CBSE Class 12 Macroeconomics Chapter 7 Aggregate Demand And Related Concepts

Chapter 7 Aggregate And Related Concepts

Aggregate Demand

Meaning: It refers to the total demand of goods & services in an economy.
It is measured in terms of total expenditure

Components of Aggregate Demand

1. Household Or Private Consumption Demand: It refers to the total goods and services demanded by the households in an economy. His consumption is directly dependent upon the level of disposable Income. Higher the disposable income, higher is the consumption but in accordance with the PSYCHOLOGICAL LAW OF CONSUMPTION. It states that whenever income increases consumption also increases but increases in consumption is always less than increase in income.

2. Private investment Demand: It refers to the money spend on the creation of capital assets in the economy. This investment is dependent upon
(a). Expected returns on revenue
(b). Costs :-
      Cost of purchase of equipment's
      Cost of maintenance
      Cost of borrowed funds ( Rate of interest)
(c). Business Expectations: Bullish or Bearish

* Investment Demand Function: It is the relationship between rate of interest & investment. There is an inverse relationship means higher the rate of interest, lesser would be investment.

3. Government Demand for goods & services: It refers to goods & services demanded by government sector in the economy.

4. Net Exports(Export - Import): It refers to the difference between the value of goods demanded by foreigners from our country and what we demand from their country.

Aggregate Demand in a Two sector Model (AD = C + I)

Here consumption curve would always start above zero, because even at zero level of income, there is a minimum consumption which is called AUTONOMOUS CONSUMPTION
AUTONOMOUS CONSUMPTION: Independent if income control. The gap between AD & C would always be equal to I

Investment Function
Meaning: Investment refers to the expenditure incurred on creation of new capital assets.

Investments are of two types:

 Aggregate Supply

Meaning: It refers to the value of goods and services produced in an economy.

Propensity of consume OR Consumption Function

Meaning: It is the functional relationship between Income & Consumption.

Average Propensity to consume
Meaning: It refers to the ratio of  consumption to the level of income
APC = C / Y

Marginal Propensity to Consume
Meaning: It is the ratio of change in consumption to change in income
MPC = change in consumption / change in income.

Consumption Function
Equation: C = C1 + BY
Diagram:

* Break even point: It is the level of income which is completely consumed. This point shows zero savings.

Saving Function OR Propensity to Save

Meaning: It is the functional relationship between income & savings
S = F(y)
Equation: S = -C1 + (1-B)Y
*(C1 = Autonomous Consumption, (1-b) = MPS )

Diagram:

Relationship between income & savings
* As income increases, savings also increases.
* When income is very low, the minimum consumption needs are satisfied from past savings, therefore there are negative savings or called as dissaving.
Average Propensity to save
Meaning: It is the ratio of savings to income.
APS = S / Y

Marginal Propensity to Save
Meaning: It s the ratio of change in savings to change in income.
MPS = change in Savings / Change in Income(y)

Derivation of Saving function From Consumption function

In Numeric:

C = C1 + BY   ..........(1)
Y = C + S  ............(2)
Now we have the value of C (Equation 1) , than put C's value in equation (2)
∴ Y = C1 + BY + S
S = Y - C1 - BY
S = -C1 + Y - BY
S = -C1 + Y(1-B)
(∴ C = Consumption, C1 = Autonomous consumption, B = MPC, Y = Income)

Diagram:

Derivation Of  Consumption function From Saving function

In Numeric:

S = -C1 + (1-B)Y ......(1)
Y = C + S
Or we Can Say C = Y - S ......(2)
 Now we have the value of S (Equation 1), than put S value in equation (2)
 C = Y - { -C1 + ( 1 - B) Y }
C = Y - ( -C1 + Y - BY)
C = Y + C1 - Y + BY
C = C1 + BY

Diagram: