Economics · Ch 4 — Determination of Income and Employment
Summary
Summary
- Aggregate Demand (AD) is the total planned spending in the economy: . In a two-sector closed economy, .
- Aggregate Supply (AS) is the total planned output, which equals national income (). In the short run, .
- Equilibrium occurs where , i.e., . Graphically, this is the intersection of the line (slope = MPC) with the line.
- Effective demand principle: when the price level is fixed and aggregate supply is perfectly elastic at that price, aggregate output is determined solely by the level of aggregate demand. This is the chapter's central result and the headline of the NCERT chapter's own summary.
- Consumption function: , where is autonomous consumption and is the marginal propensity to consume ().
- Saving function: , where is the marginal propensity to save (MPS).
- Investment is treated as autonomous () in the basic model, independent of income.
- Equilibrium condition (saving-investment approach): at the equilibrium level of income.
- Multiplier effect: A change in autonomous spending () leads to a larger change in income: . So .
- Paradox of thrift: An attempt by the whole economy to save more may reduce total savings and output if investment is fixed, because increased saving reduces AD.
- Ex-ante vs. ex-post: Planned (ex-ante) saving and investment need not be equal; actual (ex-post) saving and investment are always equal by accounting identity.
- Underemployment equilibrium: The economy can settle at an equilibrium below full employment due to deficient demand — Keynes’ key departure from classical theory. …