CBSE Class 12 Economics Chapter 5: Aggregate Demand and Its Related Concepts NCERT Solutions

The Marginal Propensity to Consume (MPC) is defined as the ratio of the change in consumption expenditure to the change in disposable income. It represents the proportion of an additional unit of income that is spent on consumption.

$$MPC\; =\; \backslash frac\{\backslash Delta\; C\}\{\backslash Delta\; Y\}$$

The Marginal Propensity to Save (MPS) is defined as the ratio of the change in saving to the change in disposable income. It represents the proportion of an additional unit of income that is saved.

$$MPS\; =\; \backslash frac\{\backslash Delta\; S\}\{\backslash Delta\; Y\}$$

Relationship between MPC and MPS:

We know that any increase in income ($\backslash Delta\; Y$) can be allocated either for consumption ($\backslash Delta\; C$) or for saving ($\backslash Delta\; S$). Therefore:

$$\backslash Delta\; Y\; =\; \backslash Delta\; C\; +\; \backslash Delta\; S$$

Dividing both sides of the equation by $\backslash Delta\; Y$, we get:

$$\backslash frac\{\backslash Delta\; Y\}\{\backslash Delta\; Y\}\; =\; \backslash frac\{\backslash Delta\; C\}\{\backslash Delta\; Y\}\; +\; \backslash frac\{\backslash Delta\; S\}\{\backslash Delta\; Y\}$$

Since $\backslash frac\{\backslash Delta\; Y\}\{\backslash Delta\; Y\}\; =\; 1$, $\backslash frac\{\backslash Delta\; C\}\{\backslash Delta\; Y\}\; =\; MPC$, and $\backslash frac\{\backslash Delta\; S\}\{\backslash Delta\; Y\}\; =\; MPS$, the equation becomes:

$$1\; =\; MPC\; +\; MPS$$

This equation shows that the sum of the marginal propensity to consume and the marginal propensity to save is always equal to one. This is because the entire increase in income is either consumed or saved.

'Parametric shift of a line' refers to a change in the line's position due to a change in one of its parameters, which affects its slope or intercept. This can cause the line to pivot or shift parallelly.

Let's consider the consumption function as an example: $C\; =\; \backslash overline\{C\}\; +\; bY$, where $C$ is consumption, $\backslash overline\{C\}$ is autonomous consumption (the intercept), and $b$ is the marginal propensity to consume (MPC), which represents the slope of the consumption curve.

(i) When the slope increases:

If the slope ($b$) increases, the consumption curve pivots upwards around the vertical axis. For instance, if the MPC increases from 0.5 to 0.75, the line becomes steeper. This indicates that a larger proportion of additional income is now being consumed.

(ii) When the intercept increases:

If the intercept ($\backslash overline\{C\}$, autonomous consumption) increases, the consumption curve shifts upwards parallelly. For example, if autonomous consumption increases from 2 to 5, the entire consumption curve shifts upwards. This means that at every level of income, consumption is higher by the amount of the increase in autonomous consumption, while the MPC (slope) remains unchanged.

In macroeconomics, Aggregate Demand (AD) refers to the total expenditure that all sectors of an economy are willing to undertake on all newly produced goods and services at a given level of income during a specific period. It represents the ex-ante (planned) demand for goods and services.

AD is composed of planned consumption expenditure (C) and planned investment expenditure (I). In a closed economy, AD = C + I. In an open economy, AD = C + I + G + (X - M), where G is government spending, X is exports, and M is imports.

Aggregate Supply (AS) in macroeconomics represents the total value of all goods and services that all producers in an economy are willing and able to supply at a given price level and over a specific period. It is essentially the total output of goods and services produced in an economy.

The value of aggregate supply is measured by the total income paid to the factors of production (land, labour, capital, entrepreneurship) for their services. Thus, AS is often considered equivalent to the National Income (NI) or Net National Product at factor cost.

The consumption function expresses the functional relationship between aggregate consumption expenditure and national income in an economy. It indicates how consumption expenditure changes with a change in national income.

Mathematically, it is often represented as $C\; =\; f(Y)$, where $C$ denotes consumption expenditure and $Y$ denotes national income. A common linear form is $C\; =\; \backslash overline\{C\}\; +\; bY$, where $\backslash overline\{C\}$ is autonomous consumption (consumption at zero income) and $b$ is the marginal propensity to consume (MPC).

No, the Average Propensity to Consume (APC) cannot be less than zero. APC is defined as the ratio of total consumption expenditure to total income ($APC\; =\; \backslash frac\{C\}\{Y\}$). Since consumption expenditure is always positive (even at zero income, there is autonomous consumption), and income is also generally considered non-negative, the ratio $\backslash frac\{C\}\{Y\}$ cannot be negative.

Even when income is zero, consumption is positive due to autonomous consumption ($\backslash overline\{C\}$). In this scenario, APC would be undefined or infinitely large. As income increases, APC falls but remains positive and greater than or equal to 1 when consumption equals income, and less than 1 when there is saving.

The value of the Marginal Propensity to Consume (MPC) cannot be greater than one. MPC is defined as the ratio of the change in consumption to the change in income ($MPC\; =\; \backslash frac\{\backslash Delta\; C\}\{\backslash Delta\; Y\}$).

According to Keynes's psychological law of consumption, as income increases, consumption also increases, but by a smaller amount. This means that the increase in consumption ($\backslash Delta\; C$) is always less than the increase in income ($\backslash Delta\; Y$). Therefore, the ratio $\backslash frac\{\backslash Delta\; C\}\{\backslash Delta\; Y\}$ will always be less than 1.

If MPC were greater than 1, it would imply that consumption increases by more than the increase in income, which is economically illogical as people cannot spend more than they earn in additional income.