Q.Explain Simple Keynesian Theory of income determination.

Equilibrium income is determined where aggregate demand (C + I) equals aggregate supply, i.e. where Saving = Investment.

This 8-mark item is a central macroeconomic topic in CHSE Odisha +2 Business Economics (aligned with the NCERT/CBSE curriculum).

Background. Keynes rejected the classical view that the economy automatically reaches full employment. In his simple theory (a two-sector economy of households and firms, with a given price level and unused capacity), the level of national income and employment is determined by effective demand — the level of aggregate demand that equals aggregate supply.

The two approaches (they give the same result).

1. Aggregate Demand – Aggregate Supply approach.

• Aggregate Supply (AS) is the total value of output producers plan to supply; corresponding to full-capacity use it rises with income, shown by a 45° line (output = income).
• Aggregate Demand (AD) is the total planned spending in the economy = Consumption (C) + Investment (I). Consumption rises with income but less than proportionately (the consumption function C = a + bY, where b is the marginal propensity to consume), and investment (I) is taken as autonomous (fixed). So AD = a + bY + I.
• Equilibrium is where AD = AS, i.e. where the C + I line cuts the 45° line. At this income, whatever is produced is just bought; there is no tendency to change. If AD > AS, firms find stocks falling and expand output and income; if AD < AS, stocks pile up and firms cut output — both push income back to equilibrium.

2. Saving – Investment approach.

• Since income not consumed is saved, Saving S = Y − C. Equilibrium requires planned Saving = planned Investment (S = I). Where the upward-sloping saving curve cuts the horizontal investment line, income is in equilibrium. If S > I, income falls; if I > S, income rises, until S = I.

Numerical illustration. Suppose C = 40 + 0.8Y and autonomous investment I = 20 (in crore).

• Equilibrium: Y = C + I = 40 + 0.8Y + 20, so Y − 0.8Y = 60, i.e. 0.2Y = 60, giving Y = 300 crore.
• Check with saving: S = Y − C = Y − (40 + 0.8Y) = −40 + 0.2Y; at Y = 300, S = −40 + 60 = 20 = I. The two approaches agree. …