Part – B

Answer The Following Questions In One or Two Sentences

Question 21.
What is consumption function?
Answer:
Meaning of Consumption Function:

1. The consumption function or propensity to consume refers to income consumption relationship. It is a “functional relationship between two aggregates viz., total consumption and gross national income.”

2. Symbolically, the relationship is represented as C = f (Y)
Where,
C = Consumption; Y = Income; f = Function

3. Thus the consumption function indicates a functional relationship between C and Y, where C is the dependent variable and Y is the independent variable, i.e., C is determined by Y. This relationship is based on the ceteris paribus (other things being same) assumption, as only income consumption relationship is considered and all possible influences on consumption are held constant.


Question 22.
What do you mean by propensity to consume?
Answer:

1. The consumption function or propensity to consume refers to income consumption relationship. It is a “functional relationship between two aggregates viz., total consumption and gross national income.”

2. Symbolically, the relationship is represented as C = f(Y) Where, C = Consumption; Y = Income; f = Function

3. Thus the consumption function indicates a functional relationship between C and Y, where C is the dependent variable and Y is the independent variable, i.e., C is determined by Y. This relationship is based on the ceteris paribus (other things being same) assumption, as only income consumption relationship is considered and all possible influences on consumption are held constant.

Question 23.
Define average propensity to consume (APC)?
Answer:
Average Propensity to Consume:

1. The average propensity to consume is the ratio of consumption expenditure to any particular level of income.” Algebraically it may be expressed as under:
Where, C = Consumption; Y = Income
APC = CY
Where, C = Consumption; Y = Income.

Question 24.
Define marginal propensity to consume (MPC)?
Answer:
Marginal Propensity to Consume:

1. The marginal propensity to consume may be defined as the ratio of the change in the consumption to the change in income. Algebraically it may be expressed as under:
MPC = ΔCΔY
Where, ∆C = Change in Consumption; ∆Y = Change in Income
MPC is positive but less than unity, 0 < ΔCΔY < 1.

Question 25.
What do you mean by propensity to save?
Answer:

  1. Thus the consumption function measures not only the amount spent on consumption but also the amount saved.
  2. This is because the propensity to save is merely the propensity not to consume.
  3. The 45° line may therefore be regarded as a zero – saving line, and the shape and position of the C curve indicate the division of income between consumption and saving.

Question 26.
Define average propensity to save (APS)?
Answer:
Average Propensity to Save (APS):

  1. The average propensity to save is the ratio of saving to income.
  2. APS is the quotient obtained by dividing the total saving by the total income. In other words, it is the ratio of total savings to total income. It can be expressed algebraically in the form of equation as under
  3. APS = SY Where, S = Saving; Y = Income

Question 27.
Define Marginal Propensity to Save (MPS)?
Answer:
Marginal Propensity to Save (MPS):

1. Marginal Propensity to Save is the ratio of change in saving to a change in income.

2. MPS is obtained by dividing change in savings by change in income. It can be expressed algebraically as MPS = ΔSΔY
∆S = Change in Saving; ∆Y = Change in Income
Since MPC + MPS = 1
MPS = 1 – MPC and MPC = 1 – MPS.

Question 28.
Define Multiplier?
Answer:

  1. The multiplier is defined as the ratio of the change in national income to change in investment.
  2. If AI stands for increase in investment and AY stands for resultant increase in income, the multiplier K =AY/AI.
  3. Since AY results from AI, the multiplier is called investment multiplier.

Question 29.
Define Accelerator?
Answer:

  1. “The accelerator coefficient is the ratio between induced investment and an initial change in consumption.”
  2. Assuming the expenditure of ₹50 crores on consumption goods, if industries lead to an investment of ₹100 crores in investment goods industries, we can say that the accelerator is 2.
  3. Accelerator = 100ΔY = 2

Part – C
Answer The Following Questions In One Paragraph.

Question 30.
State the propositions of Keynes’s Psychological Law of Consumption?
Answer:
Propositions of the Law:
This law has three propositions:
1. When income increases, consumption expenditure also increases but by a smaller amount. The reason is that as income increases, we wants are satisfied side by side, so that the need to spend more on consumer goods diminishes. So, the consumption expenditure increases with increase in income but less than proportionately.

2. The increased income will be divided in some proportion between consumption expenditure and saving. This follows from the first proposition because when the whole • of increased income is not spent on consumption, the remaining is saved. In this way, consumption and saving move together.

3. Increase in income always leads to an increase in both consumption and saving. This means that increased income is unlikely to lead to fall in either consumption or saving. Thus with increased income both consumption and saving increase.

Question 31.
Differentiate autonomous and induced investment?
Answer:
Autonomous Investment:

  1. Independent
  2. Income inelastic
  3. Welfare motive

Induced Investment:

  1. Planned
  2. Income elastic
  3. Profit Motive

Question 32.
Explain any three subjective and objective factors influencing the consumption function?
Answer:
Subjective Factors:

  1. The motive of precaution: To build up a reserve against unforeseen contingencies. e.g. Accidents, sickness. ,
  2. The motive of foresight: The desire to provide for anticipated future needs. e.g. Old age.
  3. The motive of calculation: The desire to enjoy interest and appreciation. Consumption and Investment Functions.

Objective Factors:
1. Income Distribution:
If there is large disparity between rich and poor, the consumption is low because the rich people have low propensity to consume and high propensity to save.

2. Price level:
Price level plays an important role in determining the consumption function. When the price falls, real income goes up; people will consume more and propensity to save of the
society increases.

3. Wage level:
Wage level plays an important role in determining the consumption function and there is positive relationship between wage and consumption. Consumption expenditure increases with the rise in wages. Similar is the effect with regard to windfall gains.

Question 33.
Mention the differences between accelerator and multiplier effect?
Answer:
Accelerator Effect Multiplier Effect:

1. Accelerator is the numerical value of the relation between an increase in consumption and the resulting increasing in Investment. Multiplier is the ration of the change in national income to change in Investment.

2. Accelerator (β) = ΔIΔC
ΔI = Change in Investment
ΔC = Change in consumption demand Multiplier (K) = ΔIΔC
ΔI = Increase in Investment ΔY = Increase in Income ΔY results from ΔI

3. Accelerator Effects are –

  1. Increase in consumer demand.
  2. Films get close to fill capacity.
  3. Film invest to meet rising demand. Multiplier Effects are

Multiplier Effect:
1. Multiplier is the ration of the change in national income to change in Investment.

2. Multiplier:
Multiplier (K) = ΔYΔI
ΔI = Increase in Investment
ΔY = Increase in Income
ΔY results from ΔI

Multiplier Effects are:

  1. Positive Multiplier an initial increases is an injection (or a decrease in a leakage) leads to a greater final increase in real GDP.
  2. Negative Multiplier an initial increases in an injection (or an increase in a leakage) leads to a greater final decrease in real GDP.

Question 34.
State the concept of super multiplier?
Answer:
Super Multiplier: (k and β interaction):

  1. The super multiplier is greater than simple multiplier which includes only autonomous investment and no induced investment, while super multiplier includes induced investment.
  2. In order to measure the total effect of initial investment on income, Hicks has combined the k and β mathematically and given it the name of the Super Multiplier.
  3. The super multiplier is worked out by combining both induced consumption and induced investment.

Question 35.
Specify the limitations of the multiplier?
Answer:

  1. There is change in autonomous investment.
  2. There is no induced investment
  3. The marginal propensity to consume is constant.
  4. Consumption is a function of current income.
  5. There are no time lags in the multiplier process.
  6. Consumer goods are available in response to effective demand for them.
  7. There is a closed economy unaffected by foreign influences.
  8. There are no changes in prices.
  9. There is less than full employment level in the economy.

Part – D
Answer The Following Questions In About A Page.

Question 36.
Explain Keynes psychological law of consumption function with diagram?
The three propositions of the law:


Proposition (1):
Income increases by ₹ 60 crores and the increase in consumption is by ₹ 50 crores.

Proposition (2):
The increased income of ₹ 60 crores in each case is divided in some proportion between consumption and saving respectively, (i.e., ₹ 50 crores and ₹ 10 crores).

Proposition (3):
As income increases consumption as well as saving increase. Neither consumption nor saving has fallen. Diagrammatically, the three propositions are explained in figure. Here, income is measured horizontally and consumption and saving are measured on the vertical axis. C is the consumption function curve and 45° line represents income consumption equality.


Proposition (1):
When income increases from 120 to 180 consumption also increases from 120 to 170 but the increase in consumption is less than the increase in income, 10 is saved.

Proposition (2):
When income increases to 180 and 240, it is divided in some proportion between consumption by 170 and 220 and saving by 10 and 20 respectively.

Proposition (3):
Increases in income to 180 and 240 lead to increased consumption 170 and 220 and increased saving 20 and 10 than before. It is clear from the widening area below the C curve and the saving gap between 45° line and C curve.

Question 37.
Briefly explain the subjective and objective factors of consumption function?
Answer:
Subjective Factors:

  1. The motive of precaution: To build up a reserve against unforeseen contingencies. e.g. Accidents, sickness
  2. The motive of foresight: The desire to provide for anticipated future needs, e.g. Old age
  3. The motive of calculation: The desire to enjoy interest and appreciation.
  4. The motive of improvement: The desire to enjoy for improving standard of living.
  5. The motive of financial independence.
  6. The motive of enterprise (desire to do forward trading).
  7. The motive of pride.(desire to bequeath a fortune)
  8. The motive of avarice.(purely miserly instinct)

Objective Factors:
1. Income Distribution:
If there is large disparity between rich and poor, the consumption is low because the rich people have low propensity to consume and high propensity to save.

2. Price level:

  1. Price level plays an important role in determining the consumption function.
  2. When the price falls, real income goes up; people will consume more and propensity to save of the society increases.

3. Wage level:

  1. Wage level plays an important role in determining the consumption function and there is positive relationship between wage and consumption.
  2. Consumption expenditure increases with the rise in wages.
  3. Similar is the effect with regard to windfall gains.

4. Interest rate:

  1. Rate of interest plays an important role in determining the consumption function.
  2. Higher rate of interest will encourage people to save more money and reduces consumption.

5. Fiscal Policy:
When government reduces the tax the disposable income rises and the propensity to consume of community increases.

6. Consumer credit:

  1. The availability of consumer credit at easy installments will encourage households to buy consumer durables like automobiles, fridge, computer.
  2. This pushes up consumption.

7. Demographic factors:

  1. Ceteris paribus, the larger the size of the family, the grater is the consumption.
  2. Besides size of family, stage in family life cycle, place of residence and occupation affect the consumption function.

8. Duesenberry hypothesis:
Duesenberry has made two observations regarding the factors affecting consumption.

  1. The consumption expenditure depends not only on his current income but also past income and standard of living.
  2. Consumption is influenced by demonstration effect. The consumption standards of low income groups are influenced by the consumption standards of high income groups.

9. Windfall Gains or losses:
Unexpected changes in the stock market leading to gains or losses tend to shift the consumption function upward or downward.

Question 38.
Illustrate the working of Multiplier?
Answer:
Working of Multiplier:

  1. Suppose the Government undertakes investment expenditure equal to ₹ 100 crore on some public works, by way of wages, price of materials etc.
  2. Thus income of labourers and suppliers of materials increases by ₹ 100 crore. Suppose the MPC is 0.8 that is 80 %.
  3. A sum of ₹ 80 crores is spent on consumption (A sum of ₹ 20 Crores is saved).
  4. As a result, suppliers of goods get an income of ₹ 80 crores.
  5. They intum spend ₹ 64 crores (80% of ₹ 80 cr).
  6. In this manner consumption expenditure and increase in income act in a chain like maimer.

The final result is ∆Y = 100 + 100 × 4/5 + 100 × [4/5]2 + 100 × [4/5]3 or,
∆Y = 100 + 100 × 0.8 + 100 × (0.8)2 + 100 × (0.8)3
= 100 + 80 + 64 + 51.2… = 500 .
that is 100 × 1/1 – 4/5
100 × 1/1/5
100 × 5 = ₹ 500 crores
For instance if C = 100 + 0.8Y, I = 100,
Then Y = 100 + 0.8Y + 100
0.2Y = 200
Y = 200/0.2 = 1000 → Point B
If I is increased to 110, then
0.2Y = 210
Y = 210/0.2 = 1050 → Point D
For ₹ 10 increase in I, Y has increased by ₹ 50.
This is due to multiplier effect.
At point A, Y = C = 500
C = 100 + 0.8 (500) = 500; S = 0
At point B, Y = 1000
C = 100 + 0.8 (1000) = 900; S = 100 = I At point D, Y = 1050
C = 100 + 0.8 (1050) = 940; S = 110 = I
When I is increased by 10, Y increases by 50.
This is multiplier effect (K = 5)
K = 10.2 = 5


Question 39.
Explain the operation of the Accelerator?
Answer:
Operation of the Acceleration Principle:

  1. Let us consider a simple example. The operation of the accelerator may be illustrated as follows.
  2. Let us suppose that in order to produce 1000 consumer goods, 100 machines are required.
  3. Also suppose that working life of a machine is 10 years.
  4. This means that every year 10 machines have to be replaced in order to maintain the constant flow of 1000 consumer goods. This might be called replacement demand.
  5. Suppose that demand for consumer goods rises by 10 percent (i.e. from 1000 to 1100).
  6. This results in increase in demand for 10 more machines.
  7. So that total demand for machines is 20. (10 for replacement and 10 for meeting increased demand).
  8. It may be noted here a 10 percent increase in demand for consumer goods causes a 100 percent increase in demand for machines (from 10 to 20).
  9. So we can conclude even a mild change in demand for consumer goods will lead to wide change in investment.

Diagrammatic illustration:
Operation of Accelerator.

  1. SS is the saving curve. II is the investment curve. At point E1 the economy is in equilibrium with OY1 income. Saving and investment are equal at OY1 Now, investment is increased from OI2 to OI4.
  2. This increases income from OY1 to OY3, the equilibrium point being E3 If the increase in investment by I2 I4 is purely exogenous, then the increase in income by Y1 Y3 would have been due to the multiplier effect.
  3. But in this diagram it is assumed that exogenous investment is only by I, I3 and induced investment is by I3I4.
  4. Therefore, increase in income by Y1 Y2 is due to the multiplier effect and the increase in income by Y2 Y3 is due to the accelerator effect.


Question 40.
What are the differences between MEC and MEI?
Answer:
Marginal Efficiency of Capital (MEC):

  1. It is based on a given supply price for capital.
  2. It represents the rate of return on all successive units of capital without regard to existing capital.
  3. The capital stock is taken on the X axis of diagram.
  4. It is a “stock” concept.
  5. It determines the optimum capital stock in an economy at each level of interest rate.

Marginal Efficiency of Investment (MEI):

  1. It is based on the induced change in the price due to change in the demand for capital.
  2. It shows the rate of return on just those units of capital over and above the existing capital stock.
  3. The amount of investment is taken on the X – axis of diagram.
  4. It is a “flow” concept.
  5. It determines the net investment of the economy at each interest rate given the capital stock.