Question 1

Calculate the equilibrium level of income in the economy, if C = 500 + (0.9) Y; and Investment Expenditure = 3,000. (Equilibrium Level of Income = 35.000)

Accepted Answer

Consumption Function is C = 500+ 0.9 Y where Y in the income in&#10;the economy.&#10;&#10; At&#10;equilibrium level of income,&#10;&#10; AS=AD&#10;&#10;Y=&#10;C+I &#10;&#10;=>&#10;Y= 500 + 0.9 Y + 3,000&#10;&#10;=>&#10;Y - 0.9 Y = 500 + 3,000&#10;&#10;=>&#10;0.1 Y = 3,500&#10;&#10;=>&#10;Y = 3,500/ 0.1 = 35,000.

Question 2

Explain the working of investment multiplier with the help of a numerical example.

Accepted Answer

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment. For example investment is increased by 1,000 crore rupees, now ParticularsIncrease in Income(Rs. Crores)Change in Consumption(Rs. Crores)Change in Saving(Rs. Crores)Fist Round1000800200Second Round800640160Third Round640512128All other Rounds 2,5602,048512Total5,0004,0001,000(a) In the multiplier process, increase in income in the first round is always equal to additional investment. So, Increase in income in the first round =Rs.1,000=Rs.1,000 crores. (b) The saving off  Rs. 200 crores indicates that increase in consumption will be Rs. 800 crores in the first round. - additonal consumption of Rs. 800 crores out of an additional income of Rs. 1,000 indicates that 80% of income is spent, Le. MPC = 0.8. The values of second and third round are calculated on the basis of this data. (c) Total Increase in Income = Additional Investment x kxk. In the given case: Multiplier (k)=11&#8722;MPC=11&#8722;0.8=5(k)=11&#8722;MPC=11&#8722;0.8=5So, Total Increase in Income =1,000&#215;5=Rs.5,000 crores=1,000&#215;5=Rs.5,000crores(d) Total Increase in Consumption == Total increase in Income &#215;&#215; MPC =5,000 x 0.8=Rs.4,000 crores=5,000x0.8=Rs.4,000crores.(e) Total Increase in Saving == Total Increase in Income &#8722;&#8722; Total Increase in Consumption =5,000&#8722;4,000=1,000 crores=5,000&#8722;4,000=1,000crores.(f) Values of All other Rounds' is calculated after subtracting the values of first, second and third round from the total increase in income, consumption and saving respectively.

Question 3

If in an economy: (a) Consumption function is given by C = 100 + 0.75 Y, and (b) Autonomous Investment Is 150 crores. Estimate (I) Equilibrium level of Income and (ii) Consumption and Savings at the Equilibrium Level of Income. ((i) Rs. 1,000 crores; (ii) Consumption = Rs. 850 crores, Savings= Rs. 150 crass)

Accepted Answer

(I) Consumption Function is C = 100+ 0.75 Y where Y in the income in&#10;the economy.&#10;&#10; At equilibrium level of income,&#10;&#10; AS=AD&#10;&#10;Y= C+I &#10;&#10;=> Y= 100 + 0.75 Y + 150&#10;&#10;=> Y - 0.75 Y = 100 + 150&#10;&#10;=> 0.25 Y = 250&#10;&#10;=> Y = 250/ 0.25 = Rs. 1,000 crores (II) Consumption Function is C = 100+ 0.75 Y where Y in the income in the economy. At equilibrium level of income,C= 100 + 0.75 ( 1,000)   = 100 + 750    = Rs. 850 crores Savings = Investments               = Rs. 150 crores

Question 4

The consumption function for an economy is given as: C = 200 + 0.8Y. (i) Determine the value of MPC and MPS; (ii) Autnomous Consumption; (iii) Derive the corresponding saving function; (iv) Calculate consumption at the income levels of Rs. 3,000 crores and Rs. 5,000 crores. (v) Determine the break-even level of income. ((i) MPC = 0.8; MPS =0.2; (ii) Autnomous Consumption = 1200 crows (iii) S = -200 + 0.20Y (iv) Rs. 2,600 crams and Rs. 4,200 crores; (v) Rs. 1,000 crores)

Accepted Answer

(i) Marginal&#10;Propensity to consume refers to the percentage change in consumption for every&#10;one rupee of change in the income. It is the ratio between the change in income&#10;and corresponding change in consumption.MPC= 0.8 &#10;Marginal Propensity to save refers to the percentage change&#10;in savings for every one rupee of change in the income. It is the ratio between&#10;the change in income and its corresponding change in savings.MPS = 1 - MPC = 1- 0.8 = 0.2 (ii) Autonomous&#10;consumption refers to that consumption which occurs when there is no income in&#10;the economy. It is the minimum level of consumption that takes place in the&#10;economy. So if income is zero, then C = 200 + 0.8 * 0 = 200 crores (iii) Savings&#10;function refers to the standard equation of savings which defines the&#10;relationship between savings and income where savings value can be derived at each level with the use of income value. &#10;&#10;S= s + Y(1-b) where s=autonomous&#10;savings, (1-b)= marginal propensity to save, and Y= income.The&#10;consumption function is C= 200+0.8Y where Y is the income at different level in&#10;the economy. &#10;&#10;Income = consumption +&#10;savings &#10;&#10;=> Savings = Income&#10;- consumption &#10;&#10;=> S = Y- C&#10;&#10;=> S = Y - ( 200 +&#10;0.8Y)&#10;&#10;=> S = Y- 200 - 0.8Y&#10;&#10;=> S = - 200 + Y ( 1&#10;- 0.8) &#10;&#10;=> S = -200 +&#10;0.2Y &#10;&#10;Therefore, the saving&#10;function is S= -200 + 0.2Y  where autonomous savings= -200 crores, MPS= 0.2 and Y is income at all&#10;levels. (iv) At income level 3,000 crores, &#10;&#10; C= 200 + 0.8 (3000) &#10;&#10;   = 200+ 2400&#10;&#10;   = Rs. 2600 croresAt income level 5000&#10;crores,  C= 200 + 0.8 (5000)    = 200+ 4000&#10;&#10;&#10;&#10;&#10;&#10;   = Rs. 4200&#10;crores(v) Break even&#10;point refers to the point where the income=consumption or savings= 0.&#10;Therefore, &#10;&#10;Y=C &#10;&#10;=> Y= 200 +0.8 Y&#10;&#10;=> Y- 0.8 Y=200&#10;&#10;=> 0.2 Y = 200 &#10;&#10;=> Y= 200/0.2 = 1000&#10;crores.

Question 5

Calculate autonomous consumption expenditure from the following date about an economy which is In equilibrium. National income = Rs. 1,200 Marginal propensity to save = 0.20 Investment expenditure = Rs. 100 (Autonomous Consumption Expenditure = 140)

Accepted Answer

If MPS=0.20, then MPC= 1-MPS= 1-0.20= 0.80 Consumption Function is C = c + 0.80 Y where Y in the income in the economy and c= Autonomous consumption. &#10;&#10;At equilibrium level of output,&#10;&#10; AS=AD&#10;&#10;Y= C+I &#10;&#10;=> 1,200 = c + 0.80  (1,200)  + 100&#10;&#10;=> 1,200 = c+ 960 + 100 &#10;&#10;=> 1,200 = c+ 1,060&#10;&#10;=> c = 1,200- 1,060 = Rs.140

Question 6

Explain the determination of equilibrium level of national income using 'saving and investment approach. Use diagram. Also explain the effects if saving is greater than investment.

Accepted Answer

According to this approach of&#10;equilibrium, the equilibrium is reached only when Investment(I) equals&#10;Savings(S) because at this level there is no tendency for income and output to&#10;change.  &#10;In the diagram the&#10;equilibrium is at E where savings intersects investment curve At this&#10;point, I=S.&#10;When S is more than I , then&#10;the planned inventory would fall below the desired level. To bring back the&#10;Inventory at the desired level, the producers expand the output More&#10;output means more income. Rise in output means rise in I and rise in&#10;income means rise in S. Both continue to rise till they reach E, S=I. &#10;When S is less than I, then&#10;the planned inventory rises above the desired level. To clear the unwanted&#10;increase in inventory, firms plan to reduce the output till S becomes equal to&#10;I.&#10;So, equilibrium takes place&#10;only at point E, when S=I.

Question 7

Using the 'saving and investment' approach explain how is the equilibrium level of national income determined? Also explain what will happen if the equilibrium condition is not fulfilled.

Accepted Answer

According to this approach of equilibrium, the equilibrium is reached only when Investment(I) equals Savings(S) because at this level there is no tendency for income and output to change. In the diagram the equilibrium is at E1  where savings intersects investment curve At this point, I=S.When S is more than I , then the planned inventory would fall below the desired level. To bring back the Inventory at the desired level, the producers expand the output More output means more income. Rise in output means rise in I and rise in income means rise in S. Both continue to rise till they reach E1, S=I. When S is less than I, then the planned inventory rises above the desired level. To clear the unwanted increase in inventory, firms plan to reduce the output till S becomes equal to I.So, equilibrium takes place only at point E1, when S=I.

Question 8

If MPC = MPS, then value of multiplier is __________.

Accepted Answer

Investment&#10;multiplier refers to the number of time by which the increase in output or&#10;income exceeds the increase in investment. It is measured as the ratio between&#10;change in income and change in investment and it is denoted as 'k'.Multiplier(k) => Change in income / change&#10;in investment = 1/ MPS(s) where s is the marginal propensity to&#10;save. So if MPS=MPC then ,We know that MPC + MPS =1 => 2 MPS= 1 => MPS= 1/2 => MPS= 0.5  Multiplier (K) = 1/ MPS= 2 times.Hence, the value of the multiplier is two.

Question 9

Explain the relationship between MPC and multiplier with the help of an example.

Accepted Answer

Investment multiplier refers to the number of time by which the&#10;increase in output or income exceeds the increase in investment. It is measured&#10;as the ratio between change in income and change in investment and it is&#10;denoted as 'k'.Marginal Propensity to consume refers to the percentage change in&#10;consumption for every one rupee of change in the income. It is the ratio&#10;between the change in income and corresponding change in consumption.Multiplier(K) = 1/ (1- MPC) = 1 / (1 - Change in consumption/ change in&#10;income)    = change in income/ change in income- change in&#10;consumption   = change in income/&#10;change in savings &#10;&#10;&#10;&#10;&#10;&#10;   = change in income/ change in&#10;investment For example, If MPC= 0.8 then Multiplier(K) = 1/ (1- 0.8) = 1 / (1 - 8/ 10)    = 10/ 10- 8   = 10/ 2  = change in income/ change in investment   = 5 times Therefore, Change in income = 10 and change in investment = 2

Question 10

Demand curve slopes upwards from left to right.

Accepted Answer

False. Demand curve slopes downward from left to right because of the law of diminishing marginal utility. According to this law, the utility/satisfaction of the consumer goes on decreasing with every additional consumption of the commodity and hence, the consumer will buy more goods only when the price decreases. Other reasons are income effect, substitution effect, different uses of commodity etc.