NCERT Solutions Class 12 Macroeconomics Chapter 4 – Determination of Income and Employment
In Macroeconomics, the basic objective is to determine the value of variables such as national income, price level, interest rate, etc. It is done by developing models that provide a theoretical explanation as to why an economy goes through a period of slow growth or recession and the reason for the increase in the price level or rising unemployment. When constructing models, it is difficult to attain the values of all the variables at once, so when economists have to find the value of a particular variable, they keep the value of all concerning variables constant. In Chapter 4, which is on the determination of income and employment, students will look at how national income is determined under an assumption of a fixed price of the final goods and a constant rate of interest in the economy. As students now dive into the world of learning Macroeconomics, they must understand the core concepts mentioned in their NCERT texts and what they are taught in their classrooms. To provide them with a helping hand, NCERT Solutions Class 12 Macroeconomics Chapter 4 provided by Extramarks can be an excellent resource.
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Key Topics Covered in NCERT Solutions Class 12 Macroeconomics Chapter 4
Determination of Income and Employment, Chapter 4 in Class 12 Macroeconomics, covers a wide range of topics that provide an overview of calculating national income with the premise that economic interest rates are constant and that final items have a set price. The students can study various important concepts that help in this income determination.
Some key topics covered in NCERT Solutions Class 12 Macroeconomics Chapter 4 are as follows:
- Aggregate Demand
- Ex Ante and Ex Post Demand
- Aggregate Supply
- Consumption Function
- Propensity to Consume
- Saving Functions
- Propensity to Save
- Relationship Between Average Propensity to Consume (APC) and Average Propensity to Save (APS)
- Relationship Between Marginal Propensity to Consume or MPC and Marginal Propensity to Save or MPS
- Investment and its Further Classification
- Equilibrium Level of Income
- Types of Employment
- The Multiplier Mechanism
- Investment Multiplier
- Aggregate Demand and Aggregate Supply Approach
- Saving Investment Approach
- Excess Demand
- Deficient Demand
- Inflationary Gap and Deflationary Gap
- Ways to Control Excess Demand and Deficient Demand
Let us now look at the detailed information on each of the above-listed subtopics in the NCERT Solutions Class 12 Macroeconomics Chapter 4:
- It represents the entire cost of all final goods and services expected to be purchased by all economic sectors at a particular income level during a specified period.
- Hence, Aggregate Demand describes the overall expenditure on goods and services in an economy over a given period.
- Consumer products, capital goods, government spending, imports, and exports comprise aggregate demand. Fluctuations in inflation expectations, exchange rate shifts, and income resource differences can impact aggregate demand interest rates.
Components of Aggregate Demand: In an Open Economy
AD = C + I + G + (X – M)
- C refers to the consumption expenditure by households.
- I refer to the investment expenditure.
- G refers to government consumption expenditure.
- X – M refers to the net exports.
Component of Aggregate Demand: In a Closed Economy
- In a three-sector economy,
AD = C + I + G
- In a two-sector economy,
AD = C + I
Ex Ante and Ex Post Demand
Ex Ante Demand- refers to a demand that has already been planned
Ex Post Demand- refers to the actual consumer spending
- It is the monetary value of all finished goods and services that an economy can purchase over a given time. It refers to the economic movement of products and services.
- The monetary worth of finished goods and services equals net value-added; AS consists only of national revenue.
- Aggregate supply is affected by technological advancements, shifts in the type and quantity of labour, rising production costs, rising salaries, shifting subsidies and taxes, and inflation.
AS = C + S
A consumption function illustrates the relationship between consumption and income. The most fundamental consumption function assumes that consumption and income change simultaneously.
C= C + cY
C represents the consumption expenditure of households
C represents autonomous consumption. It is consumption which is independent of income. If consumption takes place at zero income level, it is because of autonomous consumption. It is income inelastic. Certain things must be purchased regardless of how much money or income a consumer has on hand at any given time.
cY represents induced consumption. It shows the dependence of consumption on income. MPC * Y also indicates it.
Y represents the income.
Propensity to Consume
The propensity to consume is of two types. A detailed explanation of the kinds of propensity to consume as stated in the NCERT Solutions Class 12 Macroeconomics Chapter 4 include the following:
- Average Propensity to Consume
- APC or Average Propensity to Consume refers to the consumption per unit of income.
- Cy calculates it.
Important points about APC:
- APC > 1: APC is greater than 1 when consumption expenditure exceeds national income before the break-even point.
- APC = 1: APC equals one when consumption expenditure equals national income at the break-even point.
- APC< 1: APC is less than one when the national income exceeds the consumption expenditure of households at the break-even point.
- Inverse Relationship with Income: Income and APC are inversely related. An increase in income will lead to a decrease in APC.
- APC Cannot Ever Be Zero: Autonomous consumption exists even at a zero income level; hence the APC can never be zero.
- Marginal Propensity to Consume
- MPC or Marginal Propensity to Consume is the change in the per unit of consumption expenditure with a difference in the income.
- ΔCΔY calculates it.
- ΔC represents the change in consumption, and ΔY represents the change in income.
Important points about MPC:
- MPC = 1: if all the additional income, that is, ΔY, is consumed, then ΔY = ΔC. It implies that a change in income equals a change in consumption.
- MPC = 0: if all the additional income is saved, then ΔC will equal zero. Hence the value of MPC will also be zero.
- Constant MPC: MPC represents the slope of the consumption curve; hence it remains constant in the short run.
- APC > MPC
A saving function illustrates the relationship between savings and national income.
S = Y – C
= Y – ( C + cY)
= Y – C -Y
= -C + (1-c)Y
-C represents dissavings. This dissavings is needed to finance autonomous consumption.
1-c represents MPS
Y represents the income.
Propensity to Save
Propensity to Save is of two types. The detailed explanation as mentioned under NCERT Solutions Class 12 Macroeconomics Chapter 4 is below:
- Average Propensity to Save
- APS or Average Propensity to Save refers to the savings per unit of income.
- SY calculates it.
Important points about APS:
- APS can never be greater than and equal to one: APS can never be greater than or equal to one, as savings can never be greater than or equal to income.
- APS = 0: APS can be zero. At the break-even point, when C=Y would imply that savings are zero, which would result in APS being zero. It happens when all that is earned is spent on consumption.
- APS can be Negative: When the consumption expenditure exceeds the income level lower than the break-even points.
- Direct Relation with Income: APS also rises with an increase in income. There is a direct relationship between APS and income.
- Marginal Propensity to Save
- MPS or Marginal Propensity to Save refers to the change in savings per unit of change in income levels.
- It is denoted by s and equals (1-c). It is because if 1 is the complete income level, deducting c or consumption from it will give savings.
- MPS follows that S+C = 1; hence total consumption and savings are equal to one.
- MPS = ΔSΔY
Points to remember about MPS:
- The value between 0-1: The value of MPS is between 0 and 1
- Savings Curve: The MPS denotes the slope of the savings curve.
- Short Run: MPS remains constant in the short run.
Relationship Between Average Propensity to Consume or APC and Average Propensity to Save or APS.
The product of APC and APS equals one.
It can be demonstrated with the following equation:
APC + APS = 1.
Y = C + S
Dividing both sides by Y, we get
YY=CY + SY
1 = APC + APS
As, APC = cy , APS = SY
Therefore, APC + APS = 1
Relationship Between Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS)
Y = C + S
hence , ΔY = ΔC + ΔS
Where ΔY represents a change in income, and ΔC and ΔS represent the change in consumption and change in savings, respectively
Dividing both sides with ΔY
ΔYΔY= ΔCΔY + ΔSΔY
1 = MPC + MPS
As, MPC = ΔCΔY and MPS = ΔSΔY
Therefore, MPC + MPS = 1
Investment and its Further Classification
An investment is a purchase of an asset or object to earn income or increase in value. Appreciation refers to an increase in the value of an asset over time. It is further classified into the following types, the details of which are mentioned below:
- Induced Investment: Induced Investment is described as a type of investment that relies on profit projections and is influenced directly by one’s income level.
- Autonomous Investment: Autonomous investment is described as a type of investment that is not influenced by changes in income and is not driven purely by financial gain.
- Ex Ante Investment: Ex-ante investment is the term used to describe investments made by businesses in the economy at a given time. Future expectations are taken into consideration when planning.
- Ex-Post Investment: Ex-post investment refers to the actual investment that all business owners made in the economy over a specific time frame. It is a result of real investment.
Equilibrium Level of Income
The equilibrium level of income is identified only when AD = AS or S = I, i.e. when the movement of goods and services in the economy equals the demand for goods and services.
This movement of goods and services cannot always be at full employment and may occasionally be less than full employment.
Types of Employment
- Full Employment: Full employment happens when all people capable and willing to work at the current wage rate are given the option to do so.
- Voluntary Employment: Voluntary employment occurs when a person can work but refuses to labour at the prevailing wage rate.
- Involuntary Employment: When a worker is able and willing to work at the going pay rate but fails to obtain employment, it refers to involuntary employment.
- Under Employment: Underemployment occurs when all persons who are capable of working at present wage rates are unable to find a job. It denotes an economic condition in which AS= AD or S=I, but there is insufficient labour force utilisation.
The Multiplier Mechanism
- The multiplier reveals the amount of change in revenue that will ultimately arise from a change in investment. Income changes as a result of changes in investment.
- When autonomous measures (A) increase, the overall demand also increases.
- As a result, income and output will rise in the next round, leading to an increase in consumption and AD. It is known as the multiplier mechanism.
- It is represented by ΔI → ΔY → ΔC → ΔY
- Let us understand with an example:
- Let’s use an example where the value of the additional output, 10, is allocated among various factors as factor payments, and the resulting increase in economic income is 10.
- When income rises by 10, consumption spending rises by (0.8)10 because people spend an additional 0.8 (= Mpc) of their income on consumption.
- As a result, the economy’s total demand rises by (0.8)10 in the following cycle, and an excess demand of (0.8)10 becomes apparent.
- To achieve this, the producers will increase their anticipated output by an additional (0.8)10 over the following production cycle.
- Once again producing an excess demand of the same amount, this additional output boosts overall consumer demand by (0.8)*(0.8)*10 and increases economic revenue by (0.8)*(0.8)*10.
- This cycle repeats itself, with producers expanding their output to meet the excess demand in each cycle and consumers spending a portion of their new income on consumption products to fuel the following round’s growth in demand.
By referring to Extramarks NCERT Solutions Class 12 Macroeconomics Chapter 4, students can easily understand the important concept of multiplier along with other topics in an easy-to-comprehend language.
The investment multiplier (K) measures the relationship between changes in investment and income (Y) (I). The investment multiplier has a value ranging from one to infinity.
Or, K= 11-MPC
Or, K= 1MPS
Aggregate Demand and Aggregate Supply Approach
In an economy, the level of output at which aggregate demand equals aggregate supply. AD = AS.
It implies that everything the producers planned to make during the year equals everything that the buyers planned to purchase during that same year.
AD = I + C (for a two-sector economy), and
AS = C + S
AD = Aggregate Demand,
AS = Aggregate Supply,
C = Consumption,
I = Investment,
S = Saving
Two Different Scenarios:
- AD > AS: In this scenario, aggregate demand outweighs the aggregate supply, resulting in continued unmet demand. The producers will raise output and production to reverse this scenario and restore equilibrium by causing AS to rising and equal AD.
- AD < AS: In this situation, there are still redundant stocks because the aggregate demand is less than the aggregate supply. The producers will reduce output and production to control this situation. The equilibrium situation would be restored as additional supply would decline and equalise additional demand.
Saving Investment Approach
It is the equilibrium point at which S=I. I represent investment or injection, and S = savings or withdrawal.
Two Different Scenarios:
- S >I: Companies are forced to hold extra inventory since a portion of the anticipated output isn’t sold. To reduce the stocks, producers will subsequently reduce their output, lowering production. Income in the economy declines as a result. Less income leads to fewer savings and so on until investment equals saving.
- S<I: When S > I, people spend more money than is necessary to buy the expected output. It indicates that AD, or more demand, outweighs AS, or additional supply in the economy. Producers will consequently raise production to make up for the problem. Investment soars as a result to the point that it matches investment.
Excess demand occurs when aggregate demand exceeds aggregate supply, leading to full employment.
Reasons for excess demand, as mentioned in the NCERT Solutions Class 12 Macroeconomics Chapter 4, are as below:
- Increasing propensity to consume has led to a rise in household consumption demand.
- The increased availability and provision of credit facilities have increased the demand for private investment.
- High spending by the public (government).
- Increase in export demand.
- Increase in the supply of money.
Impact of excess demand:
- General Price Level: When aggregate demand exceeds aggregate supply at full employment, the general price level rises, resulting in an inflationary economic condition.
- Output: Excess demand does not affect output since the economy is already at a full employment level, and there is no idle capacity. Therefore, production cannot be increased further than it is now.
- Employment: Excess demand does not affect the number of jobs. The economy is already functioning at full equilibrium employment.
It occurs when AD falls short of AS during full employment. Another way is that AD is less than AS at full employment. It is known as deficient demand.
Reasons for deficient demand:
- Reduced willingness to consume leads to a drop in household consumption demand.
- Because fewer credit facilities are available and provided, there is a decline in the demand for private investment.
- Decrease in public (government) spending.
- A decline in export demand
- The decline in the money supply
- A decline in disposable income
Impacts of deficient demand:
- General Price Level: General price levels decrease when there is a deflationary scenario in the economy, where aggregate demand is greater than aggregate supply at full employment.
- Output: Deficient demand results in low output levels due to low investment and unemployment.
- Employment: Deficient demand results in low employment levels due to the possibility of involuntary unemployment.
Inflationary Gap and Deflationary Gap
- Represents the difference between actual aggregate demand and the level necessary to attain full employment is known as the inflation gap.
- It assesses the level of excess demand.
- Since the output cannot be increased above the point of full employment, prices will rise and inflation will set in.
- A deflationary gap is a difference between current aggregate demand and the level necessary for full employment.
- It calculates the degree of low demand.
Ways to Control Excess Demand and Deficient Demand
- Fiscal Policy: Fiscal policy refers to the government’s expenditure and income policies to attain its developmental goals. It includes the following measures:
a. Change in taxation: Taxation is used to describe the government’s revenue policy.
- Excess Demand: When there is inflation, the government raises taxes, reducing the populace’s purchasing power. It is because lowering the economy’s liquidity is necessary to curb excessive demand.
- Deficient Demand: Tax rates are lowered in insufficient demand to give consumers more purchasing power. It is true because raising the level of economic liquidity is necessary to manage inadequate demand.
b. Change in Public Expenditure: The government invests a significant amount of money in public works such as building railway lines, flyovers, buildings and roads. Changes in these expenditures directly impact the economy’s AD level and aid in managing excess and insufficient demand circumstances.
- Excess Demand: The government should restrict (reduce) its spending on public works like roads, buildings and irrigation projects during an inflationary time to lower people’s income levels and consumption needs.
- Deficient Demand: Government spending on public works projects like roads, buildings and irrigation systems should be increased during periods of deficient demand because this will improve people’s income and consumer needs.
c. Shift in Public Borrowing: This involves taking loans from the public. This measure can have a lot of impact in correcting the excess demand and deficient demand scenarios.
- Excess Demand: By leaving people with less money, increasing public borrowing measures implies that the government should borrow money from the general public, which lowers people’s purchasing power. As a result, the government should raise public borrowing when there is excess demand.
- Deficient Demand: This measure means that the government should lower general population borrowings, increasing people’s purchasing power. As a result, the government should use less public borrowing when there is deficient demand.
- Monetary policy: It controls the amount of money in circulation, and the accessibility of credit in the economy is a central bank’s policy.
A. Quantitative Measures: They are the monetary policy instruments that influence the overall supply of money/credit in the economy. These instruments don’t control or restrict how much credit is given to particular economic sectors.
a. Bank Rate: The bank rate refers to the rate of interest at which a central bank loans money to commercial banks without any kind of security.
- Excess Demand: When there is excessive demand, the government should raise the bank rate because this reduces the amount of money available to banks, and consequently, the ability of commercial banks to extend credit. As a result of the economy’s low money supply and poor credit creation, aggregate demand declines.
- Deficient Demand: In times of deficient demand, the government should lower the bank rate because banks will have more money available, which will boost their ability to extend credit. As a result of the economy’s large money supply and strong credit creation, aggregate demand rises.
b. Cash Reserve Ratio: The minimal portion of a bank’s overall deposits that the institution must hold at the central bank. Commercial banks are required by law to maintain cash reserves equivalent to a predetermined portion of their deposits with the central bank.
- Excess Demand: In times of excessive demand, CRR should be raised since this lowers the amount of money available to banks and reduces the ability of commercial banks to extend credit. As a result of the economy’s low money supply and poor credit creation, aggregate demand declines.
- Deficient Demand: In instances of deficient demand, the government should reduce CRR because the amount of money available to banks increases, and commercial banks’ ability to extend credit likewise does. As a result of the economy’s large money supply and strong credit creation, aggregate demand rises.
c. Statutory Liquidity Ratio: The minimal portion of a bank’s overall deposits that the institution must hold at the central bank represents the SLR or statutory liquidity ratio. Commercial banks are required by law to maintain cash reserves equivalent to a predetermined portion of their deposits with the central bank.
- Excess Demand: In circumstances of excessive demand, the government should raise the SLR because this lowers the number of money banks has available to them, reducing their ability to extend credit. As a result, the economy’s money supply and credit creation are both low, which lowers aggregate demand.
- Deficient Demand: SLR should be lowered when there is deficient demand since this makes more money available to banks and boosts their ability to extend credit to businesses. As a result of the economy’s high rate of credit creation and money supply, aggregate demand rises.
d. Open Market Operations: Open Market Operations are when the central bank engages in open market transactions to buy and sell government securities.
- Excess Demand: The central bank should sell government securities and bonds on the open market when there is excess demand. As a result, commercial banks are less able to lend money, which lowers overall demand levels.
- Deficient Demand: The central bank should purchase government assets and bonds on the open market when there is deficient demand. Due to consumers having a higher purchasing power, this enhances the capacity of commercial banks to extend loans, which raises the levels of aggregate demand.
B. Qualitative Measures: These monetary policy tools are used to control the direction of credit.
a. Marginal Requirement: Commercial banks make loans to firms and dealers to secure their commodities. The bank will never give credit equivalent to the total value of the security. The amount is always lesser than the security value.
- Excess Demand: The margin requirements are increased when there is an excess of demand because borrowers become discouraged since a high margin requirement results in a smaller loan amount being offered to them.
- Deficient Demand: When there is insufficient demand, the margin requirements are lowered to attract borrowers to take out loans because more money will be available to them.
b. Credit Rationing: The central bank can use this strategy to instruct commercial banks to increase lending for certain goals or priority sectors or to refrain from borrowing for certain reasons.
- Excess Demand: As a part of credit rationing, When there is too much demand, which causes inflation, the central bank imposes credit rationing to stop an excessive flow of credit, especially for speculative activity. It aids in removing the extra demand.
- Deficient Demand: During periods of deficient demand, the central banks withdraw the rationing on credit. It encourages people to take up credit to make up for the low demand for goods and services in the economy.
c. Moral Suasion: Moral suasion is the term for the central bank’s efforts to convince commercial banks to support its overall monetary policy through persuasion, petition, informal suggestion, advice and appeal.
- Excess Demand: As a part of moral suasion, when there is excess demand in the economy, the central bank seeks a credit contraction.
- Deficient Demand: When there is deficient demand, the central bank proposes a loan extension.
NCERT Solutions Class 12 Macroeconomics Chapter 4: Exercise and Solution
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Key Features of NCERT Solutions Class 12 Macroeconomics Chapter 4
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- The framework of the NCERT solutions provides a comprehensive and straightforward presentation of topics related to income and employment.
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FAQs (Frequently Asked Questions)
If all persons in the economy raise the proportion of their income they save (i.e. if the MPs of the economy grow), the overall value of savings in the economy will not increase – it will either drop or remain steady. It is known as the Thrift Paradox, which asserts that as people become more thrifty, they save less or the same as before.
According to the paradox of thrift theory, people tend to save more money, and this increased saving results in reduced spending, which lowers overall consumption. Such a savings system will result in lower employment levels, lower total savings for the economy and slower economic growth. It is a key component of Keynesian economics.
JM Keynes utilised two approaches in his renowned book ‘General Theory’ for calculating the national income in the economy. Those two approaches, as mentioned in the NCERT Solutions Class 12 Macroeconomics Chapter 4, include the following two methods:
- Saving Investment Method
- Aggregate Demand and Aggregate Supply Method
It should be highlighted that the Keynesian approach to determining income only applies in the short term. According to Keynes, planned or intended saving equals planned or intended investment in the short run, determining the amount of national income.