Assuming for a hypothetical economy : (i) Autonomous Consumption Expenditure (c̄) = ₹ 250 crore (ii) Marginal

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Q. Assuming for a hypothetical economy :

(i) Autonomous Consumption Expenditure (c̄) = ₹ 250 crore

(ii) Marginal Propensity to Save (MPS) = 0·2

(iii) Autonomous Investments (I₀) = ₹ 200 crore Estimate the Break-even level of Income and Equilibrium level of Income, on the basis of information given above.

Karnataka PUCCBSE Class XII Board 2025Subjective· 4mImportance★★★★★

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Concept understanding — Aggregate Demand Equilibrium

Aggregate Demand Equilibrium: The Economy's Balancing Act

Think of a seesaw. On one side sits everything people, firms, and the government want to buy. On the other side sits everything firms produce. When the seesaw is perfectly level — when total spending exactly matches total output — the economy is in equilibrium. That's the core idea.

But why should you care? Because when the seesaw tilts, real things happen. If spending exceeds output, prices rise (inflation). If output exceeds spending, factories shut down and people lose jobs. Equilibrium is the sweet spot where neither happens.

The Precise Meaning

In macroeconomics, Aggregate Demand (AD) is the total planned spending on final goods and services in an economy during a given period. Aggregate Supply (AS) is the total output firms plan to produce.

Equilibrium occurs where:

AD = AS

At this point, what buyers intend to spend exactly equals what sellers intend to produce. No unwanted inventories pile up, and no shortages force prices up. The economy is "at rest."

Y = C + I + G + (X - M)

This is the AD identity from your NCERT textbook. It tells you that total spending in the economy comes from four sources: households, firms, government, and foreigners (net of what we buy from them).

How Equilibrium Actually Works

Imagine a simple economy with only households and firms. Households earn income $Y$ from firms. They spend part of it on consumption $C$ and save the rest $S$ . Firms produce output and also invest $I$ (buying machines, building factories).

Equilibrium condition becomes:

Y = C + I

But households don't spend all their income. They save. So $C = Y - S$ . Substituting:

Y = (Y - S) + I

Which simplifies to:

S = I

Important

In equilibrium, planned savings must equal planned investment. This is the Keynesian cross condition. If people save more than firms invest, total spending falls short of output — inventories pile up, firms cut production, and income falls until savings and investment match again.

The 45° Line Diagram (Describe It)

Draw a graph with Aggregate Demand (AD) on the vertical axis and National Income (Y) on the horizontal axis.

Draw a 45° line from the origin. Every point on this line represents $AD = Y$ — the equilibrium condition.
Draw the AD curve (which is $C + I + G + (X-M)$ ). It slopes upward because as income rises, consumption rises.
Where the AD curve crosses the 45° line — that's the equilibrium point. …

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The break-even level of income is where consumption equals income (saving is zero), and the equilibrium level of income is where aggregate demand equals aggregate output (saving equals investment). Using the given data, break-even income is ₹1,250 crore, and equilibrium income is ₹2,250 crore.

Let's start with the core idea. In a simple two-sector economy (households and firms), the break-even level of income is that point where the household sector's consumption expenditure exactly equals its income — meaning there is no saving (and no dissaving). At this point, the consumption function intersects the 45° line from the origin. The equilibrium level of income, on the other hand, is where the economy's total planned spending (aggregate demand) equals total output (aggregate supply). In a closed economy with no government, aggregate demand is just consumption plus investment.

We are given:

Autonomous consumption, $\bar{C} = ₹250$ crore
Marginal propensity to save (MPS) $= 0.2$
Autonomous investment, $I_0 = ₹200$ crore

From MPS, we immediately get the marginal propensity to consume (MPC):

MPC = 1 - MPS = 1 - 0.2 = 0.8

C = \bar{C} + MPC \cdot Y

Step 1: Break-even level of income

At break-even, consumption equals income:

C = Y

Substitute the consumption function:

\bar{C} + MPC \cdot Y = Y

250 + 0.8Y = Y

250 = Y - 0.8Y = 0.2Y

Y = \frac{250}{0.2} = 1250

Note

Notice that at break-even, saving is zero. Using the saving function: $S = -250 + 0.2(1250) = -250 + 250 = 0$ . This confirms the result.

So the break-even level of income is ₹1,250 crore.

Step 2: Equilibrium level of income

Equilibrium occurs where aggregate demand equals aggregate output:

Y = C + I

Substitute the consumption function and given investment:

Y = (250 + 0.8Y) + 200

Y = 450 + 0.8Y

Y - 0.8Y = 450

0.2Y = 450

Y = \frac{450}{0.2} = 2250

Alternatively, using the saving-investment approach: at equilibrium, planned saving equals planned investment. Saving function is $S = -250 + 0.2Y$ . Set $S = I$ :

-250 + 0.2Y = 200

0.2Y = 450

$Y = 2250$ …

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Q.Assuming for a hypothetical economy :

Step 1: Break-even level of income

Step 2: Equilibrium level of income

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