Class 12 Economics Chapter 5 Aggregate Demand and Its Related Concepts
Chapter 5 of Class 12 Economics, titled \”Aggregate Demand and Its Related Concepts,\” focuses on understanding the factors that determine the total demand in an economy. Aggregate demand (AD) is a key concept in macroeconomics and plays a crucial role in understanding the relationship between various components of the economy. This chapter introduces students to the concepts of aggregate demand, its components, and how changes in aggregate demand affect the overall economy.
What You Will Learn in Chapter 5 – Aggregate Demand and Its Related Concepts
In this chapter, you will explore the concept of aggregate demand, its components, and the various factors that influence it. You will also understand how changes in aggregate demand can lead to changes in national income and output, and how it affects the business cycle.
Key Topics Covered:
Aggregate Demand (AD): Definition and Components
Definition of Aggregate Demand: Aggregate demand is the total demand for goods and services in an economy at a given price level and in a given period. It represents the sum of all demand in the economy from households, businesses, the government, and foreign buyers.
Components of Aggregate Demand:
Consumption Expenditure (C): The total expenditure by households on goods and services.
Investment Expenditure (I): The total expenditure on capital goods like machinery, tools, and buildings by businesses.
Government Expenditure (G): The total expenditure by the government on goods and services, including public services and infrastructure projects.
Net Exports (NX): The difference between exports and imports, representing demand from foreign buyers for domestic goods and services.
Determinants of Aggregate Demand
Factors that influence aggregate demand include:
Income levels: Higher income leads to higher consumption.
Interest rates: Lower interest rates stimulate investment, increasing AD.
Government policies: Fiscal policies (e.g., government spending, taxes) and monetary policies (e.g., money supply, interest rates) can shift AD.
Consumer and business confidence: Expectations about the future can influence consumption and investment decisions.
Foreign exchange rates: A weaker domestic currency can increase exports, raising AD.
The Aggregate Demand Curve
The AD curve shows the relationship between the price level and the quantity of output demanded. It slopes downward, indicating that as the price level falls, the quantity of goods and services demanded increases.
Shifts in the Aggregate Demand Curve:
A rightward shift in the AD curve occurs when there is an increase in aggregate demand, caused by factors like higher government spending or increased consumer confidence.
A leftward shift in the AD curve occurs when there is a decrease in aggregate demand, caused by factors like higher interest rates or reduced foreign demand for exports.
Concept of the Multiplier
The multiplier effect explains how an initial change in spending (e.g., government spending or investment) leads to a larger change in national income. A change in any component of aggregate demand can trigger a chain reaction of increased income and consumption, further boosting AD.
Formula for the Multiplier:
Multiplier=11−Marginal Propensity to Consume (MPC)text{Multiplier} = frac{1}{1 – text{Marginal Propensity to Consume (MPC)}}Multiplier=1−Marginal Propensity to Consume (MPC)1
A higher marginal propensity to consume leads to a larger multiplier effect.
Aggregate Demand and Business Cycles
Changes in aggregate demand can lead to fluctuations in the business cycle. An increase in AD can lead to economic expansion, while a decrease can result in contraction or recession.
Understanding aggregate demand helps in managing policies to stabilize the economy, such as counter-cyclical fiscal and monetary policies.
Equilibrium Level of Output and Aggregate Demand
The equilibrium level of output occurs when aggregate demand equals aggregate supply (AS), meaning there is no unplanned inventory change. At this point, the economy is said to be in equilibrium.
Deviations from equilibrium may lead to inflationary or deflationary gaps, requiring policy intervention to restore balance.
Inflationary and Deflationary Gaps
An inflationary gap occurs when aggregate demand exceeds aggregate supply at full employment, leading to inflation.
A deflationary gap occurs when aggregate demand is insufficient to achieve full employment, leading to unemployment and underutilized resources.
Why Use Our NCERT Solutions for Chapter 5?
Our detailed NCERT solutions for Chapter 5: Aggregate Demand and Its Related Concepts help break down complex economic theories and concepts. With clear explanations and examples, students can easily grasp how aggregate demand works and how it influences the economy.
Highlights of Our Solutions:
Clear explanations of key concepts like the components of aggregate demand and the multiplier effect.
Step-by-step breakdown of how aggregate demand affects national income.
Diagrams and graphs to visualize the AD curve and shifts in aggregate demand.
In-depth answers to exercise questions and real-world examples of aggregate demand and its determinants.
Ideal for revision and preparation for board exams and competitive exams.
NCERT Solutions for Chapter 5 – Aggregate Demand and Its Related Concepts
Intext Questions:
Explanation of the components of aggregate demand with examples.
Detailed steps showing the effects of shifts in the AD curve.
Understanding the concept of the multiplier and its impact on national income.
Exercise Questions (Q.1 to Q.10):
Solutions to questions on the factors influencing aggregate demand.
In-depth answers explaining the concept of inflationary and deflationary gaps.
Practice problems on calculating and interpreting changes in national income due to shifts in aggregate demand.
Download Chapter 5 Solutions PDF – Aggregate Demand and Its Related Concepts
Access the free, downloadable PDF containing detailed solutions for all exercises and in-text questions. This PDF is a great resource for quick revision and exam preparation.
What’s Included:
Step-by-step solutions for all textbook questions.
Diagrams and charts explaining the AD curve and multiplier effect.
Key formulas for aggregate demand and the multiplier effect.
Recommended Preparation Tips:
Understand the components of aggregate demand and how they interact.
Practice interpreting shifts in the AD curve and their implications for the economy.
Learn the concept of the multiplier and its role in economic expansion and contraction.
Revise the concept of inflationary and deflationary gaps and their impact on national income.
Additional Study Resources:
Chapter 5 Economics Notes – Aggregate Demand and Its Related Concepts.
NCERT Exemplar Problems and Solutions for extra practice.
Previous years’ questions and MCQs on aggregate demand for board exams and competitive exams.
Flashcards for quick revision of key terms like aggregate demand, multiplier, and equilibrium output.
Mastering Aggregate Demand and Its Related Concepts
Chapter 5 of Class 12 Economics helps students understand how aggregate demand works in an economy and how it affects national income, employment, and inflation. By mastering the concepts in this chapter, students will gain the knowledge necessary to analyze the economy and understand the macroeconomic factors influencing government policy decisions.
NCERT Solutions for Class 12 Economics Chapter 5 Aggregate Demand and Its Related Concepts
NCERT Textbook Questions Solved – Class 12 Macro Economics
Question 1: What is marginal propensity to consume? How is it related to marginal propensity to save?
Answer:
(i) Marginal Propensity to Consume (MPC) is the ratio of the change in consumption (ΔC) to the change in income (ΔY). It indicates the proportion of additional income that is being spent on consumption.
MPC = ΔC / ΔY
(ii) The sum of MPC and MPS is always equal to 1. This relationship can be proven as follows:
ΔY = ΔC + ΔS
Dividing both sides by ΔY:
1 = MPC + MPS
Thus, MPC + MPS = 1, because the total increase in income is either consumed or saved.
Question 2: What do you understand by ‘parametric shift of a line’? How does a line shift when its (i) slope increases and (ii) its intercept increases?
Answer:
(i) A parametric shift occurs when a change in a parameter (such as the slope or intercept) leads to a shift in the graph.
– When the slope increases, the consumption curve pivots upward. For example, if the value of b increases from 0.5 to 0.75, the consumption curve will tilt upward.
(ii) When the intercept changes, the curve shifts parallel to the original line. For example, if the autonomous consumption C increases from 2 to 5, the consumption curve will shift upward in parallel, without any change in its slope.
Very Short Answer Type Questions
| Question | Answer |
|---|---|
| What is Aggregate Demand in Macroeconomics? | Aggregate demand refers to the total expenditure on planned consumption and planned investment in an economy at each level of income. |
| What is Aggregate Supply in Macroeconomics? | Aggregate supply is the total value of goods and services that producers are willing to supply at different levels of income in an economy. |
| What is consumption function? | The consumption function represents the functional relationship between aggregate consumption and national income. |
| Can the value of APC be less than zero? | No, APC cannot be less than zero as there will always be some consumption even at zero income, known as autonomous consumption. |
| Why can the value of MPC be not greater than one? | MPC cannot be greater than one as it represents the proportion of income spent on consumption, which is always less than or equal to the total increase in income. |
| Can the value of average propensity to save be negative? If yes, when? | Yes, the value of average propensity to save (APS) can be negative if consumption exceeds income, i.e., before the break-even point. |
| What can be the maximum value of marginal propensity to save? | The maximum value of marginal propensity to save (MPS) is 1, which occurs when MPC is 0 (i.e., all additional income is saved). |
| What is the relationship between APC and APS? | The sum of APC (Average Propensity to Consume) and APS (Average Propensity to Save) is equal to one: APC + APS = 1 |
| What is the relationship between marginal propensity to save and marginal propensity to consume? | The sum of MPC and MPS is always equal to one: MPC + MPS = 1 |
| Give the meaning of autonomous consumption. | Autonomous consumption refers to the minimum level of consumption required for survival, even when national income is zero. |
Multiple Choice Questions
| Question | Answer |
|---|---|
| If APS is 0.9, how much will be the APC? | (d) 0.1 |
| If MPC is 0.6, what will be the MPS? | (b) 0.4 |
| If disposable income is ₹1000 and consumption expenditure is ₹750, the value of average propensity to save will be | (a) 0.25 |
If the saving function is S = -50 + 0.2Y, then the MPC is | (b) 0.8 |
| There is a parametric shift in the consumption line when | (a) slope changes |
| Guideline is the alternative name of | (b) aggregate supply |
| What is the value of MPC when MPS = 0? | (d) 1 |
| If MPS is one, how much is MPC? | (c) 0 |
Short Answer Type Questions
Question 1: Explain the components of aggregate demand.
Answer:
The components of Aggregate Demand (AD) are as follows:
- Private (Household) Consumption Demand: Total expenditure by households on personal consumption. Depends mainly on disposable income and the propensity to consume.
- Private Investment Demand: Demand for capital goods by private investors (e.g., machines, factory buildings). Depends on marginal efficiency of capital and interest rate.
- Government Demand for Goods and Services: The government’s expenditure on goods and services like roads, schools, hospitals, etc. Influenced by the need for public services and the maintenance of law and order.
- Demand for Net Exports (X – M): Represents foreign demand for goods produced in the economy. Affects national output based on the level of exports and imports.
Aggregate Demand (AD) = C + I + G + (X – M)
Question 2: Explain the distinction between ‘autonomous investment’ and ‘induced investment’.
Answer:
1. Autonomous Investment: Investment that occurs irrespective of the level of national income. It is independent of the income level and determined by factors such as government policy, technological innovation, etc.
2. Induced Investment: Investment that changes with the level of national income. It occurs due to the increase in income or output in the economy, and businesses invest more to meet higher demand.
Question 3: Briefly state the concept of the consumption function. Explain with schedule and diagram.
Answer:
The Consumption Function shows the relationship between aggregate consumption (C) and national income (Y).
It is expressed as:
C = F(Y)
Example Schedule:
| National Income (Y) | Consumption (C) |
|---|---|
| 0 | 50 |
| 1000 | 800 |
| 2000 | 1550 |
| 3000 | 2300 |
Diagram:
The consumption function typically slopes upward, showing that as income increases, consumption also increases, but at a diminishing rate.
Question 4: With the help of a consumption schedule or curve, bring out the meaning of the break-even point.
Answer:
The Break-even Point occurs when consumption equals income. At this point, the total income is fully consumed, and there is no saving.
Example Schedule:
| National Income (Y) | Consumption (C) | Savings (S) |
|---|---|---|
| 0 | 0 | 0 |
| 1000 | 1000 | 0 |
| 2000 | 2000 | 0 |
| 3000 | 3000 | 0 |
The break-even point is at the level of income where consumption equals income, i.e., where the consumption curve intersects the income curve.
Question 5: What is APC? How is it calculated?
The ratio of aggregate consumption expenditure to aggregate income is known as average propensity to consume. It indicates the percentage (or ratio) of income which is being spent on consumption. It is worked out by dividing total consumption expenditure (C) by total income (Y). APC = C/Y
Question 6: Distinguish between APS and MPS. The value of which of these two can be negative and when?
APS can be negative when, at a low level of income, consumption exceeds income, making savings negative and thus APS becomes negative. It can be explained with the help of the following schedule:
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts SAQ Q6.1
Question 7: Differentiate between APC and APS and tell which of them is negative.
APS can be negative. When at a low level of income, consumption exceeds income, savings become negative, making the APS negative. This is explained with the help of the following schedule:
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts SAQ Q7.1
Question 8: Differentiate between APC and MPC.
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts SAQ Q8
Question 9: Explain saving function with the help of schedule and diagram.
The propensity to save (or saving function) shows the functional relationship between aggregate savings and income. It is given by S = f(Y). In other words, the part of income which is not spent on current consumption is known as saving. By deducting consumption expenditure (C) from income (Y), we get saving (S). S = Y – C
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts SAQ Q9
True or False
Question 1: Average propensity to save is always greater than zero.
Answer: False. Because at very low levels of income, when consumption exceeds income, saving becomes negative and APS < 0. It can be explained with the help of the following schedule:
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts True or False Q1
Question 2: Value of average propensity to save can never be less than zero.
Answer: False. The value of APS can be less than zero (i.e., negative). When consumption expenditure (C) becomes greater than income, the volume of savings becomes negative, hence APS will be negative, (i.e., less than zero). This is shown as:
Let C = 1500 and Y = 1000.
We know, S = Y – C = 1000 – 1500 = -500
APS = S/Y = -500/1000 = -0.5
Question 3: When the value of average propensity to save is negative, the value of marginal propensity to save will also be negative.
Answer: False. The value of APS has no relationship with MPS. APS is closely related to APC, i.e., APS + APC = 1. When APC is greater than unity (as in the case of lower levels of income), the value of APS is negative.
Question 4: The value of marginal propensity to save can never be negative.
Answer: True. MPS can never be less than zero as the change in savings can never be negative, i.e., the change in consumption can never be more than the change in income.
Question 5: The value of average propensity to save can never be greater than 1.
Answer: True. Because saving can never be greater than income.
Question 6: Sum of average propensity to consume and marginal propensity to consume is always equal to 1.
Answer: False. The value of APC has no relationship with MPC. Either APC + APS = 1 or MPC + MPS = 1.
Question 7: If income is Rs 10,000 crore and consumption is Rs 5,000 crore, APC would be 0.5.
Answer: True. As, APC = C/Y = 5000/10000 = 0.5.
Note: As per CBSE guidelines, no marks will be given if reason to the answer is not explained.
Long Answer Type Questions (6 Marks)
Question 1: Draw a straight line consumption curve. From it derive the saving curve. Explain the process of derivation on the diagram, show:
- The income level at which APC = 1.
- The income level at which APS is negative.
Answer: To explain the below figure we define the following two terms.
(i) Consumption function: Consumption function expresses the functional relationship between aggregate consumption and national income. It can be expressed as: C = C0 + bY, where C0 is autonomous consumption and b is the marginal propensity to consume.
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts LAQ Q1
Figure B is derived from Figure A. In Figure A at point P1, consumption equals national income, which is known as the break-even point. At point P, APC = 1 because consumption equals income at this point. Corresponding to point P, we derive the point P1 in Figure B where saving is equal to zero. At point P1, APS = 0. After point P in Figure A, national income is greater than consumption, resulting in positive saving, as shown in Figure B, after point P1. Before point P, consumption is greater than income, resulting in negative saving, as shown in Figure B before point P1.
Question 2: Draw on a diagram a straight line savings curve for an economy. From it derive the consumption curve, explaining the method of derivation. Show a point on the consumption curve at which APC = 1.
Answer: To explain the above figure, we define the following two terms.
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts LAQ Q2
Figure B is derived from Figure A. In Figure A at point P, saving = 0. Corresponding to point P, we derive point P1 in Figure B, where income = consumption. Point P1 is known as the break-even point, and at this point, APC = 1. After point P in Figure A, savings are positive, as shown in Figure B, after point P1, where income is greater than consumption, i.e., positive saving. Before point P, savings are negative, as shown in Figure B before point P1, where consumption is greater than income, i.e., negative saving.
Higher Order Thinking Skills
Question 1: Why does APC fall with the increase in income?
Answer: APC falls continuously with the increase in income because the proportion of income spent on consumption keeps on decreasing.
Question 2: Can APC be zero?
Answer: APC can be zero only when consumption becomes zero. However, consumption is never zero at any level of income. Even at zero level of national income, there is autonomous consumption.
Question 3: What can be the maximum value of marginal propensity to save?
Answer: The maximum value of marginal propensity to save is 1. This is possible only when MPC = 0, i.e., the entire additional income is saved.
Question 4: MPC of the poor is more than that of the rich. Why?
Answer: True. The poor spend a greater percentage of their increased income on consumption as most of their basic needs remain unsatisfied. In contrast, the rich spend a smaller proportion since their basic needs are already satisfied.
Question 5: In Keynes’ theory, does MPC fall with an increase in income?
Answer: False. Keynes assumed that MPC remains constant. Therefore, with the increase in income, MPC remains constant.
Question 6: What is a guideline?
Answer: The aggregate supply (AS) curve, which is a 45° positively sloping line from the origin, is also called a guideline. Every point on the AS curve is equidistant from the horizontal axis and the vertical axis, implying that total income is equal to total expenditure or spending, i.e., C + S. If the entire national income is spent on consumption of goods and services, S = 0. This is called the break-even point.
Question 7: Complete the following table:
NCERT Solutions for Class 12 Macro Economics Aggregate Demand and Its Related Concepts HOTS Q7.1
Value Based Question
Question 1: Why do the consumption expenditure of an involuntary unemployed worker not become zero, even at zero level of income?
Answer: A worker has to incur some expenditure to fulfill his basic needs even at zero level of income.
Value: Analytical.