Assuming 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 300. 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. 5 in the National Income. Calculate the following : (i) Value of Investment Multiplier (K). (ii) Change in consumption expenditure, if income changes from Rs. 300 to Rs. 400. (iii) "Sum of Average Propensity to Consume (APC) and Average Propensity to Save (APS) is always equal to one." Justify the given statement with the help of a suitable argument.

Question

Accepted Answer

Given: Hypothetical economy data

(i) Calculate missing values:
Using the consumption function C = c̄ + bY:

If autonomous consumption (c̄) = 50 and MPC = 0.75:
C = 50 + 0.75Y
S = -50 + 0.25Y

Missing values in the schedule can be derived using these functions.

(ii) Effective Demand:
Effective Demand refers to the level of Aggregate Demand that is actually realised in the economy because it equals Aggregate Supply. It is determined at the point where the AD curve intersects the 45° AS line. At this point, the planned spending equals the planned output, and there is no tendency for change. The concept was introduced by Keynes to explain how equilibrium is determined in a capitalist economy.

(iii) Equilibrium Analysis:
At the given data, equilibrium occurs where AD = AS. If AD > AS, unplanned inventory depletion leads firms to increase production. If AD < AS, unplanned inventory accumulation leads firms to decrease production. The process continues until the economy reaches equilibrium where AD = AS, determining the equilibrium level of income and output.