Calculate the Equilibrium level of Income for an imaginary economy, if it is given that : (a) Consumption func

Question 33 of 104

Q. Calculate the Equilibrium level of Income for an imaginary economy, if it is given that :

(a) Consumption function, C = 500 + 0·80 Y where C = Consumption, Y = Income

(b) Autonomous Investments (I₀) = ₹ 1,000 crore

Punjab PsebCBSE Class XII Board 2022Subjective· 2mImportance★★★★★

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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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Equilibrium income occurs when aggregate demand equals aggregate supply. By substituting the given consumption function and autonomous investment into the $AD = Y$ condition, we find the equilibrium income.

In macroeconomics, the equilibrium level of income for an economy is reached when the total amount of goods and services demanded in the economy (Aggregate Demand, $AD$ ) is equal to the total amount of goods and services supplied (Aggregate Supply, $AS$ ). This is a fundamental concept in Keynesian economics, particularly for a simple two-sector economy consisting only of households and firms.

The intuition behind this equilibrium is straightforward: if $AD > AS$ , firms will see their inventories fall, prompting them to increase production, which in turn generates more income. Conversely, if $AD < AS$ , firms will accumulate unwanted inventories, leading them to cut production and reduce income. The economy will naturally adjust until $AD = AS$ , at which point there is no incentive for firms to change their output levels, and the income level remains stable.

For a two-sector economy, Aggregate Demand ( $AD$ ) is the sum of consumption expenditure ( $C$ ) by households and investment expenditure ( $I$ ) by firms.

AD = C + I

Aggregate Supply ( $AS$ ) is equivalent to the total national income ( $Y$ ) generated in the economy.

AS = Y

Therefore, the equilibrium condition can be stated as:

Y = C + I

This condition ensures that all income generated in the economy is either consumed or invested, leading to a stable level of economic activity.

We are given the following information:

Consumption function: $C = 500 + 0.80Y$
Autonomous Investments ( $I_0$ ): $₹ 1,000$ crore Here, $500$ represents autonomous consumption (consumption independent of income), and $0.80$ is the marginal propensity to consume (MPC), indicating that $80\%$ of any additional income is spent on consumption. Autonomous investments are those investments that do not depend on the level of income. To calculate the equilibrium level of income, we use the equilibrium condition $Y = C + I$ .

State the equilibrium condition: …

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Q.Calculate the Equilibrium level of Income for an imaginary economy, if it is given that :

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