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Economics · 2026 · 4 marks
Determination of Income and EmploymentDetermination of Equilibrium Income in the Short Run4 marksApplyshort answer
CBSE 2026 · Region 4 · Set 2 · Q15
Explain the adjustment mechanism, if in an economy, ex-ante Aggregate Demand (AD) is less than ex-ante Aggregate Supply (AS).Explain the process of working of Investment Multiplier, for a hypothetical economy with Marginal Propensity to Consume (MPC) as $\displaystyle 0$·$\displaystyle 8$ and Incremental Investment as ₹ $\displaystyle 2,500$ crore.
Explain the adjustment mechanism, if in an economy, ex-ante Aggregate Demand (AD) is less than ex-ante Aggregate Supply (AS).
Explain the process of working of Investment Multiplier, for a hypothetical economy with Marginal Propensity to Consume (MPC) as $\displaystyle 0$·$\displaystyle 8$ and Incremental Investment as ₹ $\displaystyle 2,500$ crore.
Marking-scheme solution
When ex-ante Aggregate Demand (AD) is less than ex-ante Aggregate Supply (AS), it means that the households and firms are planning to consume less than what the firms are planning to produce. Thus, the inventories with the producers will rise above the desired level. As a result, the producers may decrease the output to clear the undesired stock of inventories till the equilibrium level of output is attained.
The working process of the Investment Multiplier increase in investment on the National Income, is based on the assumption that one’s expenditure is another’s income.
For the given hypothetical economy, the change in investment is of ₹ $\displaystyle 2,500$ crore Marginal Propensity to Consume (MPC) is 0.8.
| Round | Increase in investment (ΔI) (₹ in crore) | Increase in income (ΔY) (₹ in crore) | Increase in consumption (ΔC) (₹ in crore) | Increase in savings (ΔS) (₹ in crore) |
| $\displaystyle 1$ | $\displaystyle 2,500$ | $\displaystyle 2,500$ | $\displaystyle 2,000$ | $\displaystyle 500$ |
| $\displaystyle 2$ | — | $\displaystyle 2,000$ | $\displaystyle 1,600$ | $\displaystyle 400$ |
| $\displaystyle 3$ | — | $\displaystyle 1,600$ | . | . |
| — | — | . | . | . |
| Total | $\displaystyle 2,500$ | $\displaystyle 12,500$ | $\displaystyle 10,000$ | $\displaystyle 2,500$ |
Thus, an increase in investment (∆I) of $\displaystyle 2,500$ leads to a total increase in national income (∆Y) by $\displaystyle 12,500$, which is $\displaystyle 5$ times the increase in investment.
Investment Multiplier $\displaystyle = \dfrac{1}{1-\text{MPC}} = \dfrac{1}{1-0.8} = 5$
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