Prelims High-Yield Explanations & Traps

• not what people
• determinant of consumption demand is household
• that ‘investment goods’
• that G – c
• factor is availability of credit:
• that in the new
• ‘other things remaining equal’
• that as income increases either 2021–22 5555 5555 55 Income Determination the consumers does not increase consumption at all (MPC = 0) or use entire change in income on consumption (MPC = 1) or use part of the change in income for changing consumption (0< MPC<1)
• that if income goes up by Rs
• that part of output produced which is not sold and therefore remains with the firm
• the aggregate demand function can be obtained by vertically adding the consumption and investment function
• that it does not depend on income
• the new equilibrium output of the economy is only Y * 2 = 100
• that the level of output determined by the equality of Y with AD does not necessarily mean the level of output at which everyone is employed
• that if left to itself the level of income in the economy will not change even when there is unemployment in the economy

Essential Definitions & Formulas

The basic objective of macroeconomics

to develop theoretical tools, called models, capable of describing the processes which determine the values of these variables.

It

difficult to account for all the variables at the same time.

This is a stylisation typical of almost any theoretical exercise and

called the assumption of ceteris paribus , which literally means ‘other things remaining equal’.

The theoretical model used in this chapter

based on the theory given by John Maynard Keynes.

Her planned investment

Rs 100 whereas her actual, or ex post, investment is Rs 70 only.

Consumption The most important determinant of consumption demand

household income.

Since this level of consumption

independent of income, it is called autonomous consumption.

The above equation

called the consumption function.

Here C

the consumption expenditure by households.

Autonomous consumption is denoted by C and shows the consumption which

independent of income.

If consumption takes place even when income

zero, it is because of autonomous consumption.

The maximum value which c can take

1.

This

that as income increases either 2021–22 5555 5555 55 Income Determination the consumers does not increase consumption at all (MPC = 0) or use entire change in income on consumption (MPC = 1) or use part of the change in income for changing consumption (0< MPC<1).

Its marginal propensity to consume

0.

This

that if income goes up by Rs.

Savings is that part of income that

not consumed.

It is denoted by c and

equal to C Y ∆ ∆ .

It is denoted by s and

equal to 1c− .

Investment Investment

defined as addition to the stock of physical capital (such as machines, buildings, roads etc.

I

a positive constant which represents the autonomous (given or exogenous) investment in the economy in a given year.

Related PYQs (20)