Determination of Income and Employment
What this domain tests
This domain tests the consumption function, saving, equilibrium income, the investment multiplier and the concepts of full employment, deflationary gap and inflationary gap.
Core rules
- Consumption function: C = a + bY, where a is autonomous consumption and b is the marginal propensity to consume (MPC).
- APC and MPC: APC = C ÷ Y; MPC = ΔC ÷ ΔY. MPC lies between 0 and 1.
- Saving: S = Y − C; MPS = 1 − MPC.
- Equilibrium: Y = C + I, or saving equals investment. Planned expenditure equals output.
- Multiplier: k = 1 ÷ (1 − MPC) = 1 ÷ MPS.
Worked example
C = 100 + 0.8Y and I = 200. Equilibrium is Y = 100 + 0.8Y + 200, so 0.2Y = 300 and Y = ₹1,500 crore. The multiplier is 1 ÷ 0.2 = 5. If investment rises by ₹100 crore, equilibrium income rises by 5 × 100 = ₹500 crore.
Traps that cost marks
Do not confuse MPC with APC; APC falls as income rises even when MPC is constant. Do not count saving as leakage from equilibrium without also counting investment. The multiplier works in both directions. Full employment does not mean zero unemployment because frictional and structural unemployment can remain.