"In an economy ex-ante Aggregate Demand is less than ex-ante Aggregate Supply." Explain its impact on the level of output, income and employment. For a hypothetical economy, assuming there is an increase in the Marginal Propensity to Consume (MPC) from 80% to 90% and change in investment to be Rs. 1000 crore. Using the concept of investment multiplier, calculate the increase in income due to change in Marginal Propensity to Consume.

Question

Accepted Answer

When ex-ante Aggregate Demand is less than ex-ante Aggregate Supply, there is excess supply in the economy. This has the following impact:

**Impact on Output, Income and Employment:**

1. **Inventory Accumulation:** Firms produce more than what is demanded, leading to unplanned increase in inventories.
2. **Production Cut:** Firms reduce production to match the lower level of demand.
3. **Income Fall:** Lower production leads to lower factor payments, decreasing national income.
4. **Employment Decrease:** Less production requires less labor, decreasing employment.

**Hypothetical Example:**
If autonomous investment decreases by ₹100 crore and MPS = 0.2, then:
- Multiplier (K) = 1/MPS = 1/0.2 = 5
- Change in Income (ΔY) = K × ΔI = 5 × (-100) = -₹500 crore
- National income decreases by ₹500 crore until AD = AS.