NCERT Solutions for class 12th Economics Part B Chapter 4 Income Determination

NCERT Textbook Questions Solved

Question 1. What is marginal propensity to consume? How is it related to marginal propensity to save?

Ans. Marginal Propensity to Consume: MPC is defined as the rate of change in aggregate consumption expenditure as aggregate income changes. Symbolically,

If income rises from rs.100 crores to rs.120 crores and consumption rises from rs.40 crores to rs.50 crores then
MPC = 10/20 = 0.5 or 50%.
Features of MPC:

  1. Graphically, MPC is the slope of consumption curve.
  2. Value of MPC lies between 0 &1.
  3. MPC is always less than APC.

For the purpose of study, MPC is assumed to be constant throughout.
The sum total of MPC and PMS is equal to 1.
MPC + MPS = 1

Question 2. What is the difference between ex-ante investment and ex-post investment?

Ans. Ex-ante means planned or desired or intended during a particular period. For example: ex-ante investment means the planned investment during a particular period.
Ex-post means actual or realized during a particular period. For example: ex-post investment means actual or realized investment.

Question 3. What do you understand by ‘parametric shift of a line’? How does a line shift when its (i) slope decreases, and (ii) its intercept increases?

Ans. Equation of a straight line is given by
b = ma + ε
where variables are a and b but m and ε are also working in the background. Any change in m and ε also bring a change in the shape of graph.
If m changes then slope of the graph changes and if ε changes then the intercept of the curve changes. These changes bring about changes in a line which is termed as parametric shift in a line.

(i) Shift in a line when slope decreases:

Question 4. What is ‘effective demand’? How will you derive the autonomous expenditure multiplier when price of final goods and the rate of interest are given?

Ans. That level of Aggregate Demand where AD and AS become equal is called effective demand. In other words, aggregate demand at equilibrium level is called effective demand.
Meaning : It is the measure of change in national income as a result of change in autonomous expenditure. In other words, multiplier is that number which when multiplied by the amount of change in autonomous expenditure gives us the value of consequent change in income. When there is an increase in autonomous expenditure, national income increases not by the amount of autonomous expenditure but by a multiple of it. Measure of it is called multiplier.

The operation of multiplier ensures that a change in autonomous expenditure causes a change in output by an amplified amount, which is a multiple of the change in autonomous expenditure.
Suppose Government of India makes an autonomous expenditure of rs.100 crore in the villages in order to generate employment opportunities. As a result of this autonomous expenditure, national income rises by rs.200 crore. Thus, K = 200 / 100 = 2

Relationship between Autonomous expenditure Multiplier, MPC and MPS There is a direct relationship between MPC and Multiplier i.e. more will be MPC, more will be the value of multiplier and vice-versa. It is so because from the point of view of the entire economy, expenditure of one individual is the income of another. When autonomous expenditure is increased, income of the people is also increased. They spend a part of this increased income on consumption and they save the rest. How much of their income people would spend on consumption depends on MPC. If MPC is more they will spend more. There is an indirect relationship between MPS and Multiplier i.e. more will be MPS, less will be the value of multiplier and vice-versa. This relation can be expressed in terms of an equation as under if we assume that there is a change in autonomous investment and no change in autonomous consumption:

Thus, MPC & multiplier are directly related while MPS & multiplier are inversely related.

Working of Multiplier
Let us take an example. Suppose, autonomous expenditure has been increased by ` 100 crore; MPC is ½ or 0.5, K = 2

income by `100 crore. It is assumed that MPC is 0.5. Hence, due to increase in income by 100 crore, consumption will increase by 50 crore and the remaining 50 crore will be saved. One man’s expenditure is another man’s income. Therefore, due to expenditure of 50 crore in the second time period income will be increased by 50 crore. Hence, there will be increase in consumption by 25 crore and in saving also by 25 crore. Thus, in different time periods as shown in the table income will go on increasing due to increase in consumption expenditure. Ultimately income will increase to rs.200 crore.

Question 5. Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure
(A) is 50 crores, and MPS is 0.2 and level of income(y) is4000 crores. State whether the economy is in equilibrium or not (cite reasons).

Ans. AD = A + bY
AD = 50 + 0.8 (4000)
AD = 3250
No,economy is not in equilibrium because AD is less than AS and therefore, there is excess supply in the economy.

Question 6. Explain ‘Paradox of Thrift’.

Ans. Paradox of thrift : The value of K is more in case of higher MPC. Higher the value of K, more will be the additional income generated from a given investment. It follows that if the whole community tries/ attempts to save the whole or larger part of additional income, the consumption expenditure would go down and it will lose the additional rounds of income. If additional rounds of income do not get generated, the economy will end up saving less. This is known as paradox of thrift. It is an economic concept according to which if everyone tries to save an increasingly larger portion of his or her income, they would become poorer instead of richer.This is because the economy will slow down from reduction in demand and the very same people would lose their jobs. This theory, however, applies mainly to Keynesian economics where increased savings represent a diminishing circular flow of income. It is shown with the help of following diagram:

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