Macroeconomics: Aggregate Demand and Aggregate Supply, Slides of Economics

Download Macroeconomics: Aggregate Demand and Aggregate Supply and more Slides Economics in PDF only on Docsity! MACRO ECONOMICS AGGREGATE DEMAND AND AGGREGATE SUPPLY TOPICS INVESTMENT MULTILPIER NUMERICALS EXCESS DEMAND AND DEFICIENT DEMAND FISCAL AND MONETARY POLICY INVESTMENT MULTIPLIER • Investment refers to the process or action of investing time, money, efforts and matter in something with the hope that it will generate income in future. • The mechanism which shows how increase in investment leads to multiple increases in the income levels in the economy is called investment multiplier. • It is denoted by K. The value of multiplier is determined by the marginal propensity to consume (MPC). Higher is the MPC, greater the size of multiplier. • The multiplier formula can be derived by using the simple equilibrium condition for the two sector model. • As you can see in the table, MPC is assumed to be 0.9and MPS is 0.1.it means that 90% of the income is spent and 10 % is saved. • The first round starts with an assumption of autonomous investment of Rs 100 crores in the economy which results into the income generation of Rs 100 crores. • Now out of this income Rs 900 crore are used for consumption and rest Rs 100 crore saved. • Now in the next round , expenditure of Rs 900 crore , generates an income of Rs 900 crore and out of which again 90% is consumed and 10 % is saved. • It goes in the same way in the successive rounds….. FORMULA OF INVESTMENT MULTIPLER AFTER SUBSTITUTING MPC=0.90 CHANGE IN INVESTMENT= Rs.100 crore CHANGE IN INCOME COMES = Rs.1000 crore CHANGE IN CONSUMPTION = Rs.900 crore CHANGE IN SAVINGS=Rs.100 crore A Numerical Problem on Multiplier: Problem: Q1. Suppose the level of autonomous investment in an economy is Rs. 200 crores and consumption function of the economy is: C = 80 + 0.75Y (a) What will be the equilibrium level of income? (b) What will be the increase in national income if investment increases by Rs. 25 crores. Solution, (a) For equilibrium level of income, • Y = C + I • Where C = 80 + 0.75 • I = 200 crores • Substituting the values of C and I in (1) we have • Y = 80 + 0.75Y + 200 • 6.If personal disposable income is Rs. 1000/ corers , and consumption expenditure is Rs150crors ,find out average propensity to save. • 7. Find S when C=200,MPC=.4andY=100. • 8. Can APS ever be negative ?If yes, Give example. • 9. find Cat equilibrium Y when ; Y=6000,and C=100+.75Y. • 10.Find equilibrium Y ,when C=100+.5Y and I=1000/- • 11. Find equilibrium saving and equilibrium saving and equilibrium I, When Y=4400/- MPC=.75 and c=100. • 12.Give that S= -25+.5Y and I=5000, Find equilibrium Y and equilibrium C . • 13. Give C= 400 + 0.9Y and I = 4,000 . • Find (1) Equilibrium Y (II) S and C at equilibrium at Y. • 14. in an economy a govt. make some additional investment. Finds its value when MPC = 0.5 and increase in income = 1000. • 15. If MPC = 0.75 , how much additional investment is required is required to increase in income by 600. Also fing multiplier. • 16. Find MPC when investment multiplier= 1. • 17. Find the value of multiplier when MPC = MPS. • 18. If an economy, the consumption expenditure is 8,750 crores and the ratio of average propensity to consume and average propensity to save is 7 : 1. Calculate the level of income in the economy. • 19. In an economy total saving are Rs. 2,000 crores and the ratio of APS and APC is 2 : 7 . Calculate the level of income in the economy. • 20. In an economy the level of income is 15,000 crores and ratio of APC and APS is 4 : 1, How much is total consumption expenditure in the economy? Calculate. DEFICIENT DEMAND AND EXCESS DEMAND OR DEFLATONARY GAP AND INFLATIONARY GAP • Deficient demand refers to the situation when aggregate demand (AD) is less than the aggregate supply (AS) corresponding to full employment level of output in the economy. • It gives rise to deflationary gap. Deflationary gap is the gap by which actual aggregate demand falls short of aggregate demand required to establish full employment equilibrium. The concepts of deficient demand and defla tionary gap are shown in Fig. As seen in the diagram, income, output and employment are measured on the X-axis and aggregate demand is measured on the Y-axis. Aggregate demand (AD) and aggregate supply (AS) curves intersect at point E, which indicates the full employment equilibrium. Due to decrease in investment expenditure (∆I), aggregate demand falls from AD to AD1. CONTD…….. • It denotes the situation of deficient demand and the gap between them, i.e., EG is termed as deflationary gap. Point F indicates the underemployment equilibrium. • It may be noted that during deficient demand, equilibrium is determined at a level less than full employment equilibrium. It leads to underemployment equilibrium. In this situation, there exists involuntary unemployment. EXCESS DEMAND OR INFLATIONARY GAP • When in an economy, aggregate demand exceeds “aggregate supply at full employment level”, the demand is said to be an excess demand. • ALL CHILDREN ARE TO EXPLAIN THE DIAGRAM THE WAY WE EXPLAINED THE DIAGRAM OF DEFLATIONARY GAP. •  Reasons or causes for excess demand: The main reasons for excess demand are apparently the increase in the following components of aggregate demand: (a) Increase in household consumption demand due to rise in propensity to consume. (b) Increase in private investment demand because of rise in credit facilities. (c) Increase in public (government) expenditure. (d) Increase in export demand. (e) Increase in money supply or increase in disposable income. FISCAL AND MONETARY POLICY TO CORRECT THE SITUATION OF INFLATION AND DEFLATION FISCAL POLICY - Fiscal policy is the revenue and expenditure policy of the government. This is also called budgetary policy. This policy is undertaken to correct the situation of excess and deficit demand REVENUES(TAXES) OF THE GOVT. EXPENDITURES OF THE GOVT. MONETARY POLICY • Monetary policy is the policy relating to the regulation of supply of money, rate of interest and availability of money, with a view to combat situation of inflationary or deflationary gap in the economy. • This policy is taken by the Central Bank of the country. PLEASE REFER TO THE PPT ON MONEY AND BANKING . ALL THE DETAILS OF THIS TOPIC HAS BEEN SHARED. PRACTICE QUESTIONS (one mark) 1. Who is responsible for fiscal policy? 2. Which are the tools of fiscal policy? 3. what is the purpose of Monetary Policy 4. What are the tools of monetary policy tool? 5. The Federal Reserve changing the Margin Requirement is an example of ..... 6. Fiscal Policy is the means by which the government keeps the economy stable through taxes and programs provided to the people. True or false. 7. When the government raises taxes during reccession. True or false. Give reason 8. What is the most likely reason Contractionary Fiscal Policy is not often implemented? 9. Who controls monetary policy? 10. Bank rate is a quantitative tool of monetary policy. PRACTICE QUESTIONS •Give the meaning of deflationary gap •Give the meaning of inflationary gap •Explain the problem of deficient demand in an economy. State two measures to solve it. •Distinguish between inflationary gap and deflationary gap. •Explain the concept of excess demand in macroeconomics. Also, explain the role of open market operation in correcting it •Explain the concept of deficient demand in macroeconomics. Also, explain the role of bank rate in correcting it • . Explain the concept of inflationary gap. Also, explain the role of legal reserves in reducing it.