DETERMINATION OF INCOME PPT

1. UNIT 8.
DETERMINATION OF
INCOME & EMPLOYMENT

2. Macro Economics theorties relating to the determination od income and
employment have been propunded in 2 stages:
a) Classical View / Theory (By Adam Smith, David Ricardo, J.B. Say)
b) Modern View ( based on Keynes’ Theory of income and employment)

3. ASSUMPTIONS OF CLASSICAL VIEW
1. There will be full employment in the economy due to existence
of equality between AD & AS.
2. There are no savings in the economy as all that is earned is
spent or invested.
3. Existence of free and perfect competition among products and
factors.
MODERN VIEW (KEYNES’ THEORY )
1. There cannot be automatic equality between aggregate demand and
aggregate supply.
2. The situation of full employment rarely exists.
3. AD could fall short of AS. So the situation of full employment is disturbed.
4. In case of deficient demand, AD falls short of AS. According to Keynes, this
is a situation of involuntary unemployment.

4. • It is a situation in which all those people who are willing and
able to work at the existing wage rate do not get work.
• This situation arises due to excess of labour supply or deficiency
of demand in the market.
INVOLUNTARY UNEMPLOYMENT
WE IS THE EQUILIBRIUM WAGE RATE
where supply of labour = demand for
labour.
When wage rate is above equilibrium wage
rate, there will be excess supply of labour.
AB denotes the situation of involuntary
unemployment. (AB)
FULL EMPLOYMENT
• It is a situation in which all those people who are willing and able to work at the
existing wage rate get work. (or)
• It is a situation in which increase in AD does not lead to increase in the level of output
& employment. In such situation, the given capacity of the economy is fully utilized.
EMPLOYME
NT
WAGE

5. EX-ANTE AND EX-POST MEASURES
B. EX-POST MEASURES:
The planned values of the variables are called ‘ex-ante’ measures.
EX-ANTE CONSUMPTION: It refers to planned consumption expenditure on final goods
in the economy.
EX-ANTE INVESTMENT: It refers to planned investment expenditure on final goods in
the economy.
EX-ANTE SAVINGS: It refers to the planned savings at different levels of income in an
economy.
A. EX-ANTE MEASURES:
The ACTUAL OR REALISED values of the variables are called ‘ex-post’ measures.
EX-POST INVESTMENT: It refers to the actual amount of investments in the economy in
a year.
EX-POST SAVINGS: It refers to the the actual amount of savings made in an economy in
a year.

6. AGGREGATE DEMAND AND AGGREGATE SUPPLY
A. AGGREGATE DEMAND
Aggregate demand refers to the value of final goods and services that all sectors of
the economy taken together are planning to buy at a given level of income during a
given period of time.
It is ex-ante demand or planned demand.
COMPONENTS OF AGGREGATE DEMAND :
AD = C + G + I + (X –M)
= Private Final Consumption Expenditure + Government Final Consumption
Expenditure + Gross Domestic Capital Formation + Net Exports
In a two sector economy, there are only two components of AD = C + I
Consumption expenditure (C) : It is that portion of income which is spent on
purchase of goods & services by the consumers in an economy in a given year.
Investment expenditure (I): It refers to the addition to the stock of physical capital
and change in inventories of a firm in an economy.

7. DIAGRAMMATIC PRESENTATION OF AGGREGATE DEMAND :
EMPLOYMENT / INCOME /
OUTPUT
AD,
C,
I
I
C = a +bY. In this formula a is the level
of autonomous consumption, where b is
the marginal propensity to consume out of
income.

8. TABULAR REPRESENTATION OF AD = C+ I
LEVEL OF
EMPLOYMENT
(in Lakh)
INCOME (Y)
(Crore)
CONSUMPTION
EXPENDITURE
©
INVESTMENT
EXPENDITURE
(I)
AD = C+ I
(Crore)
0 0 50 50 100
10 50 75 50 125
20 100 100 50 150
30 150 125 50 175
40 200 150 50 200
50 250 175 50 225
60 300 200 50 250
Break Even
point
Y (AS) = AD
Autonomous Consumption
Autonomous consumption is the consumption at zero level of
national income which is met from past savings.

9. B. AGGREGATE SUPPLY
Aggregate supply refers to the value of final goods and services planned to be
produced by all the production units in the economy taken together during a
period.
COMPONENTS OF AGGREGATE SUPPLY:
The value of final output (AS) = the cost planned to be incurred on producing this
output.
This cost includes expenditure on payment of rent, wages, interest and profit paid
by production units.
= rent + wages + interest + profit = National income = (Y)
AS = Y
Income is either spent or saved.
So, AS = Y = C + S
AS = C + S

11. 4. In the beginning C > Y, but after C = Y (break-even point), C
lags behind (C<Y).
5. Saving curve S starts from below origin. i.e. negative side
because at zero level of income, autonomous consumption is
done from the past savings (Dis-savings). So Savings will be
negative when C > Y.
As income increases, Saving also increases. So S curve will be
upward sloping.
6. When C > Y, S is negative. (-ve)
When C = Y, which is the Break-Even point, S = 0.
When C < Y, Saving is +ve.

13. CONSUMPTION FUNCTION / PROPENSITY TO CONSUME
CONSUMPTION FUNCTION – It refers to
the functional relationship between
consumption and income.
C = f(Y)
PROPENSITY TO CONSUME: It refers to
the proportion of income spent on
consumption.
Consumption function is algebraically
expressed as:
In short, consumption equation C = C + bY
shows that consumption (C) at a given level
of income (Y) is equal to
autonomous consumption (C) + b times of
given level of income.

14. = TOTAL CONSUMPTION / TOTAL
INCOME

15. = CHANGE IN CONSUMPTION / CHANGE IN INCOME

16. AVERAGE PROPENSITY TO CONSUME
(APC) - VALUES
MARGINAL PROPENSITY TO CONSUME
(MPC) - VALUES
1. APC can be greater than 1 (APC > 1),
when C > Y. At this point consumption will
be done from past saving.
1. The value of MPC varies from 0 to 1.
2. APC can be equal to 1 when C = Y, at
break-even point.
2. The value of MPC = 1, if entire
additional income is spent. (Change in
consumption = Change in income)
3. The value of APC can be less than 1
when C < Y, to the right of break-even
point, because the increase in
consumption is not equal to increase in
income.
3. The value of MPC = 0 when entire
additional income is saved.
i.e. (Change in consumption = 0)
4.APC will never be ZERO or less than 0,
because even at zero level of income,
there is some minimum consumption from
past savings.
4. The MPC of poor is more than of rich as
poor person needs to spend on basic
necessities.
5. APC falls with increase in income. 5. In linear relationship MPC is always
constant.

17. APC FALLS WITH INCREASE IN INCOME. PROVE.
C = 100 + 0.5Y
If Y1 = 1000, then C1 = 100 + 0.5 (1000) = 600
APC = C / Y = 600 /1000 = 0.6
If Y2 = 2000, then C2 = 100 + 0.5 (2000) = 1100
APC = C / Y = 1100 / 2000 = 0.55
When income increases, APC falls .
Hence proved.

18. SAVING FUNCTION / PROPENSITY TO SAVE
SAVING FUNCTION – It refers to the functional
relationship between saving and income.
S = f(Y)
Saving is that part of income which is not
consumed. S = Y – C.
PROPENSITY TO SAVE: It refers to the
proportion of income saved.

19. PROPENSITY TO SAVE
AVERAGE PROPENSITY TO SAVE
(APS)
MARGINAL PROPENSITY TO SAVE
(MPS)
It is the ratio of total saving to
total income.
APS = TOTAL SAVING / TOTAL
INCOME = S /Y
For example, If savings are 60
crore, income is 100 crore,
APS = C/Y = 60 / 100 = 0.6 (60%)
It is the ratio of change in saving
to change in income.
MPS = CHANGE IN SAVING /
CHANGE IN INCOME =
For example, if Saving increases
from 40 Crore to 80 crore as
income increases from 100 to 200
crore, then MPC = 40 / 100 = 0.4
(40%)

20. AVERAGE PROPENSITY TO SAVE
(APS) - VALUES
MARGINAL PROPENSITY TO SAVE
(MPS) - VALUES
1. APS can be NEGATIVE. (APS -ve), when C
> Y. At this point consumption will be done
from past saving.
1. The value of MPS varies from 0 to 1.
2. APS can be equal to ZERO when C = Y, at
break-even point.
2. The value of MPS = 1, if entire additional
income is saved. (Change in saving = Change
in income)
3. The value of APS can be greater than 0
(zero) when C < Y, to the right of break-even
point, because the increase in consumption
is not equal to increase in income.
3. The value of MPS = 0 when entire
additional income is consumed.
i.e. (Change in saving = 0) (or Change in
consumption = Change in income)
4.APS will never be one or greater than 1,
because even at zero level of income, there
is some minimum consumption from past
savings.
4. The MPS of poor is less than of rich as
poor person needs to spend on basic
necessities.
5. APS increases with increase in income. 5. In linear relationship MPS is always
constant.

21. APS INCREASES WITH INCREASE IN INCOME. PROVE.
S
C = 100 + 0.5Y
If Y1 = 1000, then C1 = 100 + 0.5 (1000) = 600
S = Y-C;= 1000 – 600 = 400
APS = S / Y = 400 /1000 = 0.4 (40%)
If Y2 = 2000, then C2 = 100 + 0.5 (2000) = 1100
S = Y-C;= 2000 – 1100 = 900
APS = S / Y = 900 / 2000 = 0.45 (45%)
When income increases, APS increases.
Hence proved.

22. RELATION BETWEEN APC & APS; MPC & MPS
APC + APS = 1
MPC + MPS = 1

23. EX-ANTE SAVING:
The amount, savers or households plan to save at different levels of income in
an economy during a year.
These are intended or planned savings.
EX-ANTE INVESTMENT:
The amount, investors or firms paln to invest at different levels of income in an
economy during a year.
These are intended or planned investment.
Note:
Ex-ante savings and Ex-ante investment may or may not be equal.
These are equal only at the point of equilibrium as savers and investors are
guided by different factors.

24. EX-POST SAVING:
It refers to the actual or realized saving in an economy during a year.
EX-POST INVESTMENT:
It refers to the actual or realized investment in an economy during a year.
Note:
Ex-post savings and Ex-post investment are always equal at all levels of income
because it is an accounting identity: - means in both the cases it is excess of
consumption.
AD = C + I; AS = C + S
C + I = C + S
I = S

25. AUTONOMOUS INVESTMENT & INDUCED INVESTMENT

26. Draw a straight line Consumption Curve; from it derive a Saving curve, explaining the
process of derivation. Show the points APC = 1 and APS is negative.

28. Draw a straight line Saving Curve; from it derive a Consumption curve, explaining the
process of derivation. Show the points APC = 1 and APS is negative.

29.  According AD and AS approach, the equilibrium is
reached only when aggregate demand (AD) equals
aggregate supply (AS) because at this level there is no
tendency for income and output to change.
 The equilibrium is where AD intersects 45 line. At this
point, AD = AS.
 That is, C+I = C+S
 When AD > AS: (planned AD > planned AS):
 It means that buyers are planning to buy more goods
and services than producers are planning to produce.
 As buyers are buying faster than sellers are expecting,
inventories will start falling and come below the
desired level.
 To build the desired inventory level, producers will
expand production.
 This raises the level of employment & income.
 Tis process will continue till AD = AS.
EXPLAIN THE DETERMINATION OF EQUILIBRIUM LEVEL OF INCOME USING AD-AS
APPROACH. (Modern theory / Keynes theory)

30.  When AS > AD: (planned AD > planned AD:
 It means that buyers are planning to buy less goods and services than
producers are planning to produce.
 As buyers are buying less than sellers are expecting, inventories will start
rising and move above the desired level.
 As a result, producers will plan to cut down production.
 This will decrease the level of planned output, employment & income.
 This process will continue till AD = AS.

31. TABULAR REPRESENTATION OF EQUILIBRIUM
LEVEL OF
EMPLOYMENT
(in Lakh)
INCOME
(Y)
(Crore)
CONSUMPTION
EXPENDITURE
©
INVESTMENT
EXPENDITURE
(I)
SAVINGS
(S)
AD = C+ I
(Crore)
AS = C+S
(Crore)
0 0 50 50 -50 100 0
10 50 75 50 -25 125 50
20 100 100 50 0 150 100
30 150 125 50 25 175 150
40 200 150 50 50 200 200
50 250 175 50 75 225 250
60 300 200 50 100 250 300
Equilibrium level of income is 200 crore where AD= AS = 200 Crore.

32. EXPLAIN THE DETERMINATION OF EQUILIBRIUM LEVEL OF INCOME USING S-I
APPROACH. (Modern theory / Keynes theory)
 According S and I approach, the equilibrium is
reached only when savings (S) equals Investment (I)
because at this level there is no tendency for income
and output to change.
 I is the component od AD and S is the component of
AS.
 That is, C+I = C+S; I = S is the point of equilibrium.
 When I>S: (planned I > planned S):
 It means that buyers are planning to buy more goods
and services than producers are planning to produce.
 As buyers are buying faster than sellers are expecting,
inventories will start falling and come below the
desired level.
 To build the desired inventory level, producers will
expand production.
 This raises the level of employment & income.
 Tis process will continue till I = S.

33.  When S > I: (planned S > planned I:
 It means that buyers are planning to buy less goods and services than
producers are planning to produce.
 As buyers are buying less than sellers are expecting, inventories will start
rising and move above the desired level.
 As a result, producers will plan to cut down production.
 This will decrease the level of planned output, employment & income.
 This process will continue till S = I.

34. NUMERICAL ILLUSTRATIONS:
Q1. If the consumption function in an economy is C = 50 + 0.75 Y and
autonomous investment is RS. 30 Crore, Calculate equilibrium level of
income.
Answer: AD = AS
C + I = Y
50 + 0.75 Y + 30 = Y
80 = Y – 0.75 Y
80 = 0.25 Y
Y = 80 / 0.25 = 320 crore
Equilibrium level of income = 320 Crore.

35. Q2. Given that the saving function is S = -50 + 0.8 Y and I = 110 crore.
Calculate the equilibrium level of income.
Answer:
At equilibrium AD = AS
C + I = Y
(If S = -50 + 0.8 Y then, C = 50 + 0.2 Y)
50 + 0.2 Y + 110 = Y
160 = Y – 0.2 Y
0.8 Y = 160
Y = 160 / 0.8 = 200 Crore.
(OR)
At equilibrium S = I
-50 + 0.8 Y = 110
0.8 Y = 110 + 50
0.8 Y = 160
Y = 160 / 0.8 = 200 Crore