Class 12 Economics Chapter 4 Banking

Chapter 4 of Class 12 Economics, \”Determination of Income and Employment\”, builds on macroeconomic concepts by explaining how equilibrium level of income and employment is determined in an economy. It introduces students to the Keynesian theory of income determination, the role of aggregate demand and aggregate supply, and how these interact to determine the level of output and employment in an economy.

What You Will Learn in Chapter 4 – Determination of Income and Employment

This chapter explains the basic Keynesian model of income determination. You will learn the concepts of Aggregate Demand (AD), Aggregate Supply (AS), the concept of propensity to consume, multiplier, and how employment and output are influenced by changes in these factors. It also explains the concepts of underemployment equilibrium and measures to correct it.

Key Topics Covered:

1. Aggregate Demand and Its Components

Aggregate Demand (AD) is the total demand for goods and services in an economy at a given overall price level and in a given period. It consists of:

  • Consumption expenditure (C)

  • Investment expenditure (I)
    So,
    AD = C + I

2. Aggregate Supply and Its Meaning

Aggregate Supply (AS) refers to the total output produced by the firms at a given level of employment. In the simple Keynesian model:

  • AS = National Income (Y)

  • Equilibrium occurs when AD = AS or C + I = Y

3. Propensity to Consume: APC and MPC

  • Average Propensity to Consume (APC): Ratio of consumption to income → APC = C/Y

  • Marginal Propensity to Consume (MPC): Change in consumption due to change in income → MPC = ΔC/ΔY

These concepts help in understanding how consumption behavior influences national income.

4. Investment Function

  • Autonomous Investment (Iₐ): Investment not influenced by the level of income.

  • Induced Investment: Investment influenced by income level.

In Keynesian theory, total investment = autonomous + induced investment.

5. Equilibrium Level of Income

The economy reaches equilibrium when: Aggregate Demand = Aggregate Supply
or
C + I = Y

This condition determines the national income and employment in an economy.

6. Saving Function and Propensity to Save

  • Average Propensity to Save (APS): APS = S/Y

  • Marginal Propensity to Save (MPS): MPS = ΔS/ΔY
    It is important to note: MPC + MPS = 1

7. Multiplier Effect

The Multiplier (K) measures the ratio of change in income to change in investment:
K = 1 / (1 – MPC)
It explains how initial investment leads to multiple rounds of income increase.

8. Underemployment Equilibrium

According to Keynes, an economy can be in equilibrium even when resources are underutilized. This is known as underemployment equilibrium, where:

  • AD = AS

  • But full employment is not achieved

9. Measures to Correct Deficient Demand

To tackle underemployment and low income levels, Keynes suggested increasing:

  • Government Expenditure

  • Investment

  • Consumption This is part of expansionary fiscal and monetary policy.

Why Use Our NCERT Solutions for Chapter 4?

Our NCERT Solutions for Chapter 4: Determination of Income and Employment simplify the complex Keynesian concepts using real-life examples, graphs, and easy language. Whether it’s understanding multiplier effects or explaining the logic behind income determination, our solutions are tailored for clarity and comprehension.

Highlights of Our Solutions:

  • Conceptual clarity on AD, AS, consumption functions, and investment functions

  • Numerical illustrations for calculating equilibrium income, savings, and multiplier

  • Graphs and diagrams for visual learning

  • Insightful explanations on deficient demand and underemployment equilibrium

NCERT Solutions for Chapter 4 – Determination of Income and Employment

Intext Questions:

  • Definitions and functions of AD and AS

  • Meaning of MPC, MPS, APC, APS with examples

  • Step-by-step calculation of income using AD = AS approach

Exercise Questions (Q.1 to Q.10):

  • Full solutions to numerical questions involving income determination

  • Graph-based questions on saving and investment curves

  • Conceptual questions on underemployment and full employment

  • Short notes on multiplier, investment, and equilibrium conditions

Download Chapter 4 Solutions PDF – Determination of Income and Employment

Get the complete PDF version of Class 12 Economics Chapter 4 NCERT Solutions which includes:

  • Fully solved exercises

  • Important formulas and definitions

  • Diagrams for visual understanding

  • Practice questions for self-assessment

Recommended Preparation Tips:

  • Understand the AD-AS framework thoroughly – equilibrium is the core concept.

  • Practice numerical problems involving MPC, MPS, income, and multiplier.

  • Learn to draw and interpret graphs showing saving, consumption, and investment functions.

  • Clarify the difference between actual investment and planned investment.

  • Focus on the logic behind the multiplier to score high in application-based questions.

Additional Study Resources:

  • Chapter 4 Notes – Determination of Income and Employment

  • Practice Worksheets with Graphs and Diagrams

  • MCQs and Assertion-Reason Questions for Revision

  • Previous Years’ Board Questions and Marking Schemes

Mastering Determination of Income and Employment

This chapter lays the groundwork for understanding how macroeconomic equilibrium is achieved in real economies. By learning the relationships between consumption, investment, saving, and income, students can critically analyze issues like unemployment, inflation, and recession with a solid economic lens.

NCERT Solutions for Class 12 Economics Chapter 4 Banking

NCERT TEXTBOOK QUESTIONS SOLVED

2. What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier? [3-4 Marks]

Answer:

The money multiplier refers to the process by which a small initial deposit leads to a much larger increase in the total money supply. It shows the extent to which money is created in the banking system based on initial reserves.

The formula for calculating the money multiplier is:

Money Multiplier = 1 / LRR

Here, LRR stands for Legal Reserve Ratio, which is the mandatory percentage of deposits that banks must keep aside.

Two important components of LRR that influence the value of the money multiplier are:

  • Cash Reserve Ratio (CRR): The portion of deposits that banks are required to keep with the central bank.
  • Statutory Liquidity Ratio (SLR): The portion of deposits that banks must maintain with themselves in the form of liquid assets such as gold or approved securities.

3. What are the instruments of monetary policy of RBI? How does RBI stabilize money supply against exogenous shocks? [6 Marks]

Answer:

The Reserve Bank of India (RBI) uses a range of instruments to control the money supply and maintain economic stability. These tools are classified into two categories:

TypeInstruments
Quantitative Instruments
  • Bank Rate
  • Repo Rate
  • Reverse Repo Rate
  • Open Market Operations (OMO)
  • Cash Reserve Ratio (CRR)
  • Statutory Liquidity Ratio (SLR)
Qualitative Instruments
  • Margin Requirements
  • Moral Suasion
  • Selective Credit Controls

RBI stabilizes the money supply as follows:

  • Bank Rate Policy: An increase in bank rate raises borrowing costs for commercial banks, which lowers credit availability and curbs inflation. A decrease in bank rate makes loans cheaper, encouraging borrowing and boosting demand in deflationary periods.
  • Open Market Operations (OMO): During inflation, RBI sells government securities to absorb excess money. During deflation, it buys securities to inject liquidity into the market.
  • Margin Requirements: Higher margin requirements reduce the credit available to borrowers during inflation, and lower margins boost borrowing during deflation.
  • Moral Suasion: RBI may appeal to banks to restrict or expand credit depending on the economic scenario.

4. Do you consider a commercial bank ‘Creator of money’ in the economy?

Answer:

Yes, commercial banks act as ‘creators of money’ through the process of credit creation. They are able to create money by accepting deposits and issuing loans, which leads to an increase in the money supply.

Here is an example with numerical illustration:

Assume an initial deposit of ₹1,000 and Legal Reserve Ratio (LRR) of 10%.

RoundDeposit (₹)Cash Reserve (10%)Loan Given (₹)
11000100900
290090810
381081729
…………
Total10,000——

This process continues until the total deposits reach ₹10,000 — 10 times the original deposit, showing how commercial banks create credit in the economy.

5. What role of RBI is known as ‘Lender of last Resort’? [3 Marks]

Answer:

The RBI plays the role of the ‘Lender of Last Resort’ when commercial banks face a financial crisis and are unable to meet their obligations. In such situations, the RBI provides them with funds through loans or by discounting their eligible securities.

This function ensures stability in the banking system and maintains public confidence.

Multiple Choice Questions (1 Mark)

  1. During depression, it is advisable to
    1. lower bank rate and purchase securities in the market ✅
    2. increase bank rate and purchase securities in the open market
    3. decrease bank rate and sell securities in the open market
    4. increase bank rate and sell securities in the open market
  2. The ‘lender of last resort’ means
    1. the government coming to the rescue of poor farmers.
    2. Central Bank coming to the rescue of other banks in times of financial crisis ✅
    3. commercial banks coming to the rescue of small industrial units.
    4. None of them.
  3. Who is called the ‘bank of issue’?
    1. RBI ✅
    2. SBI
    3. IDBI
    4. ICICI
  4. Who is the fiscal agent and adviser to government in monetary and financial matters in India?
    1. SBI
    2. IDBI
    3. ICICI
    4. RBI ✅
  5. Who is the custodian of national reserves of international currency?
    1. SBI
    2. IDBI
    3. RBI ✅
    4. ICICI
  6. If an economy is to control recession like most of the Euro-Zone nations, which of the following can be appropriate:
    1. Reducing Repo Rate
    2. Reducing CRR
    3. Both (i) and (ii) ✅
    4. None of (i) and (ii)

Short Answer Type Questions (3–4 Marks)

  1. Explain issue of currency function of Central Bank.
    The central bank has the exclusive authority to issue currency notes (except coins and ₹1 notes issued by the government). These notes are legal tender and must be accepted by law for payment. The central bank maintains a separate issue department for this function.
  2. Explain the \”Banker to the Government\” function of Central Bank.
    The central bank manages the banking needs of the government. It holds government accounts, manages its public debt, provides short-term credit, and facilitates payments and receipts for government operations.
  3. Explain the “Banker’s Bank” function of Central Bank.
    The central bank acts as:
    • Custodian of cash reserves of commercial banks
    • Lender of last resort
    • Clearing house for interbank transactions
  4. How does central bank control availability of credit by open market operations?
    Through open market operations, the central bank buys/sells government securities. Selling securities absorbs excess liquidity and reduces credit creation. Buying securities infuses liquidity and increases credit availability.
  5. What is Legal Reserve Ratio? Explain its components.
    Legal Reserve Ratio is the minimum percentage of deposits that commercial banks are legally required to keep in reserve. It has two components:
    • CRR (Cash Reserve Ratio): Portion kept with the central bank
    • SLR (Statutory Liquidity Ratio): Portion maintained with the bank itself in liquid form
  6. Differentiate between central bank and commercial bank.
    • Ownership: Central bank is state-owned; commercial banks may be public or private.
    • Note Issuance: Only central bank issues currency.
    • Objective: Central bank aims at monetary stability; commercial banks aim at profit.

True or False (With Reason)

  1. Increase in statutory liquidity ratio adversely affects the capacity of commercial banks to create credit. ✅
    True. Higher SLR reduces funds available for lending.
  2. Sale of securities in the open market by the commercial banks reduces their crediting power. ❌
    False. Sale of securities by central bank reduces credit, not by commercial banks.
  3. Cash reserve ratio and statutory liquidity ratio are fixed by the central bank. ✅
    True. These are part of quantitative tools used by the RBI.
  4. Under marginal requirement, RBI directs banks to provide credit to priority sectors. ❌
    False. This comes under selective credit control, not margin requirement.
  5. There is an inverse relationship between LRR and value of money multiplier. ✅
    True. Money Multiplier = 1 / LRR
  6. To increase the money supply, central bank increases margin requirements. ❌
    False. Increasing margin requirement reduces borrowing and money supply.

Long Answer Type Question (6 Marks)

  1. (i) What is meant by Cash Reserve Ratio? How does it increase the money supply in the economy?
    Cash Reserve Ratio (CRR): CRR is the percentage of a bank’s total deposits that it must keep with the central bank. A reduction in CRR increases the lendable funds of banks, thereby increasing credit creation and money supply.

    (ii) What is meant by Open Market Operation? How does it reduce money supply in the economy?
    Open Market Operations: These involve the sale/purchase of government securities by the central bank. Sale of securities absorbs liquidity from the market, thus reducing the money supply.

High Order Thinking Skills (HOTS)

  1. Differentiate between quantitative and qualitative credit control.
    • Quantitative: Controls volume of credit (e.g., CRR, SLR, Bank Rate, OMO)
    • Qualitative: Controls purpose of credit (e.g., margin requirement, credit rationing)
  2. Calculate the value of money multiplier and total deposit created if initial deposit is ₹1000 crore and LRR is 20%.
    • Money Multiplier = 1 / LRR = 1 / 0.20 = 5
    • Total Deposits = Initial Deposit × Multiplier = 1000 × 5 = ₹5000 crore
  3. If total deposits = ₹10,000 crore and LRR = 10%, calculate initial deposit.
    • Money Multiplier = 1 / 0.10 = 10
    • Initial Deposit = Total Deposit / Multiplier = 10,000 / 10 = ₹1000 crore

Value Based Questions

  1. In inflation, credit creation benefits banks but harms the economy. Explain.
    Credit creation increases money supply, leading to excess demand and inflation, harming consumers and reducing purchasing power.
  2. What if all customers demand their deposits simultaneously? How does central bank help?
    The central bank acts as a lender of last resort. It provides emergency liquidity by rediscounting bills or lending directly to banks in crisis.

Application-Based Questions

  1. Why are banks required to keep only a fraction of deposits as reserves?
    Because:
    • All depositors do not withdraw money simultaneously.
    • There is a continuous flow of new deposits, ensuring liquidity is maintained.
  2. Explain how commercial banks create money despite central bank issuing currency. How does it affect national income?
    Commercial banks create money through credit creation. An initial deposit leads to a chain of lending and depositing, increasing total deposits beyond the original amount. This increases aggregate demand and national income.
    Example: If ₹1000 is deposited and LRR is 10%, money multiplier is 10. Total credit created = ₹10,000. This enhances investment and consumption, boosting GDP.