Aggregate Demand, Consumption and Saving for CUET Economics

Q: Planned or actual?

In the simple model, planned investment is autonomous: the same at every income, a horizontal line. Ex ante means planned; ex post means actual.

About 5 min to learn · 60 questions

The parts of aggregate demand, the consumption function and autonomous consumption, APC, MPC, APS and MPS, the saving function and the break-even point, and planned and actual investment, with graphs, worked examples and the traps CUET sets.

Syllabus area: Introductory Macroeconomics

On this page · 9 sections

01The core idea
02The consumption function
03The propensities
04The saving function
05Investment
06Exam shortcuts
07Common mistakes
08Quick revision
09Check your understanding

The core idea

Keynes's question: what decides how much an economy produces in the short run? His answer is aggregate demand (AD), the total planned spending on final goods and services. In a two-sector economy AD = C + I; with the government and trade, AD = C + I + G + (X − M).

This chapter builds the two parts of AD in the simple model: consumption, which depends on income, and investment, which does not.

The consumption function

How does consumption depend on income?

Consumption function

C = \bar{c} + bY \qquad 0 < b < 1

$\bar{c}$ is autonomous consumption: spending at zero income, paid for from past savings or borrowing.
b is the marginal propensity to consume (MPC), the slope of the line.

A consumption line C = 40 + 0.75Y starting at ₹40 crore, and a dashed 45° line. They cross at B, where income and consumption are both ₹160 crore. At K, income is ₹400 crore and consumption ₹340 crore. — Above the 45° line people consume more than their income; at B (₹160 crore) they consume all of it; beyond B they save.

The 45° line marks every point where the vertical value equals the horizontal one. Where C meets it, consumption equals income and saving is zero: the break-even point, at $Y = \bar{c} \div (1 - b)$ .

The propensities

Four ratios

\text{APC} = \frac{C}{Y} \quad \text{MPC} = \frac{\Delta C}{\Delta Y} \quad \text{APS} = \frac{S}{Y} \quad \text{MPS} = \frac{\Delta S}{\Delta Y}

\text{MPC} + \text{MPS} = 1 \qquad \text{APC} + \text{APS} = 1

Example 1 · From a schedule

Income 0, 100, 200, 300, 400 (₹ crore); consumption 40, 115, 190, 265, 340.

Each ₹100 crore of income raises consumption by ₹75 crore: MPC = 0.75, MPS = 0.25.
At Y = 100, APC = 115 ÷ 100 = 1.15: below break-even, people dissave.
At Y = 400, saving = 60, so APS = 60 ÷ 400 = 0.15, below the MPS.

Answer

MPC 0.75; APC falls as income rises

Ratio	Can it exceed 1?	Can it be negative?
APC	Yes, below break-even	No
APS	No	Yes, below break-even
MPC, MPS	No (between 0 and 1)	No

The saving function

Saving function

S = Y - C = -\bar{c} + (1 - b)Y

The consumption line C = 40 + 0.75Y, the saving line S = −40 + 0.25Y and a dashed 45° line. C meets the 45° line at B (income ₹160 crore), exactly where S crosses the income axis. At an income of ₹400 crore, C is ₹340 crore and S is ₹60 crore. — Saving is the vertical gap between the 45° line and C; it is zero at the same income, B, on both graphs.

S starts at $-\bar{c}$ below the axis, crosses it at the break-even income and rises with slope MPS.

Watch out

At low incomes the level of saving is negative, but the MPS is still a positive fraction.

Investment

Planned or actual?

In the simple model, planned investment is autonomous: the same at every income, a horizontal line. Ex ante means planned; ex post means actual.

If planned saving is ₹120 crore and planned investment ₹100 crore, households spend ₹20 crore less than firms expected, so ₹20 crore of unsold goods pile up. That is unplanned inventory investment, and actual investment becomes 120: ex post saving always equals ex post investment. Ex ante, they match only at equilibrium.

Exam shortcuts

Break-even income = $\bar{c} \div$ MPS.
MPC = 1 − MPS; APC = 1 − APS.
A parallel shift of C is a change in $\bar{c}$ ; a steeper C is a higher MPC.
AD is planned spending; C + S is income.

Common mistakes

Using C ÷ Y when the MPC is asked.
Saying MPS can be negative.
Taking the break-even point as equilibrium.
Writing AD = C + S.

Quick revision

Consumption

C = c̄ + bY; b = MPC
Break-even: C = Y, S = 0
APC > 1 below break-even

Saving

S = −c̄ + (1 − b)Y
MPC + MPS = 1; APC + APS = 1

Investment

Autonomous in the simple model
Ex post S = I always; ex ante only at equilibrium

Putting C and I together to find equilibrium income is in income determination and the multiplier.

Next · 08Quick revision

Check your understanding

60 questions, grouped by type, easy to hard. Pick an answer and check it. The worked solution opens when you ask for it.

Components of aggregate demandQ1 of 60Q1

Components of aggregate demand

8 questions

List I	List II
A. Consumption (C)	I. The government builds a highway
B. Investment (I)	II. A family buys clothes
C. Government spending (G)	III. Foreigners buy Indian tea, minus India's purchases from abroad
D. Net exports (X − M)	IV. A firm buys new machines

List I	List II
A. APC	I. ΔC ÷ ΔY
B. MPC	II. ΔS ÷ ΔY
C. APS	III. C ÷ Y
D. MPS	IV. S ÷ Y

Check your understanding

Components of aggregate demand

Question 1

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The consumption function

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APC, MPC, APS and MPS

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The saving function and break-even

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Planned investment; ex ante and ex post

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Question 60