Determination of Income and Employment
Class 12 · Economics
4 ideas in Class 12 Economics, explained in plain words, with games and quizzes to practise.
Plans Versus Outcomes and the Consumption Function
Part of: Plans, Spending and Saving
Ex ante means planned and ex post means actual; unsold stock bridges the two when sales surprise producers. The consumption function C = C-bar + cY splits spending into autonomous consumption that survives at zero income and induced consumption cY that follows income. MPC is the spending share of each extra rupee, MPS the saving share, and the two shares always sum to one.
Why it matters. Every income forecast rests on how families split extra earnings. Learners who read MPC and MPS can predict how pay rises flow into shops versus savings.
Formulas
- C = autonomous consumption + MPC x Y
- MPC = change in C / change in Y
- MPS = change in S / change in Y
- MPC + MPS = 1
- APC = C / Y; APS = S / Y
Key words
- Ex ante
- : Values of variables as planned in advance.
- Ex post
- : Values of variables as actually measured after the event.
- Autonomous consumption
- : Spending that happens even at zero income, independent of earnings.
- Induced consumption
- : The part of consumption that rises with income.
- Marginal propensity to consume
- : Change in consumption per unit change in income.
- Marginal propensity to save
- : Change in savings per unit change in income.
- Average propensity to consume
- : Total consumption divided by total income.
- Average propensity to save
- : Total savings divided by total income.
Try it in two minutes
- Ask the child to plan tomorrow's spending, then note what really happens.
- Ask why some spending happens even with no earnings that day.
- Explain that each extra rupee is split between spending and saving.
Try at home. Track one week's planned versus actual spending and compute your own marginal spending share.
Equilibrium Income in a Two-Sector Economy
Part of: Where Demand Meets Output
In a two-sector model, planned demand is AD = C-bar + I-bar + cY, with investment fixed regardless of income. The 45-degree line marks every point where output equals demand. Equilibrium income solves Y = AD, giving Y = (C-bar + I-bar) / (1 - c). If demand falls short, unsold goods pile up as unintended inventories and output is cut next round.
Why it matters. This crossing point anchors every debate on stimulus and slowdowns. Learners who can solve it see why extra investment lifts income by more than itself and why unsold stocks force production cuts.
Formulas
- AD = autonomous consumption + investment + MPC x Y
- Equilibrium: Y = AD
- Y = (autonomous consumption + investment) / (1 - MPC)
- Excess demand = planned demand - planned output
Key words
- Aggregate demand
- : Total planned spending on final goods at each income level.
- Autonomous investment
- : Investment taken as fixed, independent of current income.
- Autonomous expenditure
- : Autonomous consumption plus autonomous investment together.
- Equilibrium
- : The state where planned demand exactly equals planned output.
- Unintended inventories
- : Stocks that pile up or run down because sales missed the plan.
- 45 degree line
- : The diagonal line where output always equals demand.
- Two-sector model
- : A model with only households and firms, no government or trade.
- Inventory investment
- : Extra output that appears as unintended stocks when plans mismatch.
Try it in two minutes
- Ask the child to add planned household and business spending.
- Ask what factories do when shelves pile up unsold.
- Explain that output settles where plans on both sides agree.
Try at home. Pick any consumption rule and investment number and solve for the resting income.
The Investment Multiplier at Work
Part of: Small Push, Big Rise
An autonomous push raises demand, output and incomes round by round, with each round passing on MPC of the last. The rounds form a geometric series that sums to the multiplier 1/(1-c) times the push. With MPC 0.75 the multiplier is 4, so 20 of extra investment lifts income by 80 through rounds of 20, 15, 11.25 and so on.
Why it matters. Stimulus debates are multiplier debates. Learners who can run the rounds see why the same spending lifts income more when families spend freely and less when they save heavily.
Formulas
- Multiplier = 1 / (1 - MPC) = 1 / MPS
- Total income change = multiplier x autonomous change
- Round 2 demand rise = MPC x initial rise
- Round 3 demand rise = MPC squared x initial rise
Key words
- Investment multiplier
- : Total income rise divided by the initial autonomous spending rise.
- Pass-on fraction
- : The fraction of extra income spent in each round, equal to MPC.
- Geometric series
- : A series whose terms shrink by a constant ratio each round.
- Round effect
- : Extra income that arrives in one spending round.
- Autonomous increment
- : Spending that starts the chain without depending on income.
- Excess demand
- : Demand exceeding supply after a fresh spending push.
- New equilibrium
- : The final resting income after all rounds play out.
- Multiplier leak
- : The fall in the multiplier as the saving habit strengthens.
Try it in two minutes
- Ask the child who receives the first extra 20 spent.
- Ask how much of it is spent again at 75 per cent.
- Explain that the chain converges to four times the push.
Try at home. Start with 20 and MPC 0.75 and add the first four round effects yourself.
The Paradox of Thrift
Part of: When Thrift Backfires
When the saving habit strengthens, MPC falls and demand drops at the old income, opening excess supply. Output and income fall round by round until demand matches output again. In the worked case the MPC falls from 0.8 to 0.5, demand drops by 120 at income 400, income settles at 160, and total savings stay at 20 exactly as before.
Why it matters. This paradox warns against reading personal virtue as national policy. Learners who grasp it see why mass thrift during a slump can deepen the slump instead of building wealth.
Formulas
- Demand fall at old income = (old MPC - new MPC) x old Y
- New equilibrium Y = autonomous spending / (1 - new MPC)
- Savings = Y - autonomous consumption - new MPC x Y
Key words
- Paradox of Thrift
- : The puzzle that more thrift can leave total savings unchanged.
- Thrift shift
- : A sudden shared shift toward saving more at each income.
- Excess supply
- : The demand gap that appears when thrift rises suddenly.
- Downward swing
- : A flatter demand line after the MPC falls.
- Lower equilibrium
- : Income settling lower after all rounds of cuts.
- Aggregate savings
- : Savings counted across the whole economy, not one family.
- Autonomous reduction
- : A cut in spending imposed from outside the model's variables.
- Convergent process
- : Rounds of cuts that shrink toward zero instead of exploding.
Try it in two minutes
- Ask the child what happens to shops if all buyers turn thrifty.
- Ask what falling sales do to factory output and wages.
- Explain that lower incomes drag savings back down.
Try at home. With C = 60 + 0.8Y and I = 20, cut MPC to 0.5 and verify savings stay at 20.
What your child will practise
- Equilibrium Income in a Two-Sector Economy: Ocean Quick Fire (Quick Fire)
- Plans Versus Outcomes and the Consumption Function: Desert Puzzle (Clue Puzzle)
- Plans Versus Outcomes and the Consumption Function: Jungle Quick Fire (Quick Fire)
- The Investment Multiplier at Work: Candy Quick Fire (Quick Fire)
- The Paradox of Thrift: Ocean Puzzle (Clue Puzzle)
- Quiz: Equilibrium Income in a Two-Sector Economy (8 questions)
- Quiz: Plans Versus Outcomes and the Consumption Function (8 questions)
- Quiz: The Investment Multiplier at Work (8 questions)
- Quiz: The Paradox of Thrift (8 questions)