1. Distinguish between voluntary and involuntary unemployment.

Ans.
Voluntary Unemployment Involuntary Unemployment
(i) Voluntary unemplovment isa situation in (i) Involuntary unemployment is a situation in which a
which a worker is not willing to work at the worker is willing to work at current rate of wages but
current rate of wages. does not get work.
(ii) Voluntary unemployment is not considered in (ii) Involuntary unemployment is considered in the
the estimation of total unemployment in a estimation of total unemployment in the economy.
country.

2. Differentiate between full employment and underemployment equilibrium.

Ans.
Full Employment Equilibrium Underemployment Equilibrium
(i) Full employment equilibrium refers to the (i) Underemployment equilibrium refers to the
situation where AD = AS and all those who are situation where Al) = AS but all thuse who are able to
able to work and willing to work (at the existing work and willing to work (at the exusting wage rate)
wage rate) get work. do not get work.
(ii) Full employment equilibrium corresponds to (ii) Underemployment equilibrium does not
the highest possible level of output in the economy correspond to the highest possible level of output in
under the given circumstances. the economy.
(iii) Attempt to increase production beyond full (iii) Attempt to increase production beyond
employment equilibrium causes inflationary gap. underemployment equilibrium does not cause
inflationary gap.

3. What is the difference between planned investment and actual investment?

Ans.
Planned Investment Actual Investment
(i) Planned (or ex-ante) investment refers to the (i) Actual (or ex-post) investment refers to realized
desired level of investment. level of investment.
(ii) In an accounting year, planned investment may (ii) In an accounting year, actual investment is
or may not be equal to planned saving. always equal to actual savings. (This is according to
the principle of national income accounting.)
(iii) Equilibrium level of income is determined (iii) Actual investment has no relevance in the
where planned investment = planned saving. determination of equilibrium level of income.

4. State the meaning and components of aggregate demand.

Ans. Aggregate demand represents the planned expenditure on final goods and services in an economy
during a period of time.
There are four components of aggregate demand (AD):
(a) Private Consumption Expenditure (C). It is the most important component of aggregate demand.
It refers to the total amount of expenditure incurred by the households on the purchase of final goods
and services to satisfy their wants.
(b) Investment Expenditure (I). It refers to the expenditure incurred by the private firms on the
purchase of capital goods such as plant and equipment, construction work, etc.
(c) Government Expenditure (G). It refers to the expenditure incurred by the government on the
purchase of final goods and services. The level Of government expenditure is determined by the
government's policy.
(d) Net Exports. Net exports is the difference between exports and imports. It shows the effect of
domestic spending on foreign goods and services (Imports) and foreign spending on domestic goods
and services (Exports).
5. Explain the consumption function with the help of schedule and diagram.
Ans. Consumption function shows the relationship between consumption and income.
C = f(Y)
1. This equation states that there is a direct relation between consumption and the level of
income.
2. As the level of income increases, consumption also increases but the increase in consumption
is less than the increase in income.
3. Consumption can never be zero and the consumption curve never starts from origin.

The concept of consumption function can be further explained by following consumption schedule
and curve:
Income Consumption
0 50
100 100
200 150
300 200
400 250
500 300

The above table and diagram show that as the income increases, consumption also increases but the
increase in consumption is less than increase in income.

6. If in an economy Saving function is given by S = (—) 50 + 0.2 Y and Y = 2000 crores; consumption
expenditure for the economy would be 1,650 crores and the autonomous investment is 50 crores and
the marginal propensity to consume is 0.8. True or False? Justify your answer with proper
calculations.
[CBSE Sample Paper 2016]
Ans. Given, S = (-) 50 + 0.2 Y, Y = 2,000 crores,
Consumption Expenditure = 1,650 crores and
Autonomous Investment = 50 crores
Now, S = (-) 50 + 0.2 (2,000)
= -50 + 400 = 350 crores
At equilibrium level of income,
Y = C+S
2,000 = c + 350
c = 2,000 - 350
= 1,650 crores
As MPS = 0.2
MPC = 0.8
So, all the given values are correct.

7. "Economists are generally concerned about the rising Marginal Propensity to

Save (MPS) in an economy". Explain why? [CBSE sample Paper 2016]

Ans. Economists are justified in being concerned about the rising MPS in the economy, as rising MPS
would be at the cost of falling MPC. This is a cause of grave concern, as the proportion of additional
income going to consumption falls. Thus, fall in consumption will have an adverse impact on the
economy, culminating in a fall in equilibrium level of income in the economy.
8. Derive the corresponding saving function when consumption function is C = 50+ 0.6 Y.
Ans.
S = Y-C
S = Y [50 + 0.64Yl
= Y - 50 0.64Y
 S= - 50 + 0.4Y

9. Explain the components of saving function.

Or
Explain the components of consumption function.

Ans. The saving function is: S = - 𝑐 + (1 – b)Y

Here - 𝑐 is called the intercept and it represents the amount of savings done when there is zero level
of income. Savings is negative at zero level of income because at zero level of income, consumption
(a) is positive. Negative savings is nothing but dissaving, this means that at zero level of income
there is dissaving of amount -a.

The coefficient (1 — b) measures the slope of the savings function.

The slope of the savings function gives the increase in savings to per
unit increase in income.
This is known as marginal propensity to save (MPS). Since b, i.e.,
MPC is less than one, it follows that (1 — b), i.e., MPS is positive.
Saving is an increasing function of income.

The given figure illustrates the idea.

Income Savings(in crores)
0 -50
100 00
200 50
300 100
400 150
500 200

10. Distinguish between marginal propensity to consume and marginal propensity to save. What is the
relation between the two?
Ans. (a) Marginal Propensity to Consume (MPC) is the ratio of change in consumption to change in
income.
Δc
Symbolically, MPC =
Δy

whereas Marginal Propensity to Save (MPS) is the ratio of change in savings to change in income.

Δ𝑠
Symbolically, MPS =
Δ𝑦

(b) The value of MPC always lies between 0 and 1, i.e., 0 < MPC < 1, whereas ,the value of MPS
depends on the value of MPC. If MPC = 0.90, then MPS = 0.10.
Relationship between MPC and MPS. The sum of MPC and MPS is always equal to one.
Symbolically, MPC + MPS = 1

11. Explain the determination of equilibrium level of income using AD = AS approach.

Or
Explain with the help of a diagram, how aggregate demand and aggregate supply determine the
equilibrium level of income. Also explain the changes that take place in an economy when the
economy is not in equilibrium. Use diagram.

Ans. Equilibrium level of income is determined at that point when aggregate demand is equal to
aggregate supply.
Aggregate Demand represents the total expenditure on final goods and services in an economy. It
consists of (a) Consumption expenditure (C) and (b) Investment expenditure (I). Thus, AD = C + I.

Aggregate supply refers to the total production of final goods and services in an economy. In other
words, it refers to the country's National Product or National Income. Thus, AS = Y.

The equilibrium level of income is determined at a point where AD = AS.

The given diagram illustrates the idea. In the diagram, AD and AS curves intersect each other at

point E, which is the point of equilibrium. The

equilibrium level of income is OM.

The equality between AS and AD implies that the desired/planned level of output in the economy
(AS) is exactly equal to the desired/planned level of expenditure (AD) in the economy. So that, the
entire output as planned by the producers (during the accounting year) is purchased by the buyers.
There are no undesired or unwanted inventories with the producers.

(i) AD > AS
1. If aggregate demand is greater than aggregate supply. i.e., AD > AS. (when the
economy is at a level of income less than the equilibrium at level OM).
2. At any such lower level of income, the C + Io line lies above the 45o line, that
is, planned spending is more than planned income.
3. This means that consumers and firms together would be buying more goods
than firms were producing.
4. This would lead to an unplanned, undesired decrease in inventories.
5. Firms would then respond to this unplanned inventory decrease by
increasing employment and hence output.
This process of increase in output will continue until the economy is back at
income level OM, where again aggregate demand equals planned income and there
is no further tendency to change.

(ii) AD < AS
1. If aggregate demand is less than aggregate supply. i.e.. AD < AS. (when the
economy is at a level of income greater than the equilibrium level OM).
2. At any such greater level of income, the C + Io line lies below the 45o line
that is planned spending is less than planned income.
3. This means that consumers and firms together would be buying less goods
than firms were producing.
4. This would lead to an unplanned undesired increase in inventories of unsold
goods.
5. Firms would then respond to this unplanned inventory increase by
decreasing employment and hence output.
This process of decrease in income will continue until the economy is back at
income level OM, where again aggregate demand equals planned income andthere
is no further tendency to change.
12. Explain with the help of saving and investment curves, the determination of equilibrium level of
income. Also explain the changes that take place in an economy when the economy is not in
equilibrium. Use diagram.
Or
Explain the determination of equilibrium level of income using S—I approach.

Ans. The equilibrium level of income is determined at a point where ex – ante or planned saving and ex –
ante or planned investment are equal, i.e., S = I.
At equilibrium, AD = AS
Or
C+S=C+I
Or
S=I
Note: The schedule given is for reference purpose only.

Income (Y) Consumption (C) Saving (S) = (Y —C) Investment (I) (in crores)
0 50 -50 100
100 100 0 100
200 150 + 50 100
300 200 + 100 100
400 250 + 150 100
The given table and diagram show that the equilibrium level of income is 300 crores and at this
point,
S (100) = I (100).

Equilibrium is struck at point E where S and I lines intersect each other.

OM is the equilibrium level of income.
When the economy is not in equilibrium, two possibilities exist:

(i) S > I
In such a situation, the following changes will occur:
(a) Stocks of the producers would be in excess of the desired limit.
(b) Profits will start shrinking.
(c) Planned output for the subsequent year will fall.
(d) Level of income and employment will tend to shrink to the point where S = I.
This corresponds to point E in the diagram.
Thus, the economy will come back to the state of equilibrium.

(ii) S < I
In such a situation, the following changes will occur:
(a) Existing stocks of the producers will not be enough to cope with the level ofAD.
(ii) Profits will not be maximum because the desired level of stock is not available.
(iii) Producers will plan higher level of output for the subsequent years.
(iv) Level of output and employment will rise to drive the economy to the point of equilibrium at point E.

13. In an economy, aggregate demand is less than aggregate supply. Explain the changes that will take
place in this economy. [Al 20110
Ans. In the economy, if AD is less than AS, it implies that the buyers are planning to purchase less than
what sellers are planning to produce. As a result, inventories start piling up and rise above the
desired level. Thus, the producers reduce production and workers are thrown out of jobs. This leads
to a fall in the income level i.e. AS. This downward trend continues till AD once again becomes
equal to A.S. i.e. the economy reaches the stage of equilibrium, i.e., AD = AS.
14. Explain the relationship between marginal propensity to consume and investment multiplier.
Ans. Relationship between Multiplier andMPC. The value of the multiplier varies directly with MPC.
Higher the MPC, the higher will be the value of the multiplier and lower the MPC, the smaller will
be the value of multiplier. The relationship is expressed as:

1
K=
1−𝑀𝑃𝐶
For example, if MPC = 0.5
1 1
K= = =2
1−0.5 0.5
For example, if MPC = 0.75
1 1
then K= = =4
1−0.75 0.25

It is clear from above that higher the MPC, the larger will be the size of multiplier and lower the
MPC, the smaller will be the size of multiplier. Thus, the size Of multiplier varies directly with
MPC.
15. Define investment multiplier. Explain the relationship between marginal propensity to save and
investment multiplier.
Ans. Investment multiplier is defined as the ratio of change in income due to change in investment.
ΔY
Symbolically, Multiplier (k) =
ΔI
Relationship between Multiplier and MPS. The value of the multiplier varies inversely with MPS.
Higher the MPS, the lower will be the size of multiplier and lower the MPS, the larger will be the
value of the multiplier. The relationship can be expressed as
1
K=
𝑀𝑃𝑆

For example, if MPS = 0.4, then

1 1
K= = = 2.5
𝑀𝑃𝑆 0.4

If MPS = 0.1 then

1 1
K= = = 10
𝑀𝑃𝑆 0.1

Thus, it is clear price from above that, higher the MPS, the smaller will be the size of multiplier and
lower the MPS, the larger will be the size of multiplier. Thus, the size of multiplier and MPS are
inversely related.
Long Answer Type Questions [6 Marks]
74. Draw a hypothetical propensity to consume curve and from it draw the propensity to save curve. [Delhi
20110 Or
Explain the steps taken in derivation of the saving curve from the consumption curve. Use diagram. [Delhi
2012, 11C1
Ans. The steps involved in the derivation of the saving curve from the consumption
curve are:
• We can find savings at different
(Propensity to
levels of income by taking the consume curve) vertical distance between the CIS •S (Propensity to
consumption curve (CC) andsave curve) the 450 line.
• At point B in the diagram
incomex
and consumption expenditure are equal Y = C, i.e., savings are zero.
To the left of point B, CC curve is higher than the 450 line, which denotes income. This implies savings are
negative (or Dissaving) to the left of point B, in the diagram.
• To the right of point B, CC curve is lower than the 450 line, this implies C < Y and savings are positive.
• By plotting the distance between the CC curve and 450 line at different levels of income just below the
upper part we can derive the saving curve SS'. Since the CC curve is a straight line, the derived savings
curve -+ SS. must also be a straight line. For this we are required to locate only 2 points.
(a) Plot a perpendicular (It ) from point B on the consumption curve, intersecting the OX avis. at point D,
uhich must be on the OX axis, bccau€e savings is zero SOIcn Y = C.
(b) Plot OS on the lower part of OY axis as equal to OC on the Y-axis on the upper part. This gives us point
S. from where the saving curve will start.
• Joining poinß S and D and extending the straight line upwards we derive the saving« cur.e SDS.
75. Draw a hypothetical propensity to save curve and from it draw the propensity
to consume curve. (Al 20110
Or
Explain the steps taken in derivation of the CC from the saving curve.
Ans. The steps involved in the derivation of(Propensity to the consumption curve (CC) from the C consurne
curve)
* S (Propensity to
saving curve are:curve)
save
* Given the savings curve (SS), we can derive the consumption curve
(CC) by drawing a 45 0 line fromx the origin.
* Take distance OC (upper portion) on the Y-axis equal to OS on the y-axis (Lower portion). This will give
us the starting point. C of the consumption curve (CC).
* Draw a ir from point D, intersecting the 450 line at D.
• Joint points C and B and extend the straight line CB upwards to obtain consumption curve CBC.
76. Explain briefly the determination of equilibrium level of income. Use diagram.
Or
Explain with the help of a diagram how equilibrium level of income is determined by aggregate demand and
aggregate supply.
Ans. The equilibrium level of income of determined at the point where AD = AS.
The equilibrium is reached
When AD = AS and where AD = C + I(ii)
AS = C + S(iii)
400 Putting the three equations (i), (ii) and (iii)
together we obtain: 300
AD = AS
200
1 = S ors = 1 100
From this, we infer that the equilibrium
AD = AS and
77. Explain with the help of saving and investment curves, the equilibrium level of income in an economy.
Is equality between saving and investment necessary for full employment?
Or
Explain with the help of saving and investment curve the equilibrium level of income. Does equilibrium
level of income always indicate full employment in the economy ? Explain.
Ans. The equilibrium level of income is determined at a point where saving and investment are equal, i.e., S
= I. The given table and diagram illustrate the idea:
s
condition for income can also be written 100 200 300 400
as S = 1. Thus there are two approaches
for income determination.
The given table and diagram show that the equilibrium level of income is 300 crores and at this point S
(100) = 1 (100).
The equilibrium level of income may not necessarily be at the full employment level, i.e., it is not necessary
that there will always be full employment at the equilibrium level of income.
78. Explain the equilibrium level of income with the help of saving and investment curves. If savings exceed
planned investment, what changes will bring about the equality between them?
Or
Explain with the help of a diagram and using 'Saving = Investment' approach the determination of
equilibrium output and income level in an economy. What happens when the economy is not in equilibrium
and saving exceeds investment?
Ans. The equilibrium level of income is determined at a point where savings and investment are equal, i.e.,
S = I. The given table and diagram illustrate the determination:
Income (Y) Consumption (C) Saving -c Investment crores) (1)
100
200
300 50 100 150 200 -50 50 100 100 100 100 100
400 250 150 100
The table and diagram show that the equilibrium level of income is 300 crores and at this point S(IOO) 1
(100).
When savings exceed planned investment. It means that people are consuming less and thereby spending
less. As a result, aggregate demand is less than aggregate supply. This will lead to the accumulation of
unintended inventories with businessmen. To avoid further accumulation of inventories, businessmen will
reduce production. Consequently, output, income and employment will be
reduced till the equilibrium level of income OY (e 3()0 crores) is reached where
79. Explain the role of the following in correcting deficient demand/deflationary gap in an economy: [Delhi;
Al; Foreign 2011] (a) Bank rate (b) Open market operations
(c) Legal Reserve Ratio (d) Margin requirements
(e) Government expenditure
Or
Explain the concept of 'deflationary gap'. Also explain the role of 'margin requirements' in reducing it. [Al
2012] Or
Explain the concept of 'deficient demand' in macro economics. Also, explain the role of bank rate in
correcting it. [Delhi 2012] Or
Explain the concept of Deflationary Gap and the role of 'Open Market Operations' in reducing this gap.
[Delhi 20151 Or
What is 'deficient demand' ? Explain the role of 'Bank Rate' in removing it.
[Al 2015]
Or
What is 'deficient demand'? Explain the role of 'Margin Requirements' in removing this gap. [Foreign 2015]
Ans. (a) Decrease in bank rate. For controlling deficient demand, the Central bank should decrease the bank
rate. A decrease in bank rate lowers the rate of interest and credit becomes cheaper. Accordingly, the
demand for credit expands and aggregate demand increases.
(b) Purchase of Government Securities. For controlling deficient demand, the Central bank should resort to
buying of government securities. By buying the government securities, the Central bank injects additional
purchasing power in the system which results in the expansion of credit. As a result, aggregate demand
increases.
(c) Reduction in cash reserve ratio. For controlling deficient demand, the Central bank should reduce the
cash reserve ratio with a view to increase the flow of credit. As a result, aggregate demand increases.
(d) Lower the Margin Requirements. To correct the situation of deficient demand' in an economy the central
bank can lower minimum margin requirements in case of selected commodities, against which the
commercial bank advance loans. This in turn will raise the capacity to borrow of the
borrowers. They will now borrow more, thereby AD will increase and situation of deficient demand be
corrected.