Understanding Aggregate Demand (AD) and its related concepts is crucial for anyone studying economics. These concepts form the foundation of macroeconomic analysis, helping us understand how different sectors of an economy interact.
Topics Discussed
1 Mark Questions (Objective Type)
Q1: What is Aggregate Demand?
Aggregate Demand (AD) is the total demand for all final goods and services produced in an economy at a given price level during a specific time period.
Q2: Name the four components of Aggregate Demand.
The four components of Aggregate Demand are:
- Consumption (C)
- Investment (I)
- Government Spending (G)
- Net Exports (X – M)
Q3: Define Marginal Propensity to Consume (MPC).
Marginal Propensity to Consume (MPC) refers to the proportion of additional income that is spent on consumption. It is calculated using the formula:
MPC=ΔCΔYMPC = \frac{\Delta C}{\Delta Y}
Q4: What is Autonomous Consumption?
Autonomous Consumption is the minimum level of consumption that occurs even when income is zero. It represents basic consumption needs.
Q5: What is the relationship between Aggregate Demand and Price Level?
Aggregate Demand and price level share an inverse relationship: as the price level increases, Aggregate Demand decreases, and vice versa.
3/4 Marks Questions (Short Answer Type)
Q6: Explain the concept of Aggregate Demand with the help of a diagram.
Aggregate Demand represents the total expenditure on goods and services at different price levels. The AD curve slopes downward from left to right, indicating the inverse relationship between the price level and aggregate output demanded.
Diagram Explanation:
- The X-axis represents the output (GDP).
- The Y-axis represents the price level.
- The downward slope indicates that as prices fall, the quantity of output demanded increases.
Q7: Differentiate between Autonomous and Induced Consumption.
| Autonomous Consumption | Induced Consumption |
|---|---|
| Does not depend on the level of income | Depends on the level of income |
| Exists even when income is zero | Changes with changes in income |
| Example: Basic necessities like food | Example: Luxury items like electronics |
Q8: What is Marginal Propensity to Save (MPS) and how is it related to MPC?
Marginal Propensity to Save (MPS) is the fraction of additional income that is saved rather than spent. The relationship between MPC and MPS is given by the formula:
MPC+MPS=1MPC + MPS = 1
If MPC is 0.8, MPS will be 0.2.
6 Marks Questions (Long Answer Type)
Q9: Explain the components of Aggregate Demand in detail.
- Consumption (C):
- This refers to the total spending by households on goods and services.
- Factors affecting consumption include disposable income, consumer confidence, and interest rates.
- Investment (I):
- It represents business spending on capital goods like machinery and buildings.
- Influenced by interest rates, business expectations, and technological advancements.
- Government Spending (G):
- Refers to expenditures by the government on public goods and services such as healthcare and infrastructure.
- This component is influenced by fiscal policies.
- Net Exports (X – M):
- The difference between exports and imports.
- A positive net export increases AD, while a negative net export decreases it.
Q10: Explain the concept of Multiplier with a suitable example.
The multiplier effect measures how an initial change in spending leads to a larger change in national income. It is calculated using the formula:
Multiplier=11−MPCMultiplier = \frac{1}{1 – MPC}
Example: If the government increases spending by ₹1000 crores and MPC is 0.8:
Multiplier=11−0.8=5Multiplier = \frac{1}{1 – 0.8} = 5
Total increase in income = 5 × 1000 = ₹5000 crores.
Q11: Discuss the relationship between Aggregate Demand and Aggregate Supply in determining the equilibrium level of income.
- Equilibrium Income is achieved when Aggregate Demand equals Aggregate Supply (AD = AS).
- If AD > AS: There is excess demand leading to inflation.
- If AD < AS: There is excess supply resulting in unemployment and recession.
Diagram Explanation:
- X-axis: Income/Output
- Y-axis: Aggregate Demand/Supply
- The point where the AD and AS curves intersect is the equilibrium level of income.
Additional Important Concepts and Questions
Q12: How does fiscal policy affect Aggregate Demand? (4 marks)
Fiscal policy, through government spending and taxation, directly affects Aggregate Demand:
- Expansionary Fiscal Policy: Increases AD through higher government spending or tax cuts.
- Contractionary Fiscal Policy: Decreases AD through reduced spending or higher taxes.
Q13: What is the Paradox of Thrift? (4 marks)
The Paradox of Thrift suggests that if everyone increases their savings during a recession, overall consumption decreases, leading to a fall in Aggregate Demand and national income.
Q14: Describe the factors affecting Aggregate Demand. (6 marks)
- Consumer Spending: Affected by income, credit availability, and future expectations.
- Investment Spending: Dependent on interest rates and business climate.
- Government Policies: Fiscal and monetary policies directly impact AD.
- Net Exports: Influenced by exchange rates and global economic conditions.
Mastering these questions on Aggregate Demand and related concepts will give you a strong grasp of key macroeconomic mechanisms. Keep practicing and revising to ace your exams!