40380365 Aggregate Demand and Aggregate Supply

8/8/2019 40380365 Aggregate Demand and Aggregate Supply

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PRESENTED BY -:

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AGGREGATE DEMANDAGGREGATE DEMAND

Aggregate demand may be defined as theAggregate demand may be defined as the

total value that the households, firms andtotal value that the households, firms andgovernment are willing to pay for the outputgovernment are willing to pay for the output

of the economy during a given periodof the economy during a given period

It is measured in terms of total expenditure onIt is measured in terms of total expenditure on

the goods & services in an economy during thethe goods & services in an economy during the

period of one year.period of one year.

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Behavior OfAggregate DemandBehavior OfAggregate Demand

AD depends upon the level of income.AD depends upon the level of income.Greater the level of income, greater theGreater the level of income, greater the

purchasing power and therefore ,greaterpurchasing power and therefore ,greaterthe demand.the demand.

There is always some minimum level ofThere is always some minimum level ofdemand even when income is zerodemand even when income is zero

The rate at which income increasesThe rate at which income increasesexceeds the rate at whichexpenditureexceeds the rate at whichexpenditure

increases.increases. Group no 4


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AGGREGATE DEMANDAGGREGATE DEMAND

SCHEDULESCHEDULE

Income (Rs. Crore) Aggregate Demand

(Rs. Crore)

0

10

20

30

40

5060

20

25

30

35

40

4550

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COMPONENTS OFADCOMPONENTS OFAD

AD = C+ I ( in a closed economy )AD = C+ I ( in a closed economy )

AD = C + G + I + ( XAD = C + G + I + ( X M )M )

{ in an open economy }{ in an open economy }

Where:Where:

AD = AggregateDemandAD = AggregateDemand

C = Household ConsumptionC = Household Consumption

ExpenditureExpenditure

G = Govt. Consumption ExpenditureG = Govt. Consumption Expenditure

I = Producers Investment ExpenditureI = Producers Investment Expenditure

X = ExportsX = Exports

M = ImportsM = Imports Group no 4


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Household Consumption Expenditure (Ch)Household Consumption Expenditure (Ch)

The amount of money spent by the people on theThe amount of money spent by the people on thepurchase ofgoods and services in order topurchase ofgoods and services in order tosatisfy their wants directly , is called householdsatisfy their wants directly , is called household

consumption expenditure.consumption expenditure.

Consumption expenditure mainly depends onConsumption expenditure mainly depends onincome . Relation between consumption andincome . Relation between consumption and

income is calledincome is called consumption function.consumption function.

Ch= f ( Y )Ch= f ( Y )

CH = Ca + cy (where cy is mpc)CH = Ca + cy (where cy is mpc)

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Marginal Propensity to consumeMarginal Propensity to consume

How much consumption rises in response to aHow much consumption rises in response to a

given increase in income depends upongiven increase in income depends upon MPCMPC

MPC : It is the ratio of change in consumptionMPC : It is the ratio of change in consumption

to the change in income.to the change in income.

Thus : MPC =Thus : MPC = cc

YY

ExampleExample When income rises from Rs. 1,000 crore to Rs.When income rises from Rs. 1,000 crore to Rs.

1,100 crore and as a consequence the spending on1,100 crore and as a consequence the spending on

consumer goods also increases from Rs. 950 croreconsumer goods also increases from Rs. 950 crore

to Rs. 1040 crore. MPC will be 0.9 or 90%to Rs. 1040 crore. MPC will be 0.9 or 90%Group no 4


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Average Propensity to ConsumeAverage Propensity to Consume

APC is the ratio of the amount of theAPC is the ratio of the amount of theconsumption to total income.consumption to total income.

APC =APC = CC

YY

Example :Example :

The level of income Rs.1000 crore.The level of income Rs.1000 crore.

Consumption expenditure Rs.750Consumption expenditure Rs.750 APC =APC = 750750 = 0.75= 0.75

10001000

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Ca

Ch

O Y0 Y1

Y

C

MPC andAPC Derivation Graph

A

BA

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MPCANDAPC BOTHARE EQUAL

Y

C

O Y0

B

A

Y1

Ch

Consumption

Of Household

Income

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MPC andAPC BothAre Falling

Ch

Y0 Y1

Ca

O

A

B

PQ

Consumption

Of Household

Income


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MPC Constant andAPC Falling

Ch

Y1Y0

Ca

O

B

AConsumptionOf Household

IncomeGroup no 4


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GOVERNMENT CONSUMPTIONGOVERNMENT CONSUMPTION

EXPENDITURE (Cg)EXPENDITURE (Cg)

It refers to expenditure made by thegovernmentIt refers to expenditure made by thegovernment

on the purchase ofgoods and services.on the purchase ofgoods and services.Government makes demand of a large number ofGovernment makes demand of a large number of

goods and services forvarious purposes .Forgoods and services forvarious purposes .For

exampleexample--

Provision of public utility services like roads,Provision of public utility services like roads,schools, health, and sanitation, irrigation, powerschools, health, and sanitation, irrigation, power

Maintenance of law and orderetcMaintenance of law and orderetc

.. Group no 4


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INVESTMENT EXPENDITURE(I)INVESTMENT EXPENDITURE(I)

It refers to theexpenditure that increases theIt refers to theexpenditure that increases thestock of capital goods like machines ,stock of capital goods like machines ,factories, houses etc.factories, houses etc.

Investment is a function of Rate of Interest.Investment is a function of Rate of Interest.

I =f (r)I =f (r)

Acc.to PetersonAcc.to Peterson

Investment expenditure includesInvestment expenditure includesexpenditure for producersexpenditure for producers

durable equipment, new constructiondurable equipment, new constructionand the changes in inventoriesand the changes in inventories..

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CONTINUEDCONTINUED

Investment is of 2 typesInvestment is of 2 types

1.1. Induced InvestmentInduced Investment : Induced: Induced

investment is positively related to theinvestment is positively related to thelevel of income in an economy.level of income in an economy.

2.2. Autonomous InvestmentAutonomous Investment :An:An

investment which is not influenced byinvestment which is not influenced bylevel of income is called autonomouslevel of income is called autonomous

investment.investment.

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NET EXPORTS (XNET EXPORTS (X--M)M)

Net exports is the difference betweenNet exports is the difference between

exports & imports of a country.exports & imports of a country.

Net Exports= XNet Exports= X--MM

Exports and Imports of a countryExports and Imports of a country

depend upon various factors. Importantdepend upon various factors. Important

ones are exchange rates of differentones are exchange rates of different

countries and terms of trade in thecountries and terms of trade in the

international market.international market. Group no 4


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AGGREGATE SUPPLYAGGREGATE SUPPLY

Aggregate supply(AS)Aggregate supply(AS) refers to the totalrefers to the total

value of goods and services producedvalue of goods and services produced

and supplied in an economy per unitand supplied in an economy per unit

of time.of time.

It includes both consumergoods andIt includes both consumergoods and

producergoods.producergoods.

AS=C+S;AS=C+S;

C is the consumption andC is the consumption and

S is the saving.S is the saving.Group no 4


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Aggregate supply in terms of moneyAggregate supply in terms of money

valuevalue::

The goods and services produced per unitThe goods and services produced per unittime multiplied by their respective (constant)time multiplied by their respective (constant)

prices give the total value of the nationalprices give the total value of the national

outputoutput..

Two types of aggregate supplyTwo types of aggregate supply

Short run aggregate supplyShort run aggregate supply

(when prices are constant)(when prices are constant)

Long run aggregate supplyLong run aggregate supply

(when prices arevarying)(when prices arevarying)

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Factors influencingFactors influencing

ConsumptionConsumption

Objective Factors:Objective Factors:

Rate of interest:Rate of interest:Higher the rate of interestHigher the rate of interest

Saving will behighSaving will behigh

Consumption will be lessConsumption will be less

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Accumulated Wealth:Accumulated Wealth:

The greater the accumulation of wealth greater isThe greater the accumulation of wealth greater is

generally the propensity to consume.generally the propensity to consume.

Distribution of Income:Distribution of Income:

If national income more unequallyIf national income more unequally

distributed the lower will be the propensitydistributed the lower will be the propensity

to consume.to consume.

The Consumer Credit:The Consumer Credit:

If a Large number of households avail credit facility forIf a Large number of households avail credit facility for

buying automobile, television, music system etc. thenbuying automobile, television, music system etc. then

the consumption of these goods increases.the consumption of these goods increases.Group no 4


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Subjective FactorsSubjective Factors

There are followingfactors those areThere are followingfactors those are

restrictingconsumption expenditure.restrictingconsumption expenditure.

To build up a reserve against unforeseenTo build up a reserve against unforeseen

contingencies;contingencies;

To enjoy interest and appreciation .To enjoy interest and appreciation .

To enjoy sense of Interdependence;To enjoy sense of Interdependence;

To satisfy pure miserliness;To satisfy pure miserliness;

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AS

C

C+I

Q

R

Y10INCOME

C-CONSUMPTION

I-INVESTMENT

AS- AGGREGATE

SUPPLY

Investment =savings

So,

AS = AD

Relation betweenAggregate Demand andRelation betweenAggregate Demand and

Aggregate SupplyAggregate Supply

C+I+S

B

A

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.Contd.Contd

AS

C

C+I

Q

P

R

Y10 INCOME

C-CONSUMPTION

I - INVESTMENT

AS - AGGREGATESUPPLY

Investment AD

A

B

C+I+S

Y0

Z


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ContdContd

AS

C

C+I

Q

P

R

Y10

INCOME

C-CONSUMPTION

I-INVESTMENT

AS- AGGREGATE

SUPPLY

Investment > savings

So,

AS < AD

C+I+S

B

A

Y2

Z


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Computation of savings from AS andComputation of savings from AS and

AD CurveAD CurveAS

C

C+I

Q

P

R

Y1

0Y0

C-CONSUMPTION

I-INVESTMENT

AS- AGGREGATE

SUPPLY

D

E

U

Savingcurve

V

W

U

Y0 Y2 Y3

S1

I-INVESTMENTI

+ VE SAVINGS

Y1 Y3Y2

A

BC+I+S

0

- VE

SAVINGS Group no 4


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Investment MultiplierInvestment Multiplier

It is the ratio betweenIt is the ratio between

change in income andchange in income andchange in investmentchange in investment

MULTIPLIER = Y/ I

WHERE;Y CHANGE IN INCOME

I - CHANGE IN INVESTMENT

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Relation between multiplierRelation between multiplier

and MPCand MPC

Thevalue of multiplier is in fact determineThevalue of multiplier is in fact determine

by the MPC .by the MPC .BECAUSEBECAUSE ;;

MULTIPLIER=1/1MULTIPLIER=1/1--MPCMPC

Higher the MPC ,greater is the size ofHigher the MPC ,greater is the size of

multiplier.multiplier.

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Characteristics Of MultiplierCharacteristics Of Multiplier

Aggregate demandAggregate demand

Works in both directionWorks in both direction

Inverse relation with MPSInverse relation with MPSSize of multiplier depends upon the size ofSize of multiplier depends upon the size of

MPCMPC

Size of multiplier reduced proportionate toSize of multiplier reduced proportionate tothe leakagethe leakage

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MULTIPLIERMULTIPLIER(Contd..)(Contd..)

MULTIPLIER=1/1MULTIPLIER=1/1--mpc =1/mpsmpc =1/mps

HIGHER THE CONSUMPTION HIGHERHIGHER THE CONSUMPTION HIGHER

THE MULTIPER,HIGHER THE SAVINGTHE MULTIPER,HIGHER THE SAVINGLOWER THE MULTIPLIER.LOWER THE MULTIPLIER.

WHEN GOVERNMENT AND RO

W

WHEN GOVERNMENT AND RO

WSECTOR ARE INVOLVED IN ANSECTOR ARE INVOLVED IN AN

ECONOMY THEN MULTIPLIERECONOMY THEN MULTIPLIER

Y= A/1 Y= A/1--C[1C[1--t] +mt] +m

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DERIVATION:DERIVATION:

Y=Ch +Cg +I +EY=Ch +Cg +I +E MM

Ch=consumption ofhouseholdCh=consumption ofhousehold

Cg=consumption ofgovernmentCg=consumption ofgovernmentI = InvestmentI = Investment

E = ExportE = Export

M = ImportM = ImportWHERE,WHERE, Ch=Ca +cY(mpc)Ch=Ca +cY(mpc)

M= Ma+mY(mpm)M= Ma+mY(mpm)

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=Ca+cY+ Cg +I + E- Ma-mY

=Ca + c (Y-tY) + Cg + I +E Ma-mY

Y= Ca +cY- ctY +Cg +I +E Ma mY

Y Cy +ctY +mY =Ca +Cg + I +E Ma.

and suppose Ca +Cg + I +E Ma =A

SO,

Y[1-c +ct +m] =A

Y[1 c(1-t) +m ] =A

FINALLY Y=A/1 c (1- t) + m

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SUPPOSE A RISES

A +A, INCOME ALSO RISES Y + Y

Y + Y = A /1- c (1- t) +m + A/ 1-c(1-t ) +m

Y = A/1-c(1-t) +m

(MULTIPLIER) Y/ A =1/1-c(1- t ) +m

IMPORT MULTIPLIER Y/A = -1/1-c(1-t) +m

NOTE: IF THERE IS CHANGE IN A DUE TO IMPORT(ie Ma)

THE MULTIPLIER WILL BE NEGATIVE

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40380365 Aggregate Demand and Aggregate Supply

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