Assume, for a hypothetical economy, the following data is given : (i) Calculate the missing values in the given schedule. (ii) Define the term 'Effective Demand'. (iii) On the basis of the given data, it can be said that the equilibrium level of income is 200. Do you agree ? If not, explain the adjustment mechanism that may take place to attain equilibrium level of income. Suppose, in an economy, every Rs. 1 increase in investment expenditure leads to an increase of Rs. 4 in the National Income. Calculate the following : (i) Value of Investment Multiplier (K). (ii) Change in consumption expenditure, if the income changes from Rs. 400 to Rs. 500. (iii) "Sum of Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) is always equal to one." Justify the given statement with the help of a suitable argument.

Question

Accepted Answer

Given: Hypothetical economy data (assuming a standard schedule)

(i) Calculate missing values:
Using the consumption function C = c̄ + bY and the equilibrium condition Y = C + I:

If the schedule shows:
At Y = 0: C = 40 (autonomous consumption)
At Y = 100: C = 120
Then MPC = (120-40)/(100-0) = 80/100 = 0.8

Consumption Function: C = 40 + 0.8Y
Saving Function: S = -40 + 0.2Y

Missing values can be calculated using these functions.

(ii) Effective Demand:
Effective Demand is the level of Aggregate Demand that becomes 'effective' because it equals Aggregate Supply. It is the point where AD = AS, determining the equilibrium level of income and output. At Effective Demand, there is no tendency for change in output, employment, or income.

(iii) Equilibrium Analysis:
At the given data, equilibrium occurs where AD = AS (or S = I). The economy adjusts through inventory changes until this equality is achieved. If AD > AS, firms increase production; if AD < AS, firms decrease production. The process continues until equilibrium is reached.