Aggregate Supply
AD C I G NX
C f (Y )
The relationship between consumption and
income is called propensity to consume or
consumption function
Aggregate Demand
AD
AD Y
AD0
AD A cY
C C cY
I
C
Y0
Income/ Output
AD Y
C I C S
I S
AD Y
AD
Aggregate Demand
Saving = Investment
AD0
I
C
AD C I
C C cY
B
(Break Even Point)
Y0
Income/ Output
Net Exports
It reflects the demand of foreign countries for
our goods and services over our demand for
foreign countries goods and services.
Factors affecting net foreign demand are
Foreign exchange rates
Terms of trade
Trade policy of importing and exporting countries
Relative prices of goods
Types of exchange control
A
Y0
1 c
IU Y AD
Aggregate Demand
AD Y
AD
IU 0
AD0
AD A cY
E
IU 0
I G NX
A
C C c(TA TR ) cY
C c(TA TR )
Y0
Income/ Output
The Multiplier
The answer to previous question appears to
be simple. A Re. 1 increase will increase the
income by Re. 1? The answer is wrong.
Suppose first that output is increased by Re. 1
to match the increased level of autonomous
spending
It will give further rise to induced spending.
Out of that additional rupee of income, a
fraction c is consumed.
INCREASE IN
DEMAND
INCREASE IN
PRODUCTION
CUMULATIVE INCREASE
IN INCOME
c A
c A
(1 c) A
c2 A
c2 A
(1 c c 2 ) A
c 3 A
c 3 A
(1 c c 2 c 3 ) A
1
A
1 c
AD A(1 c c c .......)
2
1
AD
A Y0
1 c
The multiplier is denoted by
1 c
The larger the marginal propensity to consume, the
larger is the multiplier
AD Y
AD
E'
Aggregate Demand
AD0
AG
A
'
1
A
1 c
Y0
Y0 Y
'
Y0
Income/ Output
'
AD A cY
'
'
AD A cY
Tax Multiplier
Change in equilibrium income will equal the
change in aggregate demand.
Y0 c(Y0 TA)
(1 c)Y0 cTA
c
Y0
TA
1 c
AD C I G NX
AD C cYD I G NX
AD C cTR c (1 t )Y I G NX
AD C cTR I G NX c (1 t )Y
AD A c (1 t )Y
AD Y
Aggregate Demand
AD
E'
AD0
A
'
AD A c(1 t )Y
'
'
AD A c(1 t )Y
E
Y0
Y0
Y0
Income/ Output
'
Y0 c(Y0 TR)
(1 c)Y0 cTR
c
Y0
TR
1 c
BS TA G TR
Or
BS tY G TR
t
BS
1 G
1 c(1 t )
(1 c)(1 t )
BS
G
1 c(1 t )
BS tY G TR
*
N N *
W W1 1
N *
WN '
Wage rate
WN
WN ' '
W1
N*
Employment
(1 z )W
P
a
N N *
W W1 1
N *
(1 z )
N N *
P
W1 1
a
N *
N N *
P P1 1
N *
Y Y *
P P1 1
Y *
P P1 1 (Y Y *)
AS '
AS
Price rate
AS' '
Y*
Output
AS' '
AS '
Price rate
E' '
P'
AS
E'
E
Short Term
AD'
AD
Y*
Output
Thank You