Class Notes

Income Determination

1. Aggregate Demand (AD) It refers to the total demand for final goods and services in an economy during a year.
(i) Components ofAggregate Demand
(a) Private consumption demand (C)
(b) Private investment demand (T)
(c)Demand for goods and services by the government or government purchases (G)
(d) Demand for net exports (X·M)
Thus, AD = C + I + G + NE

2. Aggregate Supply (AS) It refers to the total quantity of goods and services produced by all the producers in an economy during a year.
(i) Components ofAggregate Supply
(a) Consumption (C)
(b) Saving (S)
Thus, AS=C+S

3. Consumption Function It means a functional relationship between total consumption and total disposable income.
Thus, C = f (y)
C = Consumption
y= Income

4. Average Propensity to Consume APC = C/Y
C = Total consumption
Y = Total income

5. Marginal Propensity to Consume (MPC)
MPC =Δc/Δy

Here, Δc = Change in consumption
Δy = Change in income

6. Linear Consumption Function If the consumption function is given on the assumption of constant marginal propensity to consume. It is called linear consumption function.
c=‾c+BY; ‾c.0,0,b,1
Here, c = Consumption ,‾c = Auto nomous consumption,B = Marginal propensity to consume, Y = Level of income

7. Saving Function Saving function is a schedule showing a functional relationship between total saving and income.
Thus, S = F (Y)
Here, S = Total saving ,Y = Total income

8. Average Propensity to Save

Here, S = Total saving ,Y = Total income

9. Marginal Propensity to Save  MPS = ΔS/ΔY

Here, ΔS = Change in saving, ΔY = Change in income

10. Equilibrium Level of Output Equilibrium level of output in an economy is determined at a point where planned spending (C+l) equals the planned output or where C+I curve intersects the 45° line.

11. Effective Demand It is that level of aggregate demand which becomes effective in determining equilibrium level of income because it is equal to aggregate supply.

12. Autonomous Consumption It refers to minimum level of consumption even when income is zero, it is indicated by ‘A’ in the consumption function . C=A+B
13. Ex-ante Saving It is what the savers plan to save at different levels of income in the economy.

14. Ex-ante Investment Is what the investors plan or intend to invest at different levels of income in the economy.

15. Ex-post Saving and Investment They refer to realised saving and investment in the economy. Ex-post saving is always equal to ex-post investment.

16. Multiplter Additional investment (ΔI), generates additional income (ΔY), but income generated is many times more than the investment.
Multiplier is the ratio between increase in income (ΔY) and increase in investment (ΔI) .  Multiplier (K) = ΔY/ΔI

17. Full Employment Equilibrium It refers to that situation in the economy when AD = AS along with fuller utilisation of  labour force.

18. Under Employment Equilibrium It refers to that situation in the economy when AS = AD but without the fuller utilisation of labour force.

19. Parodox of Thrift Which states that as people become more thrift they end up saving less or same as before.

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