Class | Subject | Book | Chapter | Session | Questions covered |
|---|---|---|---|---|---|
XII | Economics | Macroeconomics (NCERT) | 4 – Determination of Income and Employment | 2026-27 | 6 of 6 |
Chapter at a glance
Concept | Key point |
|---|---|
Consumption function | ; = MPC; = autonomous consumption    |
MPC and MPS | , ,    |
Ex ante vs ex post | Ex ante – planned; ex post – actual (realised) |
Aggregate demand | (with fixed price and interest rate)  |
Equilibrium | , i.e. ; also planned S = planned I   |
Effective demand principle | With perfectly elastic supply at given price, output is determined solely by aggregate demand |
Multiplier |  |
Parametric shift | Shift of a line due to change in a parameter (slope or intercept) |
Paradox of thrift | If all people try to save more, total saving may not rise (falls or stays same) because income falls |
Exercises
What is marginal propensity to consume? How is it related to marginal propensity to save?
Answer
Answer
Marginal propensity to consume (MPC) is the change in consumption per unit change in income:
Marginal propensity to save (MPS) is the change in saving per unit change in income, .
Since income is either consumed or saved, ; dividing by :
E.g. if MPC = 0.8, then MPS = 0.2.
MPC is ΔC/ΔY; since an increment of income is either consumed or saved, MPC + MPS = 1.
What is the difference between ex ante investment and ex post investment?
Answer
Answer
Basis | Ex ante investment | Ex post investment |
|---|---|---|
Meaning | Planned (intended) investment | Actual (realised) investment |
Time | What firms plan to invest before the period | What firms actually invest at the end of the period |
Unplanned inventory | Excludes unplanned changes in inventories | Includes unplanned changes in inventories |
Equality with saving | Equals ex ante saving only at equilibrium | Always equals ex post saving (identity) |
E.g. if a firm plans to add ₹ 100 to inventory but, due to lower sales, ₹ 150 of goods remain unsold, ex ante investment is ₹ 100 and ex post investment is ₹ 150.
Ex ante investment is planned investment; ex post investment is actual investment, including unplanned inventory changes, and always equals actual saving.
What do you understand by ‘parametric shift of a line’? How does a line shift when its (i) slope decreases, and (ii) its intercept increases?
Answer
Answer
A line has two parameters – the intercept and the slope . A parametric shift is the shift (or rotation) of the line when the value of a parameter changes, while the variables and remain the same.
- (i) Slope decreases: the line rotates downward (becomes flatter) about the intercept point on the vertical axis – it pivots at the y-intercept.
- (ii) Intercept increases: the line shifts upward parallel to itself (same slope, higher intercept).
Example: in the AD function , a fall in MPC () makes the AD line flatter (pivoting at ); a rise in autonomous expenditure shifts AD up parallel.
A parametric shift is a shift of a line due to a change in a parameter; a fall in slope makes the line rotate downward (flatter) about its intercept, and a rise in intercept shifts it upward parallel to itself.
What is ‘effective demand’? How will you derive the autonomous expenditure multiplier when price of final goods and the rate of interest are given?
Answer
Answer
Effective demand: when the price of final goods and the rate of interest are fixed, and aggregate supply is perfectly elastic at that price, the equilibrium output is determined solely by the level of aggregate demand. The level of AD at which AD equals output is called effective demand, and this is the principle of effective demand.
Derivation of the multiplier
Aggregate demand: . Equilibrium: , so .
If autonomous expenditure changes by :
Intuitively, an increase raises income by in the first round; people spend of it, raising income again, then , and so on: .
Effective demand is the level of aggregate demand that determines output when prices and interest rate are fixed; from Y = Ā + cY, Y* = Ā/(1 – c), so the autonomous expenditure multiplier is ΔY/ΔĀ = 1/(1 – c) = 1/MPS.
Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure (A) is ₹ 50 crores, and MPS is 0.2 and level of income (Y) is ₹ 4000 crores. State whether the economy is in equilibrium or not (cite reasons).
Answer
Answer
MPC = 1 – 0.2 = 0.8.
Output (income) is ₹ 4,000 crore, which is greater than ex ante AD of ₹ 3,250 crore. So the economy is not in equilibrium – there is excess supply of ₹ 750 crore; firms will have unplanned accumulation of inventories and will cut output. The equilibrium income is
Ex ante AD = ₹ 3,250 crore; since this is less than output of ₹ 4,000 crore, the economy is not in equilibrium (excess supply of ₹ 750 crore); equilibrium income would be ₹ 250 crore.
Explain ‘Paradox of Thrift’.
Answer
Answer
The paradox of thrift states that if all people in an economy try to save more (increase their marginal propensity to save), the total value of savings in the economy may not increase; it will either decrease or remain unchanged.
Explanation: when people save more, they spend less. Consumption and aggregate demand fall, so firms produce less and income falls through the multiplier process. At the new equilibrium, saving must equal (unchanged) planned investment, . With autonomous investment unchanged, aggregate saving remains the same, while income is lower. (If investment depends on income, saving may even fall.)
Example: , → . If falls to 0.75 (MPS rises to 0.25), . Saving remains the same (with , before and after), but income has fallen by 50.
What is good for an individual (saving more) is not necessarily good for the economy as a whole – hence the paradox.
If everyone tries to save more, consumption and income fall through the multiplier, so total saving does not rise (it stays equal to investment or falls) – individual virtue becomes a collective paradox.
Topic checklist
- ☒ MPC, MPS and consumption (Q 1)
- ☒ Ex ante and ex post (Q 2)
- ☒ Parametric shifts (Q 3)
- ☒ Effective demand, equilibrium and multiplier (Q 4, 5)
- ☒ Paradox of thrift (Q 6)