Concept
Determination of equilibrium level
Assumptions
Determination of equilibrium is to be studied in two sector model that is households and firms.
It is assumed that investment expenditure is autonomous that is investment are not influenced by level of income.
Price level is assumed to remain constant.
Soo our next concept is
Concept AD-AS APPPROACH
AD – AS approach
According to kynes theory, the equilibrium level of income in an economy is determined when aggregate demand represented by C+I is equal to the aggregate supply.
|
Income (Y) |
Consumption (C) |
Saving (S) |
Investment (I) |
AD (C+I) |
AS (C+S) |
Remarks |
|
0 |
40 |
-40 |
40 |
80 |
0 |
AD>AS |
|
100 |
120 |
-20 |
40 |
160 |
100 |
AD>AS |
|
200 |
200 |
0 |
40 |
240 |
200 |
AD>AS |
|
300 |
280 |
20 |
40 |
320 |
300 |
AD>AS |
|
400 |
360 |
40 |
40 |
400 |
400 |
(AD=AS) |
|
500 |
440 |
60 |
40 |
480 |
500 |
AD |
|
600 |
520 |
80 |
40 |
560 |
600 |
AD |
So your horizontal line is your x axis and y your vertical line is your y axis on the x axis we will show the income/output /employment and on the y axis we will show the AD.
1st is
AD is more than AS
When AD is less than AS
AD-AS approach
According to the kynesian theory the equilibrium level of income in an economy is determined when aggregate demand is equal to aggregate supply.
|
Income (Y) |
Consumption (C) |
Saving (S) |
Investment (I) |
AD (C+I) |
AS (C+S) |
Remarks |
|
0 |
40 |
-40 |
40 |
80 |
0 |
AD>AS |
|
100 |
120 |
-20 |
40 |
160 |
100 |
AD>AS |
|
200 |
200 |
0 |
40 |
240 |
200 |
AD>AS |
|
300 |
280 |
20 |
40 |
320 |
300 |
AD>AS |
|
400 |
360 |
40 |
40 |
400 |
400 |
(AD=AS) |
|
500 |
440 |
60 |
40 |
480 |
500 |
AD |
|
600 |
520 |
80 |
40 |
560 |
600 |
AD |
E is the point of equilibrium where aggreagate demand is equal to aggregate supply.
Oy is the equilibrium level of output corresponding to point E
It is a situation of effective demand. effective demand refers to that level of demand of AD which becomes effective because it is equal to AS.
When AD is more than AS
When AD is more than AS .it means the consumer is buying more goods than firm are willing to produce. As a result the planned inventory falls below the desired level. To bring the inventory back to the desired level, firm would increase their employment and output. where AD becomes equal to AS and there is no further tendency to change.
When AD is less than AS
When AD is less than AS. it means the consumer is buying less goods than firm are willing to produce. As a result, the planned inventory rises. To bring the inventory back to the desired level, firm would decrease their employment and output. where AD becomes equal to AS and there is no further tendency to change.
Question - Explain in brief AD-AS Approach?
Answer: According to the kynesian theory the equilibrium level of income in an economy is determined when aggregate demand is equal to aggregate supply.
When AD is more than AS
When AD is more than AS .it means the consumer is buying more goods than firm are willing to produce. As a result the planned inventory falls below the desired level. To bring the inventory back to the desired level, firm would increase their employment and output. Where AD becomes equal to AS and there is no further tendency to change.
When AD is less than AS
When AD is less than AS .it means the consumer is buying less goods than firm are willing to produce. As a result, the planned inventory rises. To bring the inventory back to the desired level, firm would decrease their employment and output. Where AD becomes equal to AS and there is no further tendency to change.
Concept S-I approach
|
Stages |
Income (Y) |
Consumption (C) |
Saving (S) |
Investment (I) |
remarks |
|
i |
0 |
40 |
-40 |
40 |
S |
|
|
100 |
120 |
-20 |
40 |
S |
|
|
200 |
200 |
0 |
40 |
S |
|
|
300 |
280 |
20 |
40 |
S |
|
ii |
400 |
360 |
40 |
40 |
S=I |
|
iii |
500 |
440 |
60 |
40 |
S>I |
|
|
600 |
520 |
80 |
40 |
S>I |
So, guys your first column will be of your income
Second will be consumption
Third will be saving
Fourth will be your investment and last column will be of remarks
So as in continuation of previous table of AD-AD approach, all values are given
Dictation
S-I approach
The equilibrium level of income is determined at a level, when planned saving is equal to the planned investment.
|
Income (Y) |
Consumption (C) |
Saving (S) |
Investment (I) |
remarks |
|
0 |
40 |
-40 |
40 |
S |
|
100 |
120 |
-20 |
40 |
S |
|
200 |
200 |
0 |
40 |
S |
|
300 |
280 |
20 |
40 |
S |
|
400 |
360 |
40 |
40 |
S=I |
|
500 |
440 |
60 |
40 |
S>I |
|
600 |
520 |
80 |
40 |
S>I |
The economy is in the equilibrium at point E where saving and investment curve intersect each other.
At point E ex-ante saving is equal to the ex-ante investment.
Oy is the equilibrium level of output corresponding to point E.
When S is more than I
If saving is more than investment then it means that the consumer are not consuming as much as the firm expected them to. As a result, inventory rises above the desired level.to clear the unwanted inventory firm need to reduce the production till saving and investment become equal to each other.
When S is less than I
If saving is less than investment then it means that the consumer are consuming more and saving less as what the firm expected them to. As a result, inventory falls below the desired level.to bring the inventory back to desired level. firm need to reduce the production till saving and investment become equal to each other.
Question – In an economy planned saving exceeds planned investment. How will the equality between the two be achieved? Explain.
Answer - When S is more than I
If saving is more than investment then it means that the consumer are not consuming as much as the firm expected them to. As a result, inventory rises above the desired level.to clear the unwanted inventory firm need to reduce the production till saving and investment become equal to each other.
Question - Using saving and investment approach explain how the equilibrium level of national income determined? Also explain what will happen if the equilibrium condition is not fulfilled.
Concept Equilibrium Level
Full employment
Underemployment level (less than full employment level)
Over full employment (more than full employment level)
Full employment equilibrium
Dictation
It refers to a situation when the aggregate demand is equal to the aggregate supply at full employment level.
Underemployment equilibrium
Dictation
It refers to a situation when the aggregate demand is equal to the aggregate supply when the resources are not fully employed.
Overfull employment equilibrium
So it occurs after the full employment level
So, your horizontal line is your x axis and your vertical line is your y axis ... on the x axis we will show the income/output/employment and on the y axis we will show the aggregate demand
Dictation
It refers to the situation when AD is equal to AS beyond the full employment level. It occurs after the full employment level.
Question. Explain the meaning of under employed equilibrium.
Answer: I refers to situation when aggregate demand is equal to aggregate supply when the resources are not fully employed.
Concept Investment Multiplier
.JPG)
Value of k is 5
It means, income increased 5 times with a single increase in investment.
Concept Relationship Between Multiplier and MPC (Marginal Propensity to consume)
There is a direct relationship between MPC and the value of multiplier. That means Higher the MPC, higher the value of multiplier and Lower the MPC, lower will be the value of multiplier. So we can say that the concept of multiplier is based on the fact that one person’s expenditure is another person income. When investment is increased it also increases the income of the people. Similarly people’s spend a part of their income on consumption. Hence, the amount of increased income spent on consumption depends on the value of MPC.
We can understand this from two cases:
So, Multiplier is directly related to MPC and inversely related to MPS.
Higher the value of MPS, lower will be the value of multiplier and if lower the value of MPS, higher will the value of multiplier.
Concept Working of multiplier
So, when an additional investment is made then income increases many times more than the increase in investment.
Working of multiplier
Suppose an additional investment of Rs.100 crore is made to construct flyover. This extra investment generate extra income of Rs.100 crore in the first round.
If MPC is assumed, that recipient of this additional income will spend 80% of Rs.100 crore, i.e Rs. 80 crore as consumption expenditure and the remaining amount will be saved. It will increase the income by Rs.80 crore in the second round.
In the next round, 80% of the additional income of Rs.100 crore, i.e Rs.64 crore will be spent on consumption and the remaining amount will be saved.
The multiplier process will go on and the consumption expenditure in every round will be 0.80 times of the additional income received from the previous round.
Thus, an initial investment of Rs 100 crore leads to a total increase of Rs. 500 crore in the income.
.JPG)
Diagrammatic Presentation of Multiplier:
So, The value of multiplier is given by K=∆Y/∆I
Ok clear….
The multiplier can also be shown graphically using the AD and AS approach.
In which, income is taken on the X-axis and aggregate demand on the Y-axis. Suppose, the initial equilibrium is determined at point E where AD curve intersects the AS curve. The equilibrium level of income is OY. Now, suppose that the investment increases by ∆I / so that the new aggregate demand curve (AD1) intersects the aggregate supply curve (AS) at point ‘F’.
Thus, the new equilibrium level of income is OY1. The income rises from OY to OY1, in response to an initial increase in investment (∆I ). It is clear from the figure that the increase in income (YY1 or ∆Y) is greater than increase in investment (∆I ). The value of multiplier is given by K=∆Y/∆I
|
MPC |
K |
|
0 |
1 |
|
0.2 |
1.25 |
|
0.5 |
2 |
|
1 |
∞ |
The maximum value of multiplier is infinity when the value of MPC is 1. It implies that the economy is consuming the entire additional income.
The minimum value of multiplier is one when the value of MPC = 0
Indicates that the economy decides to save the whole of its additional income and nothing is spent as consumption expenditure. So, there will be no further increase in income.
AD=C+I
Y or AS=C+S
Equilibrium is achieved when AD=AS or S=I
Question1. Calculate multiplier if MPC is
0.75
0.90
Yaani 0.75 MPC par , multiplier hai 4
Question. In an economy, the equilibrium level of income is Rs12000cr. The ratio of marginal propensity to consume and marginal propensity to save is 3:1. calculate the additional investment needed to reach a new equilibrium level of income of Rs20000cr.
Solution: ratio of 3:1 between marginal propensity to consume (MPC) and marginal propensity to save (MPS)
Signifies: MPC = or 0.75 nad MPS= or 0.25
Question. If marginal propensity to consume is 0.9, what is the value of the multiplier? How much investment is needed, if national income increases by Rs5000cr?
.JPG)
The we can say that
Multiplier (K)=10
And increase in investment is Rs500cr.
Question. In an economy with every increase in income,10 percent of the rise in income is saved. Suppose a fresh investment of Rs120cr. Takes place in the economy. calculate the following:
Solution: given MPS=0.10
Concept Practical on Equilibrium level
Question. Given consumption function C=100+0.75Y (where C=consumption expenditure and Y = national income) and investment expenditure rs1000, calculate
Equilibrium level of national income.
Consumption expenditure at equilibrium level of national income.
Solution: a. equilibrium level of national income
At equilibrium Y=C+I
Yaani Y=100+0.75Y jo ki hume value di gayi hai Question me Consumption expenditure ki + 1000 investment expenditure
Y= 100+0.75Y+ 1000
Yaani Y-0.75Y
Yaani 1 -0.75 which is = 0.25 Y
0.25Y = 100+1000
0.25Y=1100
Ab agar hum 0.25Y me se
0.25 ko = ke is side le jaye to
Ye value multiply me hai par ab idhar aake ye ho jygi divide me
Y= 1100/0.25
To Y ki value aa gayi 4400
Y=Rs. 4400
b. consumption expenditure at equilibrium level of national income.
Putting value of national income of 4400 in consumption function, we get:
C=100+0.75X4400
C=rs3400
Question. If the saving function for an economy is given as: S=-500+0.2Y and investment expenditure is Rs 100cr, then determine:
Level of income when saving will become zero.
Level of income when saving is equal to investment.
Solution:
a. Investment expenditure at equilibrium level of income
Given, equilibrium level of income (Y)=2000. Putting value of Y in saving function, we get :S=-200+0.25X2000=300
At equilibrium, planned saving (S) =planned investment (I) it means: Investment expenditure (I) at equilibrium level of income=300
b. autonomous consumption
we know , consumption (C) +saving (S) =income (Y)
Autonomous consumption means the level of consumption expenditure when income is zero.
Whn Y=0 saving =-200 so, autonomous consumption =200
{alternatively autonomous consumption can also be calculated from the saving function. we know saving function is expressed as S=
Question. Discuss the working of multiplier with the help of diagram.
Answer: Working of multiplier
Suppose an additional investment of Rs100cr (I) is made to construct flyover. This extra investment generate extra income of Rs100cr in the first round.
If mpc is assumed to be 0.90, then recipient of this additional income will spend 90% of Rs100cr, i.e Rs90cr as consumption expenditure and the remaining amount will be saved. It will increase the income by rs90cr in the second round.
In the next round,90% of the additional income of Rs90cr, i.e Rs81cr will be spent on consumption and the remaining amount will be saved.
The multiplier process will go on and the consumption expenditure in every round will be 0.90 times of the additional income received from the previous round.
Thus, an initial investment of Rs100cr leads to a total increase of Rs1000cr in the income.
Question. Why aggregate demand is equal to aggregate supply at the equilibrium level of income and output? Explain it with the help of diagram.
AD-AS approach
According to the kynesian theory the equilibrium level of income in an economy is determined when aggregate demand is equal to aggregate supply.
|
Income (Y) |
Consumption (C) |
Saving (S) |
Investment (I) |
AD (C+I) |
AS (C+S) |
Remarks |
|
0 |
40 |
-40 |
40 |
80 |
0 |
AD>AS |
|
100 |
120 |
-20 |
40 |
160 |
100 |
AD>AS |
|
200 |
200 |
0 |
40 |
240 |
200 |
AD>AS |
|
300 |
280 |
20 |
40 |
320 |
300 |
AD>AS |
|
400 |
360 |
40 |
40 |
400 |
400 |
(AD=AS) |
|
500 |
440 |
60 |
40 |
480 |
500 |
AD |
|
600 |
520 |
80 |
40 |
560 |
600 |
AD |
E is the point of equilibrium where aggregate demand is equal to aggregate supply.
Oy is the equilibrium level of output corresponding to point E
It is a situation of effective demand .effective demand refers to that level of demand of AD which becomes effective because it is equal to AS.
When AD is more than AS
When AD is more than AS .it means the consumer is buying more goods than firm are willing to produce. As a result the planned inventory falls below the desired level. To bring the inventory back to the desired level, firm would increase their employment and output. Where AD becomes equal to AS and there is no further tendency to change.
When AD is less than AS
When AD is less than AS .it means the consumer is buying less goods than firm are willing to produce. As a result, the planned inventory rises. To bring the inventory back to the desired level, firm would decrease their employment and output. Where AD becomes equal to AS and there is no further tendency to change.
Question. Discuss the concept of multiplier with the help of diagram.
Question. Why aggregate demand is equal to aggregate supply at the equilibrium level of income and output? Explain it with the help of diagram.
Question. Using saving and investment approach explain how the equilibrium level of national income determined? also explain what will happen happen if the equilibrium condition is not fulfilled.
Question. Explain the meaning of under employed equilibrium.
Question. Explain the relationship between multiplier and MPC with the help of diagram.
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