AD-AS RELATED CONCEPTS CLASS 12 ECONOMICS.pdf

ECONOMIS CHAPTER AD AND AS AND RELATED CONCEPTS CLASS 12

1. AGGREGATE DEMAND,AGGREGATE
SUPPLY AND RELATED CONCEPTS.
CH-7

2. WHAT IS AD?
•Concept : Aggregate Demand is the sum total of
expenditure that people plan to incur on the
purchase of goods and services produced in the
economy(during the period of an accounting
year)corresponding to different levels of income.
•AD can be measured with respect to general
price level or level of income.
•If AD is related to the level of income, we shall
find positive relation between income and AD.
•In our syllabus, we study AD only in relation to
level of income.

3. COMPONENTS OF AD
•Components of AD in closed economy:
•Two sector: AD=C +I
•Three sector: AD =C +I + G
•Components of AD in open economy:
•AD =C + I + G + (X-M)

4. COMPONENTS OF AD
•According to Keynes, AD is the sum total of two
components only-C and I.
•AD= C+I
•¯I= Investment curve is a straight line parallel to the X
axis because the level of investment remains constant
at all levels of income during short period.
•AD=The AD curve is obtained by adding the fixed level
of investment to the consumption expenditure. It is
positively sloped and parallel to the consumption
curve and the gap between C and AD is equal to the
amount of autonomous investment.

5. AD SCHEDULE
Income(Y) Consumption(C)Investment(I)AD(OR
PLANNED
EXPENDITURE)
= C + I
0 20 10 30
20 25 10 35
40 30 10 40
60 35 10 45
80 40 10 50
100 45 10 55
120 50 10 60

6. DIAGRAM

7. OBSERVATIONS
•AD is never zero even when income level is
zero. Because some expenditure is always
essential for our survival. This is done either
by using past saving or by borrowing.This is
called negative saving.
•AD increases when income rises.
•After a certain level of Y is reached, AD lags
behind Y. Because at higher level of income,
people start saving.

8. DIAGRAM
•45 degree line is a line of reference. At point A,
Y=AD. Prior to A, AD>Y.
•Beyond A,AD<Y.

9. AGGREGATE SUPPLY
•Concept : It refers to the flow of goods and
services as planned by the producers during
an accounting year. It is identical with the flow
of income(Y) during an accounting year.AS and
Y are therefore treated as identical.
•AS refers to ‘planned production’ or ‘desired
production’ during an accounting year.

10. AS SCHEDULE
Y C S AS(Aggregate
supply)=C +S
0 20 -20 0
20 25 -5 20
40 40 0 40
60 45 15 60
80 50 30 80
100 55 45 100
120 60 60 120

11. OBSERVATIONS
•Identity between Y and AS shows that the
producers in the economy are ready to supply
(or sell) all that they wish to produce.
•This is because there is excess capacity in the
economy.
•Keynes made this basic assumption that in the
wake of Great Depression 1930’s economies
were facing excess capacity(or unutilised
capacity)because of lack of demand.

12. DIAGRAM
•AS is indicated by a 45 degree line from the
origin.

13. CONSUMPTION FUNCTION
•It is the functional relationship (or algebraic
relationship) between C and Y.
•C = f(Y)
•Observations:
•There is always some minimum level of C, even
when Y=0.This is called autonomous consumption.
This leads to negative savings.
•C and Y are positively related.
•The rate at which C increases often lags behind
the rate at which Y increases.

14. FUNDAMENTAL PSYCHOLOGICAL LAW
•This law is propounded by Keynes.It states
that as income of the people rises, their
consumption also rises. But the entire increase
in income is not converted into consumption.
A part of it is often saved. Accordingly,the rate
at which consumption increases is often less
than the rate at which income increases.

15. TABULAR PRESENTATION
Y C
0 20
50 60
100 100
150 140

16. DIAGRAMMATIC PRESENTATION

17. OBSERVATIONS
•Let the point of intersection between C and Y be Q.
•Oa is the minimum level of consumption. It must be
incurred even when income is zero.It is called
autonomous consumption.
•C=Y at point Q, which is called break even point. At
this point, savings is zero.
Beyond point Q, C lags behind Y.This suggests that
after a particular level of income is reached, people
save a part of their income
Prior to Q,C is greater than Y; a situation of negative
savings.
After Q,C is less than Y; a situation of positive savings.

18. ALGEBRAIC EXPRESSION
•C= C + by
•C =Refers to the minimum level of consumption. It
is the value of consumption when Y=0
•b=Rate at which C increases in response to an
increase in Y. It is the slope of C function also
called Marginal Propensity to consume.
•This equation enables us to estimate the values of
C corresponding to different values of Y.

19. SLOPE OF C-LINE
•It refers to the rate at which C increases in
response to a given increase in Y.
•It indicates the proportion of additional
income that goes on consumption.
•This is measured as a ratio between ΔC and
ΔY.
•This is known as Marginal Propensity to
consume(MPC).

20. PROPENSITY TO CONSUME
•A schedule showing various amounts of
consumption which correspond to different
levels of income is known as propensity to
consume.
•It has two concepts.
•i)Average propensity to consume(APC)
•ii)Marginal Propensity to consume(MPC).

21. APC
•It is the ratio of consumption expenditure and
total income at a given level of income.
•APC= C/Y

Income(Y) Consumption(C) APC=C/Y
100 120 120/100=1.20
200 200 200/200=1

22. MPC
•It is the ratio between additional consumption
(ΔC) and additional income (ΔY).
•MPC = ΔC/ ΔY
Income(Y)ΔY C ΔC MPC=ΔC/ ΔY
0 - 40 - -
100 100 120 80 80/100=0.8
200 100 200 80 80/100=0.8

23. SAVINGS FUNCTION
•Income is either consumed or saved so that,
Y=C + S.
•The functional relationship between S and Y is
called savings function.
S=f(Y)


Y C S(=Y-C)
0 20 -20
50 60 -10
100 100 0
150 140 10

24. DIAGRAM

25. OBSERVATIONS
•S is measured along the Y axis and income on
X axis.
•i)S line starts from the Y axis. It indicates the
value of S when Y is 0.
•ii)S line is positively sloped; higher Y causes
higher S.
•iii)S line crosses X axis when Y =100.It indicates
that S=0. S is positive when Y is greater than
100.

26. ALGEBRAIC EXPRESSION
•S= Y – C
S= Y- C - bY
= - C + (1-b)Y
•-C indicates the value of S when Y= 0
•(1-b)= Marginal propensity to save.It indicates
the rate at which S changes due to a change in
Y.
•Y=Income

27. PROPENSITY TO SAVE
•It is a schedule showing amounts that will be
saved at different levels of income.
•It has two aspects:
•i)Average propensity to save(APS)
•ii)Marginal propensity to save(MPS)

28. APS
•It is the ratio of savings to income.
•APS = S/Y

Y S APS=S/Y
0 -40 -
100 -20 -0.20
200 0 0
300 20 0.067
400 40 0.10

29. MPS
•It refers to the ratio of change in saving to
change in income.
•MPS=ΔS /Δ Y


Y S ΔS Δ Y MPS=ΔS /Δ Y
0 -40 - - -
100 -20 20 100 0.20
200 0 20 100 0.20
300 20 20 100 0.20
400 40 20 100 0.20

30. RELATIONSHIP
•APC + APS =1
•MPC +MPS=1

31. PROOF
•Y = C +S
•Dividing both the sides by Y we get,
•Y/Y= C/Y + S/Y
•1= APC +APS
•[ APC= C/Y, APS =S/Y]

32. DERIVATION OF SAVINGS CURVE FROM
CONSUMPTION CURVE

33. DERIVATION OF C-CURVE FROM
S-CURVE

34. NUMERICAL
•Find savings function when consumption
function is given as C=500 +0.5Y.
•Estimate the value of Aggregate demand if in
an economy:
Autonomous investment=100 cr
MPS=0.2
Level of income=4000 cr
Autonomous consumption expenditure=50 cr.

35. NUMERICAL
•The consumption function of an economy is
C=40 +0.8 Y, Determine the level of income
where APC will be one.
•Complete the table:

Income APC S MPC
0 - -80
100 1.6
200 1
300 0.8