Determination of Income and Employment Class 12 Economics Study Notes

Understanding the chapter on Determination of Income and Employment is important for learning about macroeconomics. Macroeconomics is the crux of studying economics; it studies a country’s economy as a whole. Knowing this chapter well can help you build a career in economics. In this blog, we have made detailed study notes for this class 12th Economics chapter Determination of Income and Employment, to help you learn and revise your upcoming exams!

Aggregate Demand and Its Components

The chapter on determination and employment talks about aggregate demand. Aggregate Demand (AD) refers to the total demand for all goods and services produced in the economy. Its components are:

• Consumption
• Investment
• Government Expenditure
• Net Exports – Total Exports – Total Imports 

Planned values of the variables like consumption, investment, or output of final goods are ex-ante as opposed to ex-post, which refers to the variable’s actual value. For instance, an investor plans to spend Rs 100 for goods to add to her stock; her planned investment is Rs 100. This is the ex-ante measure.    

Two Sector Model

According to the chapter determination of income and employment, in a two-sector model, Aggregate Demand is a total of consumption expenditure and investment expenditure. Consumption and investment expenditure are an important part of it. 

Consumption

Consumption is a vital component of aggregate demand in the chapter determination of income and employment. The most important determinant of consumer demand is household income. Consumption changes as income changes and to study this relationship, we have a consumption function. 

• A Consumption Function refers to the relationship between consumption and income.
• Autonomous Consumption refers to when consumption takes place even when the income is zero. 

Consumption Function is shown as C =  C + cY

C is the consumption expenditure by households and it consists of two components autonomous consumption Cand induced consumption ( cY ). 

According to the determination of income and employment, autonomous consumption is denoted by C and shows the consumption, which is independent of income. The induced component of consumption, cY refers to the dependence of consumption on income. When income rises by Re 1. induced consumption rises by MPC, i.e. c or the marginal propensity to consume. This can be written as:

MPC = ΔC/ΔY = c

Determination of income and employment mentions that marginal propensity to consume value changes as income changes:

• When income changes, change in consumption can never exceed the difference in income. 
• The maximum value which c can take is 1. 
• The consumer may choose not to change consumption even when his/her income has changed. In this case MPC = 0. 
• Generally, MPC lies between 0 and 1. If the consumer does not increase his/her consumption as his/her income increases then MPC = 0
•  If the consumer increases his/her consumption with an increase in income, it is MPC = 1 or he/she uses a part of the change in income for changing consumption, it is 0< MPC<1. 
• The Average Propensity to Consume (APC) refers to consumption per unit of income. 

Savings is another aspect of income. It is the income that is not consumed and is written as S = Y – C.

• MPS or Marginal Propensity to save is the rate of change in savings as the income increases. MPS = ΔS/ΔY = s
• The Average Propensity to Save (APS) refers to savings per unit of income.

Investment

The chapter determination of income and employment mentions that investment is an essential component of the two-sector model. Investment is seen as an addition to the stock of physical capital and changes in the inventory of a producer.

• Investment multiplier denotes the relation between the increase in investment, leading to an increase in national income.
• Full Employment Level of income refers to that level of income where all production factors are fully employed in the production process.
• If the equilibrium level of output is more than the full employment level, demand in the economy is more than the level of output produced at the maximum employment level. 
• This situation is called the situation of excess demand. 
• The equilibrium level of output may be more or less than the full employment level of output. 
• If it is less than the full employment of output, it is because demand is not enough to employ all production factors. This situation is called the situation of deficient demand.

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