Under the Keynesian theory, ‘Reference Line’ is a straight line passing through the origin drawn at an angle o

Question 78 of 104

Q. Under the Keynesian theory, ‘Reference Line’ is a straight line passing through the origin drawn at an angle of __________. (Choose the correct option to fill in the blank) (A) 25° (B) 40° (C) 45° (D) 70°

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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 'Reference Line' in the simple Keynesian model represents all points where aggregate expenditure equals national income, forming a straight line through the origin at a 45-degree angle.

In the simple Keynesian model of income determination, we often use a diagram where national income (or output, $Y$ ) is plotted on the horizontal axis and aggregate expenditure ( $AE$ ) is plotted on the vertical axis. The 'Reference Line', also known as the 'Aggregate Supply Curve' in this context, or the 'Income-Expenditure Equilibrium Line', is a crucial component of this diagram.

This line represents all possible points where the total output produced in the economy (national income, $Y$ ) is exactly equal to the total planned spending (aggregate expenditure, $AE$ ). In other words, it is the locus of points where $Y = AE$ . This condition is fundamental for equilibrium in the Keynesian model, as it signifies that whatever is produced is exactly what is demanded, leaving no unplanned inventory changes.

Y = AE

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Q.Under the Keynesian theory, ‘Reference Line’ is a straight line passing through the origin drawn at an angle of __________. (Choose the correct option to fill in the blank) (A) 25° (B) 40° (C) 45° (D) 70°

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