It refers to the total demand for final goods and services in an economy during a year. It means a functional relationship between total consumption and total disposable income. Thus, C = f (y) C = consumption Y = Income if the consumption function is given on the assumption of constant marginal propensity to consume. It is called linear consumption function. Saving function is a schedule showing a functional relationship between total saving and total income. Equilibrium level of output in an economy is determined at a point where planned spending (C+I) equals the planned output or where C+I curve intersects the 45° line. It is that level of aggregate demand which becomes effective in determining equilibrium level of income because it is equal to aggregate supply. It is what the investors plan or intend or invest at different levels of income in the economy. It is what the saves plan to save at different levels of income in the economy. They refer to realised saving and investment in the economy. Ex-post saving is always equal to ex-post investment. Which states that as people become more thrift they end up saving less or same as before. It refers to that situation in the economy when AD = AS along with fuller utilization of labour forces.
Marginal propensity to consume refers to the ratio of change in the consumer’s expenditure due to the change in disposable income (income after deducting taxes). In other words, MPC measures how consumption will vary with the change in income.
So,
MPC
Where,
ΔC = Change in consumption
ΔY = Change in income
For example, if income increases from Rs 200 crores to Rs 250 crores and consumption increases from Rs 20 crores to Rs 40 crores, it implies that 0.4 is the MPC or 40% increase in the income is being consumed.
| S.No. | Ex-ante Investment | Ex-post Investment |
|---|---|---|
| 1 |
It refers to the planned or intended investment during a particular period of time. |
It refers to the actual level of investment during a particular period of Time. |
| 2 |
It is imaginary (intended), in which a firm assumes the level of investment on its own. |
It is factual or original that signifies the existing investment of a particular time. |
| 3 |
It is planned on the basis of future expectation. |
It is the actual result of variables. |
Considering the equation of a straight line as
b = ma + ÃŽÂμ
Where m = slope of straight line, m > 0
ÃŽÂμ = intercept on vertical axis, ÃŽÂμ> 0
Also, when a increases by 1 unit, the value of b increases by m units.
The parameters ÃŽÂμ and m are parameters of a graph.
As the value of m increases, the straight line rotates upward around the same vertical intercept. This movement is an example of parametric shift of the graph.
(i) A straight line rotates downward around the same vertical intercept as its slope decreases.
(ii) A straight line shifts parallelly upward when its intercept increases.
Effective demand refers to a situation in which equilibrium output is determined solely by the level of aggregate demand. This is because of the assumption that the supply is infinitely elastic and if there exists any inequality between the Aggregate Demand (AD) and the Aggregate Supply (AS), then the equilibrium output will only be influenced by AD. The concept of effective demand can be explained:
The x-axis represents income/output level and y-axis represents the level of aggregate demand. E is the equilibrium point where the two curves AS and AD meet. EG is the effective demand and output level is determined by AD (assuming the elasticity of supply to be perfectly elastic).
Autonomous expenditure multiplier is derived as
Y = AD (at equilibrium)
Y = A + cY [Where AD = A + cY]
Y - cY = A
Y (1 - c) = A
Where
A = Autonomous expenditure
c = MPC
Y = level of income
= autonomous expenditure multiplier
So, the autonomous expenditure multiplier is dependent on the income and MPC.
Consumption expenditure (A) = Rs 50 Crores
MPS = 0.2
So, MPC = 1 - MPS
= 1 - 0.2
= 0.8
Y = 4000 Crores
We know that AD = A + cY (1)
Putting the values in equation (1)
AD = 50 + 0.8 x 4000
= 50 + 3200
= Rs 3250 Crores
But, Rs 3250 < Rs 4000
Implies that AD < Y
Hence, the economy is not in equilibrium.
Paradox of thrift refers to a situation in which people tend to save more money, there by leading to a fall in the savings of the economy as a whole. In other words, when everyone increase his/her saving-income proportion i.e. MPS (s), then, the aggregate demand will fall as consumption decreases. This will further lead to a decrease in employment and income level and finally this will reduce the total savings for the economy. This concept was suggested by Keynes wherein increased saving at individual levels will gradually lead to the slowdown of economy in terms of circular flow of income.