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 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. 2 increase in investment expenditure leads to an increase of Rs. 8 in the National Income. Calculate the following : (i) Value of Investment Multiplier (K). (ii) Change in consumption expenditure, if income changes from Rs. 200 to Rs. 300. (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) = 30 and MPC = 0.8:
C = 30 + 0.8Y
S = -30 + 0.2Y

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

(ii) Effective Demand:
Effective Demand is the point where Aggregate Demand equals Aggregate Supply, determining the equilibrium level of income. It represents the actual level of spending that sustains production and employment in the economy. When AD = AS, there is no tendency for change, and the economy is in equilibrium. The concept explains why economies may operate below full employment — because effective demand may be insufficient to utilize all available resources.

(iii) Equilibrium Analysis:
At the given data, equilibrium occurs where AD = AS. The adjustment mechanism works through inventory changes:
- If AD > AS: Unplanned inventory depletion → firms increase production → income rises → AD = AS
- If AD < AS: Unplanned inventory accumulation → firms decrease production → income falls → AD = AS

The economy reaches equilibrium when planned expenditure equals planned output, determining the equilibrium level of income and employment.