the help of the following table which is based on the consumption that is, ΔI=1000 and MPC=4/5.
As per the table the initial increase in the investment of Rs 1000 there is a total increase in the income by Rs 5000 given MPC=4/5 . Out of this total increase in the income Rs 4000 will be
consumed and Rs 5000 be saved.
The sum of total increase in income is also derived as:
Δy=1000+800=640+512+…………….infinity.
1000+4/5×1000(4/5)2×1000+(4/5)3×1ooo+………..infinity
=1000[1+4/5+ (4/5)2+(4/5)3+………infinity]
=1000[1/1-4/5] = 1000×5/1=Rs. 5000 cores.
 
Question: Differentiate between ex ante and ex post investment.
Answer: Ex ante is the planned investment which the planner intends to invest at different level of income and employment in the economy.
Ex post investment may differ from ex ante investment when the actual sales differ from the planned sales and the firms thus face unplanned addition or reduction of inventories.
 

 Case Study Questions  Determination of Income and Employment Class 12 Economics

 “The denial of the crucial role of the interest rate as equilibrator of savings and investment led directly to the Keynesian theory of employment determinants. Given the ‘propensity to consume’and hence the proportion of any given income that will be spent by individual consumers (on which the size of R F Kahn’s ‘multiplier’ depends), the level of output and employment will be a function of investment. According to the level at which investment (also consumption) stands, the level of output and employment may be almost anything between zero and full capacity output. There is at any rate, no longer any unique level to which the system is necessarily tending. So far as investment consists of private investment, it will remain governed by the ‘marginal efficiency of capital’(anticipated profitability), modified, on one hand,by ‘expectations’ (powerfully swayed by business mood and the like) and on other hand, by the cost of borrowing, namely prevailing rate of interest.
Thus, was the casual emphasis of theory reversed:
instead of any change in saving being translated into an equivalent shift of investment and (viaincome changes) the volume of savings the dependent variable.
Interest was converted virtually into a money rate-something influenced on the one hand by monetary policy (affecting the supply of money
available) and on the other hand by the current attitude towards is as something worth holding (e.g,qua bank deposit) in preference to other assets (e.g,bonds). This later constituted the famous liquidity preference –a preference powerfully influenced by expectations (or uncertainty) about future movements of interest rates (and hence of bond prices).”

Question: The ‘multiplier’ referred to here relates to
(a) the propensity to consume which determines how much consumers spend
(b) the change in employment consequent upon a change in output
(c) the change in output consequent upon a change in investment
(d) the number that equilibrates saving and investment

Answer: C

Question: There is no unique level of output and employment to which the economic system tends, because
(a) investment consists only of private investment
(b) investment determines the level of output and can vary
(c) changes in saving are translated into an equivalent level of investment
(d) investment depends upon the propensity to consume

Answer: B

Question: Keynes treated the interest rate as
(a) entirely determined by expectations about the future
(b) the rate at which current savings and investment are equilibrated
(c) reflecting both monetary policy and liquidity preference
(d) an indicator of expected profitability

Answer: C 

Question: Expectations ……… .
(a) determine the prevailing rate of interest
(b) contribute to liquidity preference
(c) govern the cost of borrowing
(d) determine the money supply

Answer: B

Question: Assertion (A) The level of private investment in an economy arbitrarily depends on the marginal efficiency of capital.
Reason (R) Animal spirits results in boom and bust and the cost of borrowing largely influences the level of private investment.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is false, but Reason (R) is true
(d) Both the statements are false

Answer: A

Question: Liquidity preference
(a) is about holding money related to other assets
(b) is the difference between bond prices and interest rates
(c) affects the supply of money
(d) is unrelated to any of the above

Answer: A

 Suppose in equilibrium, aggregate income (in units of money per year) in an economy Y = C + I, where investment expenditure (in units of money per year)
I = 1,000 and aggregate consumption expenditure (in units of money per year) C satisfies the following conditions
• C is a function of current disposable income in the economy.
• f Yd = 0, then C= 500
•  Marginal propensity to save out of Yd is constant in the economy and equal to 30%.
Suppose the government collects direct tax revenues equal to 15% of Y and makes direct transfer payments equal to 750 units of money per year.

Question: What is the value of the investment multiplier in the economy?
(a) Between 1.7 and 1.9
(b) Between 1.9 and 2.1
(c) Between 2.1 and 2.3
(d) Between 2.3 and 2.5

Answer: D

Question: If instead of 750 units of money, the government makes an annual transfer payments equal to 10% of Y, then the equilibrium value of Y will 
(a) decrease by less than 1,000
(b) decrease by more than 1,000
(c) increase by less than 1,000
(d) increase by more than 1,000

Answer: A

Question: What is the equilibrium value of Y in the economy?
(a) Between 3,250 and 3,750
(b) Between 3,750 and 4,250
(c) Between 4,250 and 4,750
(d) Between 4,750 and 5,250

Answer: D 

Question: If instead of 750 units of money, the government makes annual transfer payments equal to 10% of Y,then the value of the investment multiplier will
(a) decrease by less than unity 
(b) decrease by more than unity
(c) increase by less than unity
(d) increase by more than unity

Answer: C

Question: The level of MPC in an economy is
(a) 0.595
(b) 0.678
(c) 0.495
(d) 0.324

Answer: A

Question: Assertion (A) Higher the MPC, higher would be the multiplier effect.
Reason (R) The multiplier effect is the magnified increase in equilibrium GDP that occurs when any component of aggregate expenditures changes.
Therefore when MPC increases, the value of multiplier increases as well.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason
(R) is the correct explanation of Assertion (A).
(b)Both Assertion (A) and Reason (R) are true, but Reason
(R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is false, but Reason (R) is true
(d)Both the statements are false

Answer: A

VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each)
 
Q. 1 Can consumption exceed income? If yes, what is the saving then?
 
Ans. Yes, when income is zero or less than subsistence level of consumption . Saving is –ve.
 
Q.2 How much new income will be generated in an economy with an increase in investment by Rs. 200 and when two-third of rise in income spent on consumption.
 
Ans. 600 Rs .
 
Q.3 Why can the value of MPC be not greater than 1?
 
Ans. It is because change in consumption can never be greater than change in income.
 
Q.4 Does an excess of AD over AS always imply a situation of inflationary gap?
 
Ans. No. Inflationary gap occurs only when AD>AS corresponding to full employment level of employment.
 
Q.5 What happens in an economy, when credit availability is restricted and credit is made costlier?
 
Ans. Aggregate demands falls
 
SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each)
 
Q.1 What happens if AD>AS prior to full employment level of employment?
 
Ans. It is a state of disequilibrium in economics. When AD>AS , producers have to cater to demand out of their existing stock of goods , implying that the desired level of stocks will decrease. It implies greater production & therefore there is increase in AS .This process continues till equilibrium is struck between AD and AS.
 
Q.2 In poor countries like India , people spend a high percentage of their income so that APC and MPC are high . Yet , value of multiplier is low . Why?
 
Ans. Working of the multiplier process is based on one fundamental assumption: that there exists, excess capacity in the economy , so that whenever consumption expenditure rises (implying increase in demand ) there is a corresponding increase in production (implying increase in income ) . But poor countries like India, lack in production capacity. Accordingly, whenever demand increases (in terms of increase in consumption expenditure), there is increasing pressure of demand on the existing output (implying inflation or rise in prices) rather than the increase in output or income.
 
Q.3 Show a point on the consumption curve at which APC= 1.
 
Ans. APC = C/Y =1 is possible if C=Y, i.e. Consumption is equal to Income.
 CBSE_Class_12_Economics_Determination_income_Set_B_1
Q.4 In what respect foreign trade will be useful in removing the adverse economic effects of deficient demand?
 
Ans. Export increases the demand for goods and services produced in the domestic territory and is helpful to reduce deficient demand.
 
Q.5 Calculate consumption expenditure at the income level of Rs.1000 crores, if autonomous consumption is Rs. 80 crores. And 20% of additional income is saved.
 
Ans. MPS = 0.2
SO , MPC =0.8
C=c + bY (c = autonomous consumption)
C= 80+ 0.8 * 1000=Rs. 880 crores.
 
Q.6 Find national income from the following:
Autonomous consumption : Rs. 100
MPC : 0.8
Investment : Rs. 50
Ans. Y = c + b Y+ I
= 100+0.8 Y +50
Y= Rs. 750
 
 
Important Questions for Class 12 Economics Determination of Income and Employment
 

Question. What do you mean by involuntary unemployment and voluntary unemployment?
Ans. Involuntary unemployment refers to that situation where all those people who have ability and also willing to work at the prevailing wage rate but fails to get the work.
Voluntary unemployment refers to all those people who are not willing to work even suitable work is available for them.

 

Question. Explain the various instruments of fiscal policy to control excess demand in the economy
Ans. It refers to income and expenditure policy of the government. It includes following instruments: –
1) Income policy/ Taxation policy: The main source of revenue to government is through taxes.
In order to control excess demand, government should increase tax rate mainly on rich people and luxury goods. So, it will reduce disposable income of people. So, AD will be reduced due to less purchasing power.
2) Expenditure policy: To control excess demand in the economy, government should decrease its expenditure on public works.
So, it will decrease the income level of society and thereby control excess demand in the economy.
3) Public Debts: In the situation of excess demand government should increase the borrowing from public. It will reduce the surplus money stock with the public and thereby will help to control excess demand in the economy.

 

Question. Distinguish between autonomous and induced investment.
Ans. Induced invest refers to that investment which is directly related to expected income from such investment. It is generally incurred by put sector for the profit motive. Investment curve is upward slope as it is income elastic.
Autonomous investment refers to that investment which is not affected by expected income level from such investment. This kind of investment is incurred by government sector with social welfare motive. Here, investment curve is horizontal in slope as it is income inelastic.

 

Question. Explain various instruments fiscal policy to correct deficient demand/ deflationary gap in the economy.
Ans. It refers to income and expenditure policy of the government. It includes following instruments: –
1) Income policy/ Taxation policy: The main source of revenue to government is through taxes.
In order to correct deficient demand, government should decrease tax rate mainly on rich people and luxury goods. So, it will increase disposable income of people. So, AD will be increased due to less purchasing power.
2) Expenditure policy: To control deficient demand in the economy, government should increase its expenditure on public works.
So, it will increase the income level of society and thereby correct deficient demand in the economy.
3) Public Debts: In the situation of deficient demand government should decrease the borrowing from public. It will increase the surplus money stock with the public and thereby will help to correct deficient demand in the economy.

 

Question. Explain various instruments of monetary policy to correct deficient demand/ deflationary gap in the economy.
Ans. Monetary policy refers to the policy used by central bank to control and regulate money supply and credit in the economy. It includes following instruments:

a) Quantitative instruments
(i) Bank rate: It is the rate at which central bank lends to commercial banks or discounts first class bills and securities of commercial banks for long-term needs.
In the situation of deficient demand, central bank decrease bank rate. It will further decrease interest rate by commercial bank, so credit will become cheaper and it will encourage the people to borrow from commercial banks. As a result, deficient demand can be corrected.
(ii) Open market operations: It refers to buying and selling of government securities by central bank in open market.
In the situation of deficient demand, central bank buys government securities from commercial banks. So, it will increase availability of funds available for credit with the banks, and it will result expansion of credit and thereby increase AD of goods and services.
(iii) CRR: It is the percentage of total deposits which commercial bank has to keep with central bank in the form of reserves.
In the situation of deficient demand, central bank decreases CRR. It means bank must keep less percentage of deposits with central bank as reserve. So, it will increase the capacity of commercial banks for credit. Thus, expansion of credit will help in correcting deficient demand.
(iv) Statutory Liquidity Ratio: It is the percentage of total deposits which a commercial bank must keep with itself in the form liquid assets. In the situation of deficient demand, central bank decreases SLR. It means less percentage of bank deposits has to keep by the bank itself. Thus, availability of funds for credit will increase. So, expansion of credit will correct deficient demand.

b) Qualitative instruments
(i) Marginal requirement: It is the difference between value of securities offered against loan and amount of loan sanctioned.
In the situation of excess demand, central bank decreases marginal requirement. It means more amount of loan will be sanctioned against the security offered to bank. So, it will result expansion of credit and helps to correct deficient demand.
(ii) Moral suasion: It refers to written or oral instruction given by central bank to commercial banks either for expansion or contraction of credit. In the situation of deficient demand, central bank may compel commercial banks to increase availability of credit.

 

Question. What do you mean by underemployment equilibrium?
Ans. Under employment equilibrium refers to that equilibrium level where AD<ASFE. So, under employment equilibrium is attained at less than full equilibrium where all economic resources are not utilized and there exists involuntary unemployment.
The main cause for underemployment equilibrium is deficiency in AD. So, there is a need to increase AD to establish full employment equilibrium.

 

1. Give the meaning of ex-ante savings.

 
Ans. : Ex-ante savings are the planned savings or expected savings
 
2. Give the meaning of deflationary Gap.
 
Ans. It is the gap between excess of aggregate supply over aggregate demand at full employment level.
 
3. What is Ex-ante aggregate demand?
 
Ans. It is planned or desired aggregate demand.
 
4. Give the meaning of Inflationary Gap.
 
Ans. It refers to the amount by which the actual aggregate demand exceeds the level of aggregate demand required to establish the full employment equilibruim.
 
5. What is meant by ex-ante investment?
 
Ans. : It is planned or desired investment during a particular period.
 
6. Define aggregate demand.
 
Ans. Aggregte demand is defined as the money value of total goods and services demanded by an economy during a given period.
 
7. What is propensity to consume?
 
Ans. Which shows the level of consumption at different levels of income in an economy.
 
8. Define marginal propensity to consume.
 
Ans. It is defined as measure of the rate at which aggregate consumption expenditure Changes as national income changes. MPC= C/Y
 
9. What is involuntry unemployment?
 
Ans . When people who are willing to work at the giving wage rate do not get work.
 
10. What is meant by excess demand in macro economics?
 
Ans. In macro economics, when aggregate demand is more than aggregate supply at full employment level, then there is excess demand.
 
11. What can be the minimum value of investment multiplier?
 
Ans. Investment multiplier K=1/1-mpc
 
if mpc = 0 than K=1/1-0 = 1 which is minimum value of investment multiplier
 
12. Give the meaning of aggregate supply?
 
Ans. Aggregate supply is the money value of total supply of goods and services available for purchase by an economy during a given period.
 
13. Can the value of APS be negative?
 
Ans. Yes, when there are dissavings.
 
14. Write the relation ship between MPS and multiplier?
 
Ans. K=1/1-MPC = 1/MPS or inverse relationship between MPS and the size of the mulitiplier.
 
3/4 - Marks Questions with Answers
 
1. In an economy the MPC is 0.75. Investment expenditure in the economy increase by Rs.75 crore. Calculate total increase in national income.
 
Ans. : K=ΔY/ΔI = 1/1-MPC
ΔY= ΔIx1/1-MPC
= 75x1/1-0.75
= 300 Crore
 
2. An economy is in equilibrium. Its consumption function is C=300 +0.8Y. and investment is 700 find national income.
 
Ans. : C= 300+0.8 Y
Y = C+I
Y = 300+0.8Y+700
=1250
 
3. Giving reasons, state whether the following statements are true or false.
 
(1) When MPC is zero, the value of investment multiplier will also be zero.
(2) Value of APS can never be less than zero
(3) When MPC>MPS, the value of investment multiplier will be greater than 5.
(4) The value of MPS can never be negative
(5) When investment multiplier is 1, the value of MPC is zero.
(6) The value of APS can never be qreater than 1.
 
Ans. (1) False because when MPC = 0
Value of investment multiplier is one K=1/1-MPC = 1/1-0 = 1
(2) False because APS is negative when there are dissavings
(3) True, if MPC is greater than 0.8 or false if MPC > 0.5 but not greater than 0.8 or
(4) True, since MPS = DS/DY if DS = 0 than MPS can at the most be zero.
(5) True because K = 1/1-MPC = 1/1-0=1
(6) True, because APC + APS = 1
 
4. Explain the distinction between voluntary and involuntry employment.
 
Ans. Voluntary unemployment is that part of the working force not willing to engage itself is gainful occupation. Involuntary unemployment is that part of labour force which is willing and able to work at the prevailing wage rate but is out of work.
 
5. Explain the relationship between investment multiplier and MPC?
Ans. K=1/1-MPC, It shows direct relationship between MPC and the value of Multiplier. Higher the proportion of increased income spend on consumption, higher will be value of investment multiplier. Higher the proportion of increased income spend on consumption, higher will be value of investment multipler.
 
6 - Marks Questions
1. Explain the role of the following in correcting deficient demand in an Economy.
(1) Open market operation
(2) Bank rate
 
Ans : (1) Open market operation refer to the sale and purchase of securities by the Central Bank incase of deficient demand when AD falling short of AS at full employment, the Central Bank buys securities in the open market and makes payment to the sellers. The money flows out of the central bank and reaches the commercial bank as deposits. This raises the lending capacity of the banks, people can borrow more. This will raise AD.
 
(2) Incase of deficient demand central bank decrease the bank rate which the central bank charges on the loan given to commercial bank. This forces the commercial banks to reduce lending rate. Since borrowing become cheaper and people borrow more. Arises.
 
2. Explain the role of the following in correcting 'Excess demand in an Economy'
(1) Bank Rate
(2) Open market
 
Ans : (1) To Correct excess demand central bank can rise the bank rate. This forces commercial bank to increase lending rates. This reduces demand for borrowing by the public for investment and consumption. Aggregate demand falls.
 
(2) When there is excess demand Central Bank sells securities. This leads to flow of money out of the commerical banks to the central bank when people make payment by cheques. This reduces deposits with the banks leading to decline in their lending capacity. Borrowing decline. AD declines.
 
3. Explain the role of following in correcting the deflationary gap in an economy.
1) Govt. Expenditure
2) Legal Reserve Ratio
 
Ans. 1) In a situation of deflationary gap or deficient demand. The Govt. should raise its expenditure i.e. there will be more economic activities in the economy like, building of roads, bridges, canal etc.
This will raise the level of exployment. It will in turn increase the income and the purchasing power. Thus aggregate demand will rise.
 
2) During deficient demand, central bank reduces the CRR. The result of reducing CRR will be seen in the surplus cash reserves with the banks which can be offered for credit. The bank’s credit bank reduces SLR, this will have expansionary effect on the credit position of the banks leading to increase in thier leading capacity borrowing increases & AD increases.
 
4. Explain the role of margin requirements for correcting the deflationary gap.
 
Ans. : Deflationary gap refers to a situation when at full employment level of income AD falls short of AS. It is called deficient demand. Margin requirements refers to the margin on the security provided by the borrower. When margin is lower, the borrowing capacity of the barrover is higher. When central bank lowers the margin the borrowing capacity of the borrowers increase. This raise AD.
 
5. In an economy 75% of the increase in income is spent on consumption. Investment increased by Rs.1000 Crore. Calculate
(1) Total increase in income
(2) Total increase in consumption expd.
 
Ans. : MPC = 75% = 75/100 =3/4
MPS = 1-3/4 = 1/4 K=4
(1) ΔY = ΔI x K
= 1000 x 4
= 4000 Crore
 
(2) ΔY = ΔC + DI
ΔC = ΔY - DI
= 4000-1000
= Rs. 3000 Crore
 
6. In an economy the equilibruim level of income is Rs.1200 Crore.
MPC : MPS = 3:1
ΔI = ?
Ans. New equilibruim income = Rs. 20000 Crore
=20000-12000=8000 Crore
K= 1/MPS = 1/0.25 = 4
ΔI = ΔY/K = 8000/4
= Rs.2000 Crore
Part A Microeconomics Chapter 01 Introduction to Micro Economics
CBSE Class 12 Economics HOTs Introduction
Part A Microeconomics Chapter 02 Theory of Consumer Behaviour
CBSE Class 12 Economics HOTs Consumer Behaviour And Demand Set A
CBSE Class 12 Economics HOTs Consumer's Choice And Demand Analysis
CBSE Class 12 Economics HOTs Consumers Equilibrium And Demand
CBSE Class 12 Economics HOTs Theory of Consumer Behaviour
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Part A Microeconomics Chapter 03 Production and Costs
CBSE Class 12 Economics HOTs Production and Costs
Part A Microeconomics Chapter 04 The Theory of the Firm under Perfect Competition
CBSE Class 12 Economics HOTs Producer Behaviour and Supply (Hindi)
CBSE Class 12 Economics HOTs Producer Behavoiur And Supply
CBSE Class 12 Economics HOTs The Theory of the Firm under Perfect Competition
Part A Microeconomics Chapter 05 Market Equilibrium
CBSE Class 12 Economics HOTs Market Equilibrium
Part A Microeconomics Chapter 06 Non Competitive Markets
CBSE Class 12 Economics HOTs Non Competitive Markets
Part B Macroeconomics Chapter 02 National Income Accounting
CBSE Class 12 Economics HOTs Economics Forms of Market and Price Determination
Part B Macroeconomics Chapter 03 Money and Banking
CBSE Class 12 Economics HOTs Money And Banking
CBSE Class 12 Economics HOTs Money and Banking (Hindi)
Part B Macroeconomics Chapter 04 Determination of Income and Employment
CBSE Class 12 Economics HOTs Determination of Income and Employment
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CBSE Class 12 Economics HOTs National Income And Related Aggregates
Part B Macroeconomics Chapter 05 Government Budget and The Economy
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CBSE Class 12 Economics HOTs Government Budget the Economy (Hindi)
Part B Macroeconomics Chapter 06 Open Economy Macroeconomics
CBSE Class 12 Economics HOTs for Balance of Payment
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