40380365 Aggregate Demand and Aggregate Supply

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    PRESENTED BY -:

    Group no 4

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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.

    Group no 4

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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

    Group no 4

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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

    Group no 4

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    Ca

    Ch

    O Y0 Y1

    Y

    C

    MPC andAPC Derivation Graph

    A

    BA

    Group no 4

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    MPCANDAPC BOTHARE EQUAL

    Y

    C

    O Y0

    B

    A

    Y1

    Ch

    Consumption

    Of Household

    Income

    Group no 4

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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;

    Group no 4

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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

    Group no 4

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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

    Group no 4

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