Macroeconomic Equilibrium with Price Level Fixed

Fig. 4.1 is a generic illustration of the intercept form of a linear equation — the algebraic form the chapter uses to draw the consumption function, the investment function and the aggregate demand line.

The horizontal axis is labelled $X$ and the vertical axis is labelled $Y$; the two variables are related by the straight line

where $a$ and $b$ are constants. The line rises from left to right and meets the vertical ($Y$) axis at a point above the origin. That point is the intercept $a$ — the value of $Y$ when $X = 0$ — and in the figure it is marked by a small brace on the $Y$ axis. The constant $b$ is the slope of the line: the figure shows the angle $\theta$ that the line makes with the horizontal, and $\tan\theta = b$.

Fig. 4.2 in the NCERT textbook is a simple two-dimensional graph that shows how consumption spending ($C$) depends on the level of income ($Y$) when the consumption function has a positive intercept. The vertical axis is labelled Consumption ($C$) and the horizontal axis is labelled Income ($Y$). The figure contains a single straight line that slopes upward from left to right, but it does not pass through the origin — it meets the vertical axis at a point above zero.

That point on the vertical axis is labelled $\bar{C}$ (read as "C-bar" or "autonomous consumption"). It represents the amount of consumption that occurs even when income is zero. The line itself is the consumption function and is drawn with a constant slope. The slope of this line is the marginal propensity to consume (MPC), denoted by $b$ or $c$ in the textbook. The line continues upward and to the right, showing that as income increases, consumption also increases — but by a smaller amount than the increase in income, because the slope is less than 1.

The physical idea the figure teaches is that consumption has two parts: a fixed part that does not depend on income (autonomous consumption, $\bar{C}$) and a variable part that does depend on income (induced consumption, which is $bY$). The total consumption at any income level is the sum of these two. The graph makes this additive relationship visually clear — the intercept is $\bar{C}$, and for any income level $Y$, the height of the line above the horizontal axis is $\bar{C} + bY$.

The key formula the textbook develops with this figure is the linear consumption function:

where:

• $C$ = total consumption expenditure
• $\bar{C}$ = autonomous consumption (the vertical intercept; consumption when $Y = 0$)
• $b$ = marginal propensity to consume (MPC), the slope of the line; it is a positive fraction less than 1
• $Y$ = level of income (or output)

Fig. 4.3 in the NCERT textbook is a simple two-dimensional graph that illustrates the investment function under the assumption that investment is entirely autonomous — that is, it does not depend on the current level of income or output.

The vertical axis is labelled Investment (I). The horizontal axis is labelled Income (Y). Because investment is autonomous, the relationship between I and Y is a horizontal straight line. This line is drawn at a height equal to the fixed amount of autonomous investment, which the textbook denotes as $\bar{I}$. The line is labelled $I = \bar{I}$.

The physical idea is straightforward: in the simplest Keynesian model, firms are assumed to make investment decisions based on long-term expectations (the "animal spirits" of entrepreneurs) and the rate of interest, not on today's production level. So no matter what the current national income is — whether the economy is in a recession or a boom — planned investment spending remains constant at $\bar{I}$.

The key formula that this figure develops is the investment function itself:

where:

• $I$ = planned investment expenditure (a flow variable, measured in rupees per year)
• $\bar{I}$ = autonomous investment, a positive constant (the intercept of the investment line on the vertical axis)

Because the line is horizontal, its slope is zero: $\frac{\Delta I}{\Delta Y} = 0$. This tells us that a change in income produces no change in planned investment.

Figure 4.4 in the NCERT textbook is a simple two-dimensional graph that shows how the economy’s total planned spending — aggregate demand — is built up from its two main components: consumption expenditure and investment expenditure. The entire point of the figure is to make the idea of vertical addition visually concrete.

The vertical axis is labelled Aggregate Demand (AD) (or sometimes just Expenditure), and the horizontal axis is labelled Output/Income (Y). Both axes start from zero. The 45° line from the origin is also drawn — it represents all points where aggregate demand equals output, and it serves as a reference line for equilibrium.

On this graph, two separate lines are drawn. The first is the consumption function, a straight line that slopes upward but with a slope less than 1. Its intercept on the vertical axis is positive — that intercept is autonomous consumption ($\bar{C}$), the amount people spend even when income is zero. The slope of this line is the marginal propensity to consume (MPC), denoted $c$ or $b$ in the textbook. So the consumption line is the graph of $C = \bar{C} + cY$.

The second line is the investment function. In this simple model (the two-sector model with no government and no foreign trade), investment is treated as autonomous — it does not depend on current income. So the investment line is a horizontal straight line at height $\bar{I}$ above the horizontal axis. It runs parallel to the income axis at a constant vertical distance.

Now comes the key visual move: the figure shows that the aggregate demand curve is obtained by vertically adding these two lines. At every level of income $Y$, you take the height of the consumption line and add the height of the investment line. Since investment is constant, the AD curve is simply the consumption line shifted upward by the amount $\bar{I}$. So the AD line has the same slope as the consumption line (MPC), but its intercept is larger: $\bar{C} + \bar{I}$.

Here:

• $\bar{C}$ = autonomous consumption (consumption when $Y=0$)
• $\bar{I}$ = autonomous investment (investment, independent of $Y$)
• $c$ = marginal propensity to consume ($0 < c < 1$)
• $Y$ = national income / output

The figure therefore teaches a fundamental principle: aggregate demand is not a new, separate curve — it is the sum of the component spending curves. The vertical distance between the AD line and the consumption line at any income level is exactly $\bar{I}$, the constant investment. And the vertical distance between the consumption line and the horizontal axis at any income level is $\bar{C} + cY$.

Fig. 4.5 shows the aggregate supply schedule of the fixed-price model as a single $45^\circ$ line. The vertical axis is labelled Aggregate Supply and the horizontal axis is labelled GDP, $Y$; a straight line is drawn from the origin at $45^\circ$ to the horizontal axis and is itself labelled Aggregate Supply.

Why a $45^\circ$ line? In the first stage of the analysis the price level is taken as fixed and resources are assumed to be unused, so firms supply whatever quantity is demanded. Every point on a $45^\circ$ line has the same horizontal and vertical coordinate, so along this line aggregate supply is always exactly equal to GDP: whatever level of output is called for, that much is produced.

The figure illustrates this with one worked point. Suppose GDP is ₹1,000, marked as point A on the horizontal axis. The amount supplied is then also ₹1,000, shown at point B, which lies directly above A where the vertical line through A meets the $45^\circ$ line. A dashed vertical line from A up to B makes this correspondence explicit. …