Aggregate Demand and Its Related Concepts NCERT SOLUTION CLASS 12TH MACRO ECONOMICS | EDUGROWN NOTES

Short Answer Type Question:

Q.1 Explain the components of aggregate demand.
Or
State components of AD. Describe any one.[CBSE 1995, 96, 96C, 97C, 2005C, 06, 09]
ANSWER: The components of aggregate demand are:

1. Private (or Household) consumption demand
   (a) The total expenditure incurred by all the households of the countiy on their personal consumption is known as private consumption expenditure.
   (b) Consumption demand depends mainly on disposable income and propensity to consume.
2. Private investment demand
   (a) Private investment demand refers to the demand for capital goods by private investors.
   (b) It is addition to the existing stock of real capital assets such as machines, tools, factory-building etc.
   (c) Investments demand depends upon marginal efficiency of capital (Marginal efficiency of investment) and interest rate.
   (d) Investment is of two types, Autonomous Investment and Induced investment, but in Keynes theory investment assumed to be Autonomous.
3. Government demand for goods and services
   (a) In a modem economy, the government is an important buyer of goods and services.
   (b) The government demand may be on account of public needs for roads, schools, hospitals, power, irrigation etc, for the maintenance of law and order and for defence.
4. Demand for net export (X – M)
   (a) Net export represents foreign demand for goods and services produced by an economy.
   (b) When exports exceed imports, net exports is positive and when imports exceed, net exports is negative.
   (c) Exports and imports of a country are influenced by a number of factors such as foreign trade policy, exchange- rate, prices and quality of goods etc.
   Thus, aggregate demand consists of these four types of demand.
   AD = C + I + G + (X – M)

Q.2Explain the distinction between ‘autor mous investment’ and “induced investment’. [CBSE 2013 (C)]
ANSWER: 

Q.3 Briefly state the concept of consumption function. Explain with schedule and diagram. [CBSE 2008; AI 08, 09]
ANSWER:   (i) Consumption function expresses functional relationship between aggregate consumption and national income. Thus, consumption (C) is a function of income (Y).
C = F (Y)
Where,
C = Consumption
F = Function
Y = Disposable income
(ii) It can be explained with the help of the following schedule and diagram:

The above schedule and diagram shows Keynes’ Psychological law of Consumption, which states that as income increases consumption expenditure also increases but increase in consumption is smaller than the increase in income.

Q.4 With the help of consumption schedule or curve bring out meaning of break-even point.
ANSWER:   Break-even point refers to that point in the level of income at which consumption is just equal to income. In other words, whole of income is spent on consumption and there is no saving. Below this level of income, consumption is greater than income but above this level, income is greater than consumption.
It can be explained with the help of following schedule and diagram:

In the above imaginary house hole schedule of consumption and saving, at annual income level of Rs 60,000, consumption is Rs 60,000 and in consequence there is no saving. This is break-even point.

In the above diagram, when Consumption (C) = National Income(Y), savings are zero. This is known as break-even point. This is shown by point E in the diagram. Thus break even point indicates a point where consumption becomes equal to income or consumption curve cuts the income curve.

Q.5 What is APC? How is it calculated?[AT 1991; CBSE 92 C, 2004]
ANSWER:  The ratio of aggregate consumption expenditure to aggregate income is known as average propensity to consume. It indicates the percentage (or ratio) of income which is being spent on consumption. It is worked out by dividing total consumption expenditure (C) by total income (Y). APC=C/Y

Q.6 Distinguish between APS and MPS. The value of which of these two can be negative and when? [CBSE 2004, 2011]
ANSWER:

APS can be negative, when at low level of income consumption exceeds income, savings are negative which make the APS negative. It can be explained with the help of the following schedule:

Q.7 Differentiate between APC and APS and tell which of them is negative.
ANSWER:

APS can be negative. When at low level of income consumption exceeds income, savings are negative and make the APS negative. It can be explained with the help of the following schedule.

Q.8 Differentiate between APC and MPC.
ANSWER:

Q.9 Explain saving function with the help of schedule and diagram. [AI 2008]
ANSWER:  (i) Propensity to save (or saving function) shows the functional relationship between aggregate savings and income.S=f(Y)
In other words, the part of income which is not spent on current consumption is known as saving. By deducting consumption expenditure (C) from income (Y), we get saving (S). S = Y – C

Long answer Type Question:

Q.1 Draw a straight line consumption curve. From it derive the saving curve. Explain the process of derivation on the diagram, show:
(i) The income level at which APC =1.
(ii) The income level at which APS is negative. [CBSE Sample Paper 2014] Or
Outline the steps taken in deriving saving curve from the consumption curve. Use diagram. [CBSE 2012] Or
Draw on a diagram a straight line Consumption curve for an economy. From it derive the saving curve, explaining the method of derivation. Show a point on the consumption curve at which APS = 0?
ANSWER: To explain the below figure we define the following two terms.
(i) Consumption function: Consumption function expresses functional relationship between aggregate consumption and national income. It can be expressed as:[Math Processing Error] =C+bY [Math Processing Error]
where =[Math Processing Error] =Autonomous consumption, b= marginal propensity to consume.

(iii) Figure B is derived from figure A. In Figure A at point [Math Processing Error] consumption is equal to national income, which is known as break-even point. At point P, APC = 1 because consumption is equal to income at this point.
(iv) Corresponding to point P, we derive the point [Math Processing Error]in figure B where Saving is equal to zero. At point [Math Processing Error]APS =0. After point P in figure A, national income is greater than consumption,i.e., positive saving, which has shown in figure B, after point [Math Processing Error], where savings are positive.
(v) Before point P in figure A consumption is greater than income, i.e., negative saving or dis-saving, which has been shown in figure B before point [Math Processing Error] where savings are negative.

Q.2 Draw on a diagram a straight line savings curve for an economy. From it derive the consumption curve, explaining the method of derivation. Show a point on the consumption curve at which APC =1? [CBSE 2006]
ANSWER:   To explain the above figure we define the following two terms.

(iii) Figure B is derived from A. In Figure A at point P saving = 0. Corresponding to point P, we derive the point P: in figure B where income = consumption. Point Pj is known as to be break-even point and at this point only APC = 1.
(iv) After point P in figure A savings are positive, which has been shown in figure B, after point Pt where Income is greater than consumption, i.e., positive saving.
(v)  Before point P in figure A savings are negative which has shown in figure B before point Pi; where consumption is greater than income, i.e., negative saving or dis-saving.