Question

“In an economy, ex-ante Aggregate Supply is more than ex-ante Aggregate Demand.” Explain its impact on the level of output, income and employment. OR…

Accepted Answer

(a) In an economy, if ex-ante Aggregate Supply is more than ex-ante Aggregate Demand, it implies that households are planning to consume less than what the firms expected them to. This will lead to an unintended rise in inventories. To restore the desired level of inventories, producers may plan to reduce production. As a result, there may be a decrease in the level of output, employment and income in the economy. OR (b) Income (Y) (in ₹ Crore) Saving (in ₹ Crore) Average Propensity to Consume (APC) Marginal Propensity to Save (MPS) --- --- --- --- 0 (-) 30 - - 100 0 1 0.3 200 30 0.85 0.3 300 60 0.8 0.3 Consumption function, C = c + bY C = 30 + 0.7Y Alternate answer: Consumption at ₹ 200 crore level of income = ₹ 170. Working Note: At an income level of ₹ 200 crore, Marginal Propensity to Save (MPS) = 0.3 and Marginal Propensity to Consume (MPC) = 1 - MPS ⇒ 1 - 0.3 = 0.7

Income (Y) (in ₹ crore)	Savings (in ₹ crore)	Average Propensity to Consume (APC)	Marginal Propensity to Save (MPS)
$\displaystyle 0$	(–) $\displaystyle 30$	–	–
$\displaystyle 100$	…………	$\displaystyle 1$	…………
$\displaystyle 200$	…………	$\displaystyle 0$·$\displaystyle 85$	…………
$\displaystyle 300$	…………	$\displaystyle 0$·$\displaystyle 8$	…………

Income (Y) (in ₹ Crore)	Saving (in ₹ Crore)	Average Propensity to Consume (APC)	Marginal Propensity to Save (MPS)
$\displaystyle 0$	(-) $\displaystyle 30$	-	-
$\displaystyle 100$	$\displaystyle 0$	$\displaystyle 1$	$\displaystyle 0.3$
$\displaystyle 200$	$\displaystyle 30$	$\displaystyle 0.85$	$\displaystyle 0.3$
$\displaystyle 300$	$\displaystyle 60$	$\displaystyle 0.8$	$\displaystyle 0.3$

“In an economy, ex-ante Aggregate Supply is more than ex-ante Aggregate Demand.”
Explain its impact on the level of output, income and employment.

Marking-scheme solution

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