Important Questions For NCERT Class 12 Economics Income Determination and Employment

Notes for Class 12

Please refer to Economics Income Determination and Employment Class 12 Economics Notes and important questions below. The Class 12 Economics Chapter wise notes have been prepared based on the latest syllabus issued for the current academic year by CBSE. Students should revise these notes and go through important Class 12 Economics examination questions given below to obtain better marks in exams

Income Determination and Employment Class 12 Economics Notes and Questions

The below Class 12 Income Determination and Employment notes have been designed by expert Economics teachers. These will help you a lot to understand all important topics given in your NCERT Class 12 Economics textbook.

Income Determination and Employment

Question. Define Aggregate Demand.
Ans.
Aggregate Demand refers to total demand of all the final goods and services in an economy in a year. In other words, it refers to that amount which all the buyers in an economy plans to spend on the purchase of goods and services during an accounting year.

Question. What are the components of aggregate demand?
Ans. 1. Household consumption demand- It refers to that amount which all the households plan to spend on the consumption of goods and services in an year to satisfy their individual needs and to increase their living standard.
2. Private investment demand- It refers to that amount which all the producers plan to spend on the purchase of capital assets like machines, building, furniture, tools, etc. for the production of goods and services in an accounting year.
3. Government demand for goods and services- It is the demand by government sector of goods and services for the production of public goods and services for the production of public goods like roads, parks, schools, etc. to satisfy common needs of society of the objective of social welfare.
4. Net exports- It is the difference of exports and imports of a nation during a year. In the other words, it is the excess of demand of domestic goods and services by foreigners over the demand of over the demand of foreign goods and services by domestic nation during a year.

Question. Define consumption function/propensity to consume. What are its types? Also explain its properties.
Ans. The functional relationship between consumption and income is called consumption function. It explains how change in income leads to change in consumption. It is also called propensity to consume.

There are 2 parts of consumption.

1. Autonomous consumption (c̅)- It refers to that consumption which is independent of income level. In other words, it is the minimum consumption at zero income level.

2. Induced consumption (bY)- It refers to that consumption which is directly related to income level. It is obtained by multiplying value of MPC and income level.
Algebraically,
C = c̅ + bY c̅= Autonomous consumption
b= part of increased income spent on consumption
Y= Income
Let c̅ =40, b=60%=0.60
C=40+0.6(Y)

Chapter 4 Income Determination

Types of propensity to consume

1. Average propensity to consume- It is the ratio of consumption and income level. It explains how much part of income is spent on consumption at a particular level of income.
𝑨𝑷𝑪=𝑪/𝒀

2. Marginal propensity to consume- It is the ratio of change in consumption to the change in income level. It explains how much part of increased income is spent on consumption.
𝑴𝑷𝑪=Δ𝑪/Δ𝒀

Properties/ Features of consumption function

1. At a very low-income level, consumption may exceed income which indicates dis-savings. So, value of APC will be more than one.

2. According to psychological law of consumption given by Keynes, increase in income leads to increase in consumption but increase in consumption is always less than increase in income.

Question. Define savings function/propensity to save. Explain its types and properties.
Ans. The functional relationship between savings and income level is called saving function. It explains how change in income leads to change in savings. It is also called propensity to save.
Algebraically,
S=Y-C
S=Y-[c̅+bY]
S=-c̅+Y-By
S=-c̅+Y(1-b)

Types of savings function/ Propensity to save

1. Average propensity to save- It is the ratio of savings and income level. It explains how much part of income is saved at a particular level of income.
𝑨𝑷𝑺=𝑺/𝒀

2. Marginal propensity to save- It is the ratio of change in savings to the change in income level. It explains how much part of increased income is saved.
𝑴𝑷𝑺=Δ𝑺/Δ𝒀

Question. What is the relationship between
a) APC and APS
b) MPC and MPS
Ans. A) The sum of APC and APS is always equal to 1
                             C+S=Y
                    Dividing both sides by ‘Y’
                            C/Y+SY/=1
                            APC+APS=1

B) The sum of MPC and MPS is always equal to 1
                           C+S=Y
                       Î”C+ΔS=ΔY
                  Divide both sides by ‘ΔY’
                       Î”C/ΔY+ΔS/ΔY=1
                         MPC+MPS=1
Break-even level/point → Y=C, S=0, APC=1

Question. If consumption function is given as
                                                      C=100+0.5(Y)
Show that value of APC decreases as income increases.
Ans.

Chapter 4 Income Determination

Can,
        APC>1                        Yes/No
        APC=1                        Yes/No
        APC<1                        Yes/No
        APC=0                        Yes/No
        APC<0                        Yes/No

Can,
        APS>1                        Yes/No
        APS=1                        Yes/No
        APS<1                        Yes/No
        APS=0                        Yes/No
        APS<0                        Yes/No

Question. Define aggregate supply.
Ans. Aggregate supply is the money value of all the final goods and services to be produced by an economy in a year.
It has two components, i.e. consumption and savings. It is because aggregate supply is equal to national income as whatever value of output is produced, the same is distributed among factors of production in the form of rent, interest, wages and profit and the sum of such factor payment is called national income. This income can either be used for consumption or savings.
So, AS=C+S
AS curve is graphically shown by 45˚ line from origin. It means each point on AS curve is equidistant to x-axis and y-axis which shows equality of income and output.

Question. Explain the derivation of saving curve from given linear consumption curve.
Ans. Saving refers to that part of income which is not spent on consumption. Thus, it is the excess of income over the consumption. Consumption and savings are complimentary to each other. Derivation of saving curve from linear consumption curve is explained as below: –

Income curve is shown by 45˚ line and linear consumption curve is given by upward sloping as directly related to income level and starts from positive value of y-axis due to autonomous consumption.

At income level zero, saving is negative value of autonomous consumption as shown by ‘a’ in the lower panel of the diagram.

When income and consumption curve intersect each other i.e. point ‘M’ i.e. both are equal, then savings will be equal to zero shown by point ‘M1’.

Chapter 4 Income Determination

At income level OY2, saving will be equal to ΔS. By joining three points, i.e. S, M1 and T, we get saving curve.

Question. Explain the determination of equilibrium level of income using aggregate demand and aggregate supply approach.
                    OR
C+I curve intersect 45˚ line
Ans. According to Keynes, equilibrium level of income and employment is determined where aggregate demand is equal to aggregate supply.

Aggregate demand
It is the total demand of all the final goods and services by all the buyers in an economy in a year.
In two sector economy, AD is the sum of consumption and investment demand.
                AD=C+I

Aggregate supply
It is the money value of all the final goods and services to be produced by an economy in a year.
It has two components i.e. consumption and savings
               AS=C+S

If AD and AS are not equal at income level, then following changes will arise.
a) If AD>AS in an economy, then producers will plan to increase the output to meet the excess demand. It will increase employment. So, income level tends to rise.
b) If AD<AS in an economy, then producers will plan to decrease the output due to deficient demand. It will decrease employment. So, income level tends to fall.

Thus, equilibrium level of income and employment is attained only where AD=AS. It is explained with the help of following example and diagram.
Algebraically,
AD=AS
C+I=Y
c̅+bY+I̅=Y
c̅+I̅=Y(1-b)
Y=( 1 / 1−b )(c̅+I̅)
Eg. Let C=40+0.60Y and I=80Cr

Equilibrium level of income
                                                      AD=AS
                                                      C+I=Y
                                               40+0.60Y+80=Y
                                                     Y=₹300Cr

Chapter 4 Income Determination
Chapter 4 Income Determination

In the above table, equilibrium level of income is ₹300Cr, where AD=AS. Graphically, it is shown by point ‘E’ where AD and AS curves intersect each other.

Determination of equilibrium income level using investment and saving approach
We know that equilibrium level of income and employment level is obtained where AD=AS.
In two sector economy, AD is the sum of consumption and investment demand and AS is the sum of consumption and savings.
Equilibrium level of income is obtained where,
                            AD=AS
                            C+I=Y
                          C+I=C+S
                              I=S
(Planned Investment) = (Planned Saving)

a) If Ip>Sp in the economy, it means there is large consumption expenditure, so it will increase AD. It will further decrease desired level of inventory stock. So, producer will plan to increase the output, it will further increase employment, so income level will tend to increase.
b) If Ip<Sp in the economy, it means there is low consumption expenditure, so it will decrease AD. It will further increase desired level of inventory stock. So, producer will plan to decrease the output, it will further decrease employment, so income level will tend to decrease.

Thus, equilibrium level of income will be attained where Planned Investment is equal to Sp. Its is explained with the help of following example and diagram: –
Eg. Let savings function is given as S=-40+0.40Y and investment is ₹80Cr

Equilibrium level of Income

Planned Investment = Planned Savings
                80=-40+0.4Y
                  120=0.4Y
                   Y=300Cr

Chapter 4 Income Determination

In the above table, equilibrium level of Y is ₹300Cr where Ip=Sp. Graphically, it is shown by point ‘E’ with the equilibrium level of Y ‘OY’ where S and I curve intersect each other.

Investment Multiplier

Investment multiplier is the ratio of change in income to the change in investment level. In other words, it refers to that value which explains how many times income level will change from additional unit of investment. It is explained with the help of following example and diagram.

Eg. Let investment level increases from 400Cr to 500Cr. As a result, income level increases from 2000Cr to 2500Cr.
                                    ΔI=100Cr
                                   Î”Y=500Cr
                             K=ΔY/ΔI=500/100=5

                              AD, AS and AD+I
Curves Then show how change in investment leads to change in income

                                  Derivation
                                   AD=AS
                                   C+I=Y
                                ΔC+ΔI=ΔY
                              Divide by ‘Δ𝑌’
                           Î”C/ΔY+ΔI/ΔY=1
                            MPC+ΔI/ΔY=1
                            ΔI/ΔY=1−MPC
                     Î”Y/ΔI=1/1−MPC=1/MPS
                              𝑘=1MPS

Question. Explain the relationship between the value of MPC and investment multiplier.
Ans. There is direct relationship between value of MPC and multiplier. So, increase in the value of MPC increases the value of multiplier and vice-versa.
K=1 / 1−MPC

Chapter 4 Income Determination

Question. Explain the relationship between value of MPS and multiplier.
Ans. There is inverse relationship between value of MPS and multiplier. So, increase in value of MPS decrease the value of multiplier and vice versa.
K=1 / MPS

Chapter 4 Income Determination

Process/ Working of investment multiplier
Investment multiplier is the ratio of change in income is to change in investment. It explains how many times income will increase with additional unit of investment.

Working of investment multiplier is based on the fact that expenditure of one person is the income of another person.

Eg. Expenditure of person A will be income of person B and expenditure of B will be income of C and so on.

Initial expenditure is the increase in investment expenditure whereas subsequent increase in consumption expenditure depends upon value of MPC. It is explained with the help of following example.

Let there is increase in investment level ₹10,000 and value of MPC is 0.80. This initial investment will increase the income by ₹10,000 in the first round.

As a result, consumption expenditure will increase by ₹8,000(₹10,000 X 0.8) which will be the income of another person in the next round. Similarly, consumption expenditure will further increase by ₹6,400(₹10,000 X (0.8)2) which further will be the income of next person and this process will continue which is given as below.

Let investment level increase by ₹10,000 and value of MPC=80%=0.8

Chapter 4 Income Determination

ΔY = 10,000+8,000+6,400+5,120+…+∞
     = 10,000+10,000(0.8)+10,000(0.8)2+10,000(0.8)3+…+∞
     = 10,000(1+0.8+(0.8)2+(0.8)3+…+∞)
     = 10,000(1/1−0.8)                                    [𝑎+𝑟+𝑟2+𝑟3+⋯+∞=𝑎/1−𝑟]
     = 50,000

Full Employment

Full Employment refers to that situation where all those people who have the ability and also willing to do the work at the prevailing wage rate are employed.

Question. What do you mean by full employment equilibrium?
Ans. Full Employment Equilibrium refers to that situation when AD=AS at full employment. At this level, all economic resources are fully utilized with zero involuntary unemployment.

Question. What is excess demand in macroeconomics?
Ans. In an economy when AD is more than AS at full employment level, it is called excess demand. Thus, it is a situation where current aggregate expenditure exceeds full employment output level.
Inflationary gap: In the situation of excess demand, the gap between current AD and AS at full employment level is called inflationary gap. In other words, it is the excess of current AD over the full employment output level.

Question. What do you mean by deficient demand in macroeconomics?
Ans. Deficient Demand- In an economy when AD is less than AS at full employment, then it is called deficient demand.
Thus, it is the situation when current aggregate expenditure is less than full employment output level.
Deflationary gap- In the situation of deficient demand, the gap between current AD and AS at full employment level is called deflationary gap.
Thus, it is the amount by which AD is less than required AD to attain full employment level.

Question. Explain various instruments of monetary policy to control excess demand/ inflationary gap.
Ans. Monetary policy refers to the policy used by central bank to control and regulate money supply and credit in the economy. It includes following instruments: –

a) Quantitative instruments
(i) Bank rate: It is the rate at which central bank lends to commercial banks or discounts first class bills and securities of commercial banks for long-term needs.
In the situation of excess demand, central bank increase bank rate. It will further increase interest rate by commercial bank, so credit will become costlier and it will discourage the people to borrow from commercial banks. As a result, excess demand can be controlled.
(ii) Open market operations: It refers to buying and selling of government securities by central bank in open market. In the situation of excess demand, central bank sells government securities to commercial banks. So, it will decrease availability of funds available for credit with the banks, and it will result contraction of credit and thereby reduce AD of goods and services.
(iii) Capital Reserve Ratio(CRR): It is the percentage of total deposits which commercial bank has to keep with central bank in the form of reserves.
In the situation of excess demand, central bank increases CRR. It means bank must keep more percentage of deposits with central bank as reserve. So, it will decrease the capacity of commercial banks for credit. Thus, contraction of credit will help in controlling excess demand.
(iv) Statutory Liquidity Ratio(SLR): It is the percentage of total deposits which a commercial bank must keep with itself in the form liquid assets.
In the situation of excess demand, central bank increases SLR. It means more percentage of bank deposits has to keep by the bank itself. Thus, availability of funds for credit will decrease. So, contraction of credit will control excess demand.

b) Qualitative instruments
(i) Marginal requirement: It is the difference between value of securities offered against loan and amount of loan sanctioned.
In the situation of excess demand, central bank increases marginal requirement. It means less amount of loan will be sanctioned against the security offered to bank. So, it will result contraction of credit and helps to control excess demand.
(ii) Moral suasion: It refers to written or oral instruction given by central bank to commercial banks either for expansion or contraction of credit. In the situation of excess demand, central bank may compel commercial banks to reduce availability of credit.

Question. Explain various instruments of monetary policy to correct deficient demand/ deflationary gap in the economy.
Ans. Monetary policy refers to the policy used by central bank to control and regulate money supply and credit in the economy. It includes following instruments:

a) Quantitative instruments
(i) Bank rate: It is the rate at which central bank lends to commercial banks or discounts first class bills and securities of commercial banks for long-term needs.
In the situation of deficient demand, central bank decrease bank rate. It will further decrease interest rate by commercial bank, so credit will become cheaper and it will encourage the people to borrow from commercial banks. As a result, deficient demand can be corrected.
(ii) Open market operations: It refers to buying and selling of government securities by central bank in open market.
In the situation of deficient demand, central bank buys government securities from commercial banks. So, it will increase availability of funds available for credit with the banks, and it will result expansion of credit and thereby increase AD of goods and services.
(iii) CRR: It is the percentage of total deposits which commercial bank has to keep with central bank in the form of reserves.
In the situation of deficient demand, central bank decreases CRR. It means bank must keep less percentage of deposits with central bank as reserve. So, it will increase the capacity of commercial banks for credit. Thus, expansion of credit will help in correcting deficient demand.
(iv) Statutory Liquidity Ratio: It is the percentage of total deposits which a commercial bank must keep with itself in the form liquid assets. In the situation of deficient demand, central bank decreases SLR. It means less percentage of bank deposits has to keep by the bank itself. Thus, availability of funds for credit will increase. So, expansion of credit will correct deficient demand.

b) Qualitative instruments
(i) Marginal requirement: It is the difference between value of securities offered against loan and amount of loan sanctioned.
In the situation of excess demand, central bank decreases marginal requirement. It means more amount of loan will be sanctioned against the security offered to bank. So, it will result expansion of credit and helps to correct deficient demand.
(ii) Moral suasion: It refers to written or oral instruction given by central bank to commercial banks either for expansion or contraction of credit. In the situation of deficient demand, central bank may compel commercial banks to increase availability of credit.

Question. Explain the various instruments of fiscal policy to control excess demand in the economy
Ans. It refers to income and expenditure policy of the government. It includes following instruments: –
1) Income policy/ Taxation policy: The main source of revenue to government is through taxes.
In order to control excess demand, government should increase tax rate mainly on rich people and luxury goods. So, it will reduce disposable income of people. So, AD will be reduced due to less purchasing power.
2) Expenditure policy: To control excess demand in the economy, government should decrease its expenditure on public works.
So, it will decrease the income level of society and thereby control excess demand in the economy.
3) Public Debts: In the situation of excess demand government should increase the borrowing from public. It will reduce the surplus money stock with the public and thereby will help to control excess demand in the economy.

Question. Explain various instruments fiscal policy to correct deficient demand/ deflationary gap in the economy.
Ans. It refers to income and expenditure policy of the government. It includes following instruments: –
1) Income policy/ Taxation policy: The main source of revenue to government is through taxes.
In order to correct deficient demand, government should decrease tax rate mainly on rich people and luxury goods. So, it will increase disposable income of people. So, AD will be increased due to less purchasing power.
2) Expenditure policy: To control deficient demand in the economy, government should increase its expenditure on public works.
So, it will increase the income level of society and thereby correct deficient demand in the economy.
3) Public Debts: In the situation of deficient demand government should decrease the borrowing from public. It will increase the surplus money stock with the public and thereby will help to correct deficient demand in the economy.

Question. What do you mean by underemployment equilibrium?
Ans. Under employment equilibrium refers to that equilibrium level where AD<ASFE. So, under employment equilibrium is attained at less than full equilibrium where all economic resources are not utilized and there exists involuntary unemployment.
The main cause for underemployment equilibrium is deficiency in AD. So, there is a need to increase AD to establish full employment equilibrium.

Question. What do you mean by involuntary unemployment and voluntary unemployment?
Ans. Involuntary unemployment refers to that situation where all those people who have ability and also willing to work at the prevailing wage rate but fails to get the work.
Voluntary unemployment refers to all those people who are not willing to work even suitable work is available for them.

Question. Distinguish between autonomous and induced investment.
Ans. Induced invest refers to that investment which is directly related to expected income from such investment. It is generally incurred by put sector for the profit motive. Investment curve is upward slope as it is income elastic.
Autonomous investment refers to that investment which is not affected by expected income level from such investment. This kind of investment is incurred by government sector with social welfare motive. Here, investment curve is horizontal in slope as it is income inelastic.

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Income Determination and Employment Class 12 Economics Notes