(MACRO)

CHAPTER - 8
DETERMINATION OF NATIONAL INCOME , OUTPUT AND
EMPLOYMENT

Q. How is the equilibrium level of income / output / employment

determined with the help of C+I approach , AD and AS
Approach / planned spending and planned output approach ?
Ans. According to Keynes, equilibrium level of income is determined at
a point where AD =AS (45 line) i.e planned spending = planned
output.
 Aggregate demand shows planned spending i.e total expenditure
which economy plans to incur on the purchase of final goods and
services .
 Assuming that there are only two sectors i.e households and firms
and further there is no government interference and foreign trade .
 Therefore AD = C+ I where C is private consumption demand by
households and I is autonomous investment which remains same
at all levels of income .
 Aggregate supply shows planned output and it is the money value
of total output available for purchase by economy during a given
period .
 Total production of goods and services in the economy is same as
national income as income is either consumed or saved . Therefore
AS = C + S
 Equilibrium level of income / output is determined at a point
where AD = AS or (Y)
 C+I=C+S
 I = S
i.e Planned investment = Planned savings .
This can be explained with the help of following schedule and
diagram : -

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  SCHEDULE
Income Consu - Savings Planned Agg Agg
mption Investment Demand Supply
(Y) (C) (S) (I) AD = C+I AS=C+S
0 100 -100 100 200 0
100 150 -50 100 250 100 AD>AS
200 200 0 100 300 200
300 250 50 100 350 300
400 300 100 100 400 400 AD = AS
500 350 150 100 450 500
600 400 200 100 500 600 AS > AD

As shown in schedule and diagram , equilibrium level of income is 400

i.e OM because at this point AD = AS . E is the point of equilibrium
because at this point AD = AS .
 DIAGRAM

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  If AD > AS
 Planned spending will be more than planned output i.e AD > AS
at the level of income which is less than the equilibrium level of
income .
 There is unplanned decrease in inventory but producer will try to
produce more goods and services by employing more people .
 As a result output tends to increase , leading to increase in income
generation till it reaches the point of equilibrium where AD = AS .
 Only Understanding  AD  Production  Employment
Income  AS  AD = AS
 If AS > AD
 Planned output will be more than planned spending at level of
income which is more than the equilibrium level of income .
 There is unplanned increase in inventories so producer will try to
produce less goods and services by employing less people .
 As a result output tends to decrease leading to decrease in income
generation till it reaches the point of equilibrium OM where AD =
AS .
 Only Understanding  AS  P  Employment   Income
  AD  Impact  AD = AS

Q. What happens when planned spending > planned output or AD

> AS ?
Ans. Write AD > AS from above ( give diagram also pg 2 )
Q. What happens when planned output is more than planned
spending i.e AS > AD ?
Ans. Write AS > AD from above ( give diagram also pg 2 )
Q. What happens when planned output is not equal to planned
spending ?
Ans. Write AD > AS and AD < AS (give diagram also pg 2)
Explain both cases same as above .

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Q. How is equilibrium level of income determined with planned
saving and planned investment approach ? or ( Saving -
Investment approach)
Ans. According to Keynes , equilibrium level of income is determined at
a point where planned saving = planned investment i.e S = I .
 Saving is excess of income (Y) over consumption (C) .
S=Y-C
 Savings here is planned savings i.e what we intend to save in a
given period of time .
 Investment is creation of new capital assets like building ,
machinery which further helps in production .
 According to Keynes , investment is autonomous i.e it remains
same at all levels of income .
 Thus equilibrium will be determined at a point where
AD = AS
 C+I =C+S
 I = S
i.e Planned Investment = Planned Savings
There can be explained with the help of following schedule
and diagram :-
 SCHEDULE
S = -100 + 0.5 Y
Income Planned Saving Planned investment
(Y) (S) (I)
0 -100 100
100 - 50 100 I>S
200 0 100
300 50 100
400 100 100 S=I
500 150 100
600 200 100 S>I
 As shown in the schedule , 400 is the equilibrium level of income
because here savings = Investment .

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 DIAGRAM

 In the diagram E is the point of equilibrium because at this point

S = I and is equilibrium level of income .
 If I > S
 Planned investment is greater than planning savings when
economy is at the level of income less than equilibrium level of
income i.e I > S.
 When investment > Savings , then there is more investment by
producers and thus these are less savings by households .
 Thus there will be unplanned decrease in inventories and
producer will produce more by employing more people .
 As a result output increases leading to increase in income
generation till it reaches the point of equilibrium where planned
savings = planned investment .
 Only Understanding  I  P  E  Output  Y  S 
Impact I = S

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  If S > I
 Savings is greater than investment when economy is at the level of
income more than the equilibrium level of income i.e S > I .
 When S > I , there is less investment by the producers and there
are more savings by the households .
 Thus there will be unplanned increase in inventories and producer
will produce less by employing less people .
 As a result, output decreases leading to decrease in income
generation till it reaches a point of equilibrium where planned
savings = planned investment .
 Only Understanding S  P   E   Y   AS  Impact 
S=I
Q. What happens when planned investment is greater than planned
savings i.e I > S ?
Ans. Write I > S from above (give diagram pg 5 )
Q. What happens when planned savings > planned investment , S >
I?
Ans. Write S > I from above (give diagram pg 5 )

NOTE :- If these two ques come for 6 marks write equilibrium ques
also.
Q. How is equilibrium level of national income determined ?
Ans. If no approach is mentioned give both in brief .
 Equilibrium level of national income is determined a point where
AD = AS and S = I .
 Explain definitions, give schedule common Pg 2 . Give both
diagrams from Pg 2 and 5 .

Q. Define full employment level of output .

Ans. Full employment level of output of goods and services is the
largest output that the economy is capable of producing when all
resources are fully employed .

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Q. Given C = 200 + 0.9Y and I = 3000 Calculate .
(i) Equilibrium level of National and Income
(ii) Savings of equilibrium level of income .
Ans. Y = 32,000 ,  S = 3,000

Q. C = 60 , I = 15 , b = 0.8 . What will be the equilibrium level of

output ?
Ans. Y = 375

Q. In an economy C = 500 + 0.9Y , I = 1000 .S Calculate equilibrium

level of income , consumption expenditure at equilibrium level .
Ans. Y = 15000 , C = 14000

Q. Measure the level of AD when autonomous investment and

consumption expenditure is 50 crores and MPS = 0.2 . The level
of income is Rs 4000 crores . State whether economy is at
equilibrium or not .

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Ans. AD = 3250 , AS = 4000 , AD ≠ AS
No , Economy is not in equilibrium .

Q. C = 80 , I = 20 , b = 0.8 . Calculate income and aggregate

demand and state whether economy is in equilibrium .
𝐀
New formula Y = where A = C + I , b = MPC .
𝟏−𝐛

Ans. Y = 500 , AD = 500 , Yes , Economy is in equilibrium .

𝐀
 DERI VATION OF Y =
𝟏−𝐛

AD = C + I -1
We know C = C + bY
I = I (autonomous Investment i.e investment remains
constant at all levels of income) .
Putting values in equation - 1 , we get
AD = C + bY + I
AD = C + I + bY -2
C +I = A (A = Autonomous expenditure)
Putting this value in equation 2 , we get
AD = A + bY
We know AD = AS ( Because AS = Y )
 AD = Y
 Y = A + bY
Y -bY = A
Y( 1-b) = A

A
Y=
1−b

Q. What do you mean by Paradox of thrift ?

Ans. The concept of paradox of thrift was given by Keynes . According
to this concept as people become more thrifty , they end up saving
less or same as before .

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  If all the people in the economy start saving more , then MPS ie
∆𝐒
( ) increases , the value of savings in the economy will not
∆𝐘
increase rather it will decline or remain unchanged .
 Thus consumption decreases and with decrease in consumption ,
aggregate demand decreases . Thus producer produces less by
employing less people . Hence there is fall in income , output and
employment which leads to less savings .
 Only Understanding  Save  MPS  C   AD   Y  
Output   Saving 

Q. Explain the 'effective demand principle ' .

Ans. The level of aggregate demand required to achieve full
employment equilibrium is called effective demand .
 In other words , the particular aggregate demand which is equal
to aggregate supply and determines the equilibrium national
income is called effective demand .
 Effective demand refers to that level of income / output where ex-
ante aggregate demand is equal to the ex-ante aggregate supply
i.e AD = AS .
 In short run analysis , aggregate output is solely determined by
aggregate demand as aggregate supply function is constant . This
is effective demand principle . Because in short run aggregate
supply do not change , so it is the level of effective demand or
aggregate demand which determines the level of output income
and unemployment . Thus for increasing the level of income and
employment , increase in effective demand is essential .
NOTE :-
If question is long , give table from pg 2 of equilibrium .

Q. How is equilibrium level of output determined under short run

fixed price ?
Ans. Equilibrium level of output is determined under short run
fixed price by the level of ex-ante aggregate demand .

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Q. Define short run from macro economic view .
Ans. According to Keynes, short run is defined as a time period during
which the level of output is exclusively determined by level of
employment in an economy . Higher level of employment there
will be proportionately higher level of output and vice versa.
(Technology remains constant) .
AS = f (employment , technology )

INVESTMENT MULTIPLIER

Q. Define Multiplier / Investment Multiplier / Output Multiplier .

Ans. Investment Multiplier is the ratio of change in income (Y) to the
change in investment (I) . It is denoted by K .

∆Y
 K=
∆I

 Thus multiplier denotes the number of times the income increases

as a result of small change in investment .
 Let multiplier investment increases by Rs 100 crores and as a result
income increases by Rs 500 crores . Thus multiplier is 5 as shown
below :-
∆𝐘
K =
∆𝐈

𝟓𝟎𝟎
K = = 5
𝟏𝟎𝟎

Q. Explain the relationship between MPC and K ?

Ans. There is direct relationship between MPC and K . When MPC
increases , K also increases and vice versa .
 When MPC increases it means people are consuming more out of
their income .
 More consumption leads to more demand of goods and services .
Thus producer will try to produce more by more investment and
more employment .
 Thus there is increase in income generation in the economy and
the value of K increases .
𝟏
K=
𝟏−𝐌𝐏𝐂

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10
  EXAMPLE
𝟑 𝟒
If MPC = (0.75) and If MPC = (0.8)
𝟒 𝟓
𝟏 𝟏
Then , K = Then K =
𝟏−𝐌𝐏𝐂 𝟏−𝐌𝐏𝐂

𝟏 𝟏
K= K=
𝟑
𝟏− 𝟒 𝟏−𝟒𝟓
𝟏 𝟏
𝟏 = 4 𝟏 =5
𝟒 𝟓
It shows as MPC increases , K also increases .

 DERIVATION
At the point of equilibrium Y = AD
 Y = AD
Y = C + I ( AD = C + I )
Multiplying both sides by  , we get
Y=C + I
Dividing both sides by  Y , we get
∆𝐘 ∆𝐂 ∆𝐈
= +
∆𝐘 ∆𝐘 ∆𝐘

𝟏
1 = MPC +
𝐊

𝟏
1 - MPC =
𝐊

𝟏 𝟏
= 1 - MPC or K=
𝐊 𝟏−𝐌𝐏𝐂

GIVE DERIVATION ONLY IF QUESTION IS FOR 6 MARKS

Q. Explain the relationship between K and MPS .
Ans. There is inverse relationship between K and MPS . As MPS
increases , K decreases and vice versa .
𝟏   MPS = 1 - MPC
K=
𝐌𝐏𝐒

 As MPS increases people save more out of their income and thus
consume less .

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  Decrease in consumption leads to decrease in demand of goods
and services .
 Thus producer will produce less and employ less . As result there
is decrease in output leading to decrease in income generation in
the economy .
 Thus MPS increases , K decreases and vice - versa .
 EXAMPLE
1 1
 If MPS = If MPS =
3 5
𝟏 𝟏
then K = 𝟏 = 1 
3
=1
5
=3 then K = 𝟏 =5
1 1
𝟑 𝟓
Hence K increases with decrease in MPS .

Q. What is the maximum value of K ?

Ans.
 It is infinity . It happens when MPC = 1 , K = ∞
 K lies between 1 and ∞
1
K=
1−𝑀𝑃𝐶

1 1
K= = =∞
1−1 0

K=∞
Q. What is the minimum value of K ?
Ans. The minimum value of K is 1 .
It happens when MPC = 0 , K = 1 .
1 1 1
K= =K = =1
1−𝑀𝑃𝐶 1−0 1

Q. What is the value of K when MPC = MPS ?

Ans. We know MPC + MPS = 1
When MPC = MPS
Then MPC = MPS = 0.5
1 1 1
K= = = =2
1−𝑀𝑃𝐶 1−0.5 𝑂.5

Hence, When MPC = MPS , K = 2

Q. Can value of K be zero ?
Ans. The value of K cannot be zero because whenever there is some
investment , income tends to increase .

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Q. Explain the working of Investment Multiplier with numerical
example . or
How change in investment leads to change in income ?
Ans. Investment Multiplier is the ratio of change in income ( Y) to the
change in investment( I ) . It is denoted by K .
∆Y
K=
∆I

 It indicates the number of times the income increases as a result of

small change in investment .
 WORKING OF MULTIPLIER

Change in  Change in  Change in  Change in

investment income Consumption income

 Initially there is change in investment which leads to change in

income by the same amount . This change in income leads to
change in consumption depending upon the value of MPC . Thus
final increase in income is many times more than the change in
investment because of the working of multiplier .
 The working of multiplier is based an following assumptions :-
 ASSUMPTIONS :-
(i) Let increase in investment is equal to increase in income .
i.e  I = Y
(ii) MPC = 0.5
(iii) One man's expenditure is another man's income .
 NUMERICAL EXAMPLE
Time (I) (Y) (C) (S)
Period Increase in Increase in Change in Change
Investment income Consumption Savings
1 100 crores 100 50 50
2 . 50 25 25
3 . 25 12.5 12.5
4 . 12.5 6.25 6.25
5 . 6.25 3.125 3.125
6 . - . .
7 . . . .
. . . .
Total 100 200 100 100

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 As MPC = 0.5
1 1 1
K= = = =2
1−𝑀𝑃𝐶 1−0.5 𝑂.5

∆Y
K=
∆I
∆Y
2=
100

 Y = 200 crores
 EXPLANATION
 The above eg or table shows that due to initial increase in
investment by 100 crores , the income changes by 100 crores . Since
MPC = 0.5 , the consumption will increase by Rs 50 crores and the
remaining Rs 50 crores will be saved .
 Due to an expenditure of Rs 50 crores on consumption , there will
be an increase in income by Rs 50 crores in the next time period .
 It will lead to increase in consumption by Rs 25 crores and Savings
will also increase by the same amount .
 This process will continue in different time periods i.e income will
go on increasing as result of consumption expenditure . Ultimately
, income will increase to Rs 200 crores . Hence multiplier i.e K = 2 .
 The endless chain of secondary consumption pattern leads to
increase in income to Rs 200 crores .
 Hence at equilibrium level , Rs 100 crores of additional investment
results in Rs 200 crores of additional income.
 i.e  I  Y  C  Y  C .

 DIAGRAM

Next page

GIVE DIAGRAM ONLY IF ASKED IN QUESTION

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14
  Initially E is the point of equilibrium where AD = AS
corresponding to 0Y level of income .
 When aggregate demand increases from AD to AD' because of
change in investment (I) .
 E' is the new equilibrium and income increases from 0Y to 0Y1
indicating forward action of multiplier.
 Multiplier action is forward when there is multiple increase in
income caused by an increase in investment .
 Thus change in income (Y) is more than change in investment i.e
(I) because of working of multiplier .
 When investment falls aggregate demand falls from AD to AD2
and E2 is equilibrium and income falls from 0Y to 0Y2 . This
indicates backward action of multiplier .
 Multiplier action is backward if there is a multiple decrease in
income caused by decrease in investment.

Q. What will be the value of multiplier when entire additional

income is converted into additional consumption ?
Ans. In this situation C = Y
∆𝐶 1
 MPC = = =1
∆𝑌 1
1 1 1
K= = = =∞
1−𝑀𝑃𝐶 1−1 0

 When C = Y , K = ∞

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15
IMP NOTES ABOUT K

 When MPC = 0 , K = 1 

 When MPC = 1 , K = ∞ 
 There is inverse relationship between K and MPS .
 There is direct relationship between K and MPC .

 When MPC = MPS , K = 2 

 K cannot be zero .
 K lies between 1 and ∞ 

1 1
 K= or K=
1−𝑀𝑃𝐶 𝑀𝑃𝑆

∆𝑌
 K=
∆𝐼

 When C = Y , K = ∞ 

Q. Why is aggregate demand curve parallel to the consumption

curve ?
Ans. The aggregate demand curve is parallel to the consumption curve
since they have the same slope , i.e MPC .
 This is because AD = C + I , where I remains constant irrespective
of the level of income . So , AD rises only with the rise in
consumption , C . So, the slope of the aggregate demand curve
remains the same as that of the consumption curve .

Q. State the two components of autonomous expenditure . How do

they behave in general ?
Ans. There are two components of autonomous expenditure ( A ) :
(i) Autonomous consumption (C )
(ii) Autonomous investment (I )
 In reality , the two components of autonomous expenditure
behave in different ways .
 C remains more or less stable over time .
 However, I undergoes periodic fluctuations . We have assumed
that investment is autonomous , which means that it does not
depend on income . But , investment may increase at lower interest
rates .

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