The document discusses key concepts in macroeconomics such as aggregate demand, aggregate supply, equilibrium output, and the multiplier effect. It defines ex-ante demand as planned demand and ex-post demand as actual demand. Aggregate demand is the total final expenditure and is affected by consumption, investment, government spending, and net exports. Equilibrium output occurs at the point where aggregate demand and supply intersect. The investment multiplier shows that a change in investment leads to a greater change in total income through subsequent rounds of spending.

1. Theory of income and Employment
Economics 12th ISC Refresher course

2. Exante Demand
• Exante demand refers to the desired demand or planned demand during the
period of one year.
• This is the market demand which is intented to be expected in the economy
during the period of one year.

3. Ex post demand (effective)
• Ex-post aggregate demand refers to the actual demand in the economy
during the period of one year.
• Actual consumer spending and business capital investment are
included in ex-post aggregate demand.
• In other words, the ex-post describes what actually occurred.

4. Aggregate demand and its components
Aggregated demand means the total demand for final goods and services in an economy.
It is the total (final) expenditure of all the units of the economy, i.e., households, firms,
government, and the rest of the world.
• Aggregate Demand refers to the desired level of expenditure in the economy during an
accounting year. It is what people wish to spend on the purchase of goods and services
during an accounting year. Aggregate demand= C+I+G+ (X-M) where
• C= Consumption expenditure
I= Investment expenditure
G= Government expenditure
(X-M)= Net export, where X= Exports and M= Imports.

5. Marginal propensity to save
• Marginal Propensity to Save or MPS is a concept propounded in Keynesian macroeconomic
theory, which refers to the proportion of any additional income that is saved by a consumer
rather than utilizing it for spending on the consumption of goods and services.
• In other words, it shows how much an individual is willing to save when he receives some
additional income. For example, if we say MPS is 2%, then the individual is willing to save 2
rupees for every 100 rupees earned by him.
• MPS is represented by a savings line which is a sloped line that is created by putting change
in savings on the y-axis (vertical) and change in income on the x-axis (horizontal)

6. Marginal Propensity to save
Any change in government expenditure will lead to an increase in
disposable income that will lead to increased consumption. The
increased consumption will result in an increase in disposable
income for other sectors, which leads to further consumption.
Calculating MPS
MPS is calculated using the following formula
MPS = Change in Savings (ΔS) / Change in Disposable Income
(ΔY)

7. Marginal propensity to Save
Y
S S= -a+(1-b) y
dS
dY
MPC = b
MPS= 1-b or
dS/dY
-a Autonomous saving
( negative at low
income)

8. Marginal propensity to Consume
• Marginal Propensity to Consume or MPC is an important component of the Keynesian
macroeconomic theory. This theory suggests that the individual has a propensity to consume more
with an additional rise in income.
• In other words, Marginal Propensity to Consume (MPC) measures the proportionate rise in the
consumption with increase in income or we can say it measures the proportion of extra pay that is
spent on consumption of goods and services rather than saving it.
• Marginal Propensity to Consume or MPC is dependent on the income level. It may vary with the
income levels and it can be seen that the MPC is lower at higher income levels.
• MPC can be calculated by determining the change in consumption divided by the change in income.
• MPC is represented by the consumption line, which is a sloped line that is formed when change in
consumption is plotted on the vertical y-axis with change in income on the horizontal x-axis.

9. Marginal propensity to consume
Consumption
Income
MPC = C
Y
C= Change in consumption
Y= Change in Income

10. Average propensity to consume
• The average propensity to consume (APC) is a measure of the fraction of the total
disposable income consumed. It is considered a significant concept for both
individual consumers and economists.
• The average propensity to consume (APC) is the cumulative measure of the
fraction of spent income.
• The APC is graphically represented by the slope of the consumption function.
• An estimate of the average propensity to consume not only shows the proportion
of household income that is saved but also the total amount saved.

11. Average Propensity to Save
• The ratio of total saving to total income is called APS. Alternatively, it is that part of
total income which is saved.
• By dividing total saving (S) with total income (Y), we get APS
• APS = S/Y
• For instance, in the following table when national income is Rs 200 crore, saving is
Rs 30 crore. In this case APS = SA’ = 30/200 = 0.15 or 15%.

12. Equilibrium output ( Aggregate demand and
Aggregate supply approach )
According to the Keynesian theory, the equilibrium level of income in an
economy is determined at the intersection point of AD and AS curves.
Aggregate demand
Aggregate demand means the total demand for final goods in an economy.
• The AD curve has a positive slope, which means that when income increases, AD (expenditure) also increases. It is
represented by C + I.
• Aggregate supply
• It is the value of the total quantity of final goods and services produced in the economic territory of a country.
An aggregate supply curve is the sum total of consumption and saving.It is a positively sloped 45° straight line curve
starting from the origin.

13. E AD=C+I
C= C +cY
AS = Y=
Expenditure
T
Planned output
45°
I
C
AD
Planned expenditure

14. Aggregate demand is more than Aggregate supply.
• When AD > AS
• i.e., the economy is operating at any level before the equilibrium
• It means that households and firms taken together are willing to buy more than what the firms are
planning to produce, i.e., the AD curve lies below the AS curve.
• It would lead to the unplanned and undesired decrease in inventories.
• Remedy
• If some unemployed or under-employed resources are there in the economy, firms would utilise them
and increase production.
• This will increase the level of income and employment.
This process of increase in the output will continue until the economy reaches the equilibrium level,
where AD = AS.

15. Aggregate demand is less than Aggregate supply.
• It means that households and firms taken together are willing to buy less than what the firms are planning to
produce, i.e., the AD curve lies above the AS curve.
It would lead to unplanned/unwanted accumulation of inventories.
• Remedy
• In this situation, firms would decrease production and employment.
• This will decrease the level of income as well as the aggregate demand.
This process of decrease in the output and income will continue until the economy reaches the equilibrium level,
where AD = AS.

16. Equilibrium output (Savings and Investment
Approach )
S
1
Y
M1
I
E1
S=I
Equilibrium
I=S
o
Y’
Saving / Investment
Income / Output / Employment

17. Equilibrium output: Savings and Investment
approach
• According to this approach of equilibrium, the equilibrium is reached only when Investment(I)
equals Savings(S) because at this level there is no tendency for income and output to change.
• In the diagram the equilibrium is at E where savings intersects investment curve At this point,
I=S.
• When S is more than I , then the planned inventory would fall below the desired level. To bring
back the Inventory at the desired level, the producers expand the output More output means
more income. Rise in output means rise in I and rise in income means rise in S. Both continue to
rise till they reach E, S=I.
• When S is less than I, then the planned inventory rises above the desired level. To clear the
unwanted increase in inventory, firms plan to reduce the output till S becomes equal to I.
• So, equilibrium takes place only at point E, when S=I.

18. Investment multiplier
• Investment multiplier is an important part of economic theories suggested by notable economist John
Maynard Keynes. According to this concept, in the event of an increase in the investment activities either
public or private which can be in the form of private consumption spending, government spending in an
economy, there is a corresponding increase in the Gross Domestic Product (GDP) of the economy by a
value more than the amount invested.
• In simple words, investment multiplier refers to the increase in the aggregate income of the economy as a
result of an increase in the investments done by the government in the form of new projects.
• The size of the investment multiplier is determined by the decisions of the households in an economy in the
areas of spending (which is known as marginal propensity to consume) or saving (known as marginal
propensity to save).

19. The multiplier can be represented by the following formula.
K = ΔY / ΔI
Where,
ΔY = Increase in GDP or National Income
ΔI = Increase in Investment
Also,
• k = 1/ 1- MPC
Where k = Investment Multiplier
MPC = Marginal Propensity to Consume
And, k = 1/ MPS
MPS = Marginal Propensity to Save
Therefore, it can be concluded that K = 1/ 1- MPC = 1/ MPS

20. It can be said that in order to find the value of the investment multiplier, either the value
of MPC or MPS should be determined or the value of the multiplier can be determined
if MPC or MPS values are provided. Let us understand the mechanism of investment
multiplier with an example.

21. • Suppose the government has made an investment of 100 crores in a road
construction project. This will lead to hiring of labourers, engineers and
suppliers of raw materials, logistics. In short such an investment will lead to
job opportunities for many people. It will result in income generation, which
will result in their tendency to consume and save.Let’s say the MPC of the
labourers is 0.5, that means that for every 1 rupee earned they spend 0.50
rupees in consumption of goods and services.
Simple Numerical

22. Similarly, we can find the value of the multiplier when MPS = 0.2
K = 1/MPS
K= 1/0.2
K= 5
Therefore, it can be seen that if the MPS value is less than the multiplier, the value increases, and when
the value of MPC is more then the investment multiplier becomes more.
The value of MPS or MPC can be used to find the total increase in income obtained from the initial
investment by using the following formula

23. K = ΔY / ΔI
• and, K = 1/MPS
Therefore, in the above example an investment of 100 crores will bring total income of
ΔY / ΔI = 1/MPS
ΔY / 100 = 1/0.2
ΔY / 100 = 5
ΔY = 500
Therefore, the total increase in income will be 500 Crores.

24. Full Employment
• Full employment refers to a situation in which all those people, who are
willing and able to work at the existing wage rate, get work without any
undue difficulty. It also refers to employment of all the other available
resources and factors of production for the production of optimum output.

25. Excess demand
EF indicates the excess demand or the inflationary gap.
Excess demand is the excess of aggregate demand over and above
its level required to maintain full employment equilibrium in the
economy. It implies two things-
1) Planned aggregate demand in the economy happens to exceed its
full employment level.
2) The level of aggregate demand surpasses the level of aggregate
supply even when the available factors are fully utilized.

26. Deficient Demand
Deficient demand refers to a situation wherein aggregate demand
in the economy falls short of aggregate supply of goods and
services at full employment.
Impacts:
1)Deficient demand leads to a fall in the income
level, output and employment.
2)A persistent fall in the deficient demand leads to a state of
depression in the economy.

27. Measures to correct excess demand and
deficient demand
• Two measures by which a central bank can check the excess demand or inflation are as
follows:
• 1) Increase in bank rate: During inflation bank rate is increased. As a follow-up action, the
commercial banks rise the market rate of interest. This reduces the demand for credit and
thus inflation can be combated.
• 2) Open market operation is the policy that focuses on increasing and decreasing the stock
of liquidity with the people, through sale and purchase of securities by the central bank.
During excess demand or inflation, the central bank tries to sell securities. The sale of
securities reduces purchasing power from the market. Consequently, aggregate demand is
decreased and excess demand or inflationary gap gets combated.

28. Presentation by Himaan Harish S
BSc Economics ( Honours )
BASE University