1. Ex ante and ex post values
- Ex ante (planned): what households and firms intend before a period: planned consumption, saving, investment.
- Ex post (realised): what actually happened, recorded after the period.
- Planned saving (households) and planned investment (firms) are decided by different people for different reasons, so they may differ.
- Realised saving and investment are always equal: any gap shows up as an unplanned change in stock, which is counted in realised investment.
- If planned saving > planned investment: goods remain unsold, stocks rise, firms later cut output. If planned saving < planned investment: stocks fall, firms later raise output.
| Ex ante (planned) | Ex post (realised) | |
|---|---|---|
| When measured | Before the period, as intentions | After the period, as outcomes |
| Who decides | Households and firms separately | Recorded in the accounts |
| Saving and investment | May be unequal | Always equal |
| Item (₹ crore) | Ludhiana hosiery cluster |
|---|---|
| Planned (ex ante) investment | 150 |
| Unsold sweaters added to stock | 25 |
| Realised (ex post) investment | 175 |
Key terms
- Ex ante
Planned or intended value of a variable, before the period.
- Ex post
Realised or actual value of a variable, after the period.
- Unplanned inventory
An addition to or fall in stock that firms did not intend.
2. Effective demand
Effective demand is the level of aggregate demand at which it becomes equal to aggregate supply. At this level, planned spending is exactly enough to buy the output produced, so it decides actual output and employment.
In Keynes's view effective demand need not be at full employment: if planned spending is low, the economy can settle where some people who want work cannot find it (the idea of involuntary unemployment, taken further in the next chapter).
Key terms
- Effective demand
The level of aggregate demand that equals aggregate supply and so fixes output and employment.
3. Aggregate demand and aggregate supply
- Aggregate demand (AD): total planned spending on final goods and services in a period.
- Open economy with government: AD = C + I + G + (X − M); two sectors: AD = C + I.
- C households' consumption; I firms' investment (new capital and stock); G government purchases; X − M net exports (imports subtracted because they buy foreign output).
- Aggregate supply (AS): total value of output produced, equal to the income generated. From the income side, in two sectors, AS = C + S.
| Component | Who spends | Imagined example |
|---|---|---|
| C — private consumption | Households | A Jaipur family buys a mixer-grinder |
| I — investment | Firms | A Pune factory installs a new press and adds to its stock |
| G — government expenditure | Government | A state buys ambulances for district hospitals |
| X − M — net exports | Buyers abroad, less spending on foreign goods | Prawns sold to a hotel abroad, minus imported phones |
| Component (₹ crore) | Navkhand |
|---|---|
| C | 820 |
| I | 260 |
| G | 180 |
| X | 140 |
| M | 160 |
| AD = C + I + G + (X − M) | 1240 |
| Aggregate demand | Aggregate supply |
|---|---|
| Total planned spending | Total value of output |
| C + I + G + (X − M) | C + S (two sectors) |
| Spending side | Income side |
Key terms
- Aggregate demand
Total planned expenditure on final goods and services in an economy during a period.
- Aggregate supply
Total value of goods and services produced in an economy during a period.
- Net exports
Exports minus imports.
4. The consumption function; APC and MPC
- Consumption function: C = f(Y); in straight-line form C = c̄ + bY, where c̄ (autonomous consumption) is consumption at zero income and b is the MPC.
- APC = C ÷ Y; it can exceed 1 at low incomes (dissaving) and falls as income rises.
- MPC = ΔC ÷ ΔY; normally 0 < MPC < 1 because part of extra income is saved.
- Break-even income: where C = Y (the curve meets the 45° line): S = 0 and APC = 1. For C = c̄ + bY it is c̄ ÷ (1 − b); in imagined Neelgiri Pradesh, 90 ÷ 0.3 = 300.
- For a straight-line function with c̄ > 0, APC > MPC at every positive income.
| Y | C | S | APC | APS |
|---|---|---|---|---|
| 0 | 90 | -90 | — | — |
| 100 | 160 | -60 | 1.6 | -0.6 |
| 200 | 230 | -30 | 1.15 | -0.15 |
| 300 | 300 | 0 | 1 | 0 |
| 400 | 370 | 30 | 0.925 | 0.075 |
| 500 | 440 | 60 | 0.88 | 0.12 |
| 600 | 510 | 90 | 0.85 | 0.15 |
| Income | Consumption | Saving | APC | MPC |
|---|---|---|---|---|
| 20 | 22 | -2 | 1.1 | — |
| 30 | 30 | 0 | 1 | 0.8 |
| 40 | 38 | 2 | 0.95 | 0.8 |
| 50 | 46 | 4 | 0.92 | 0.8 |
Key terms
- Autonomous consumption
Consumption that does not depend on income; it takes place even at zero income.
- Average propensity to consume
Consumption as a share of income, C ÷ Y.
- Marginal propensity to consume
The share of extra income spent on consumption, ΔC ÷ ΔY.
- Break-even income
The income at which consumption equals income and saving is zero.
5. The saving function; APS and MPS
- Saving function: S = Y − C = −c̄ + (1 − b)Y; it starts at −c̄ and has slope (1 − b) = MPS.
- APS = S ÷ Y; it is negative below break-even income, zero at it, positive above it.
- MPS = ΔS ÷ ΔY; for Neelgiri Pradesh 0.3.
- The saving curve cuts the income axis at the break-even income, the same income at which the consumption curve meets the 45° line.
Key terms
- Average propensity to save
Saving as a share of income, S ÷ Y.
- Marginal propensity to save
The share of extra income saved, ΔS ÷ ΔY.
- Dissaving
Consumption above income, financed from past savings or borrowing.
6. The two identities and working with schedules
- Since Y = C + S: APC + APS = 1.
- Since ΔY = ΔC + ΔS: MPC + MPS = 1.
- To complete a schedule: S = Y − C; then the four ratios, writing each formula; check both identities.
- A falling MPC (rising MPS) as income rises shows that better-off households save a larger share of extra income.
| Income | Consumption | Saving | MPC | MPS |
|---|---|---|---|---|
| 100 | 120 | -20 | — | — |
| 200 | 200 | 0 | 0.8 | 0.2 |
| 300 | 270 | 30 | 0.7 | 0.3 |
| 400 | 330 | 70 | 0.6 | 0.4 |
Key terms
- APC + APS = 1
Average propensities to consume and save add up to one.
- MPC + MPS = 1
Marginal propensities to consume and save add up to one.
Exam tips
Common mistakes
- Adding imports in AD instead of subtracting them.
- Using totals for the MPC or changes for the APC.
- Saying the MPC can be above 1, or that the APC equals the MPC for C = c̄ + bY.
- Starting the consumption curve at the origin, or the saving curve at zero.
- Writing that ex ante saving always equals ex ante investment.
- Saying effective demand means full employment.
How marks are usually awarded
- 1 mark: one correct option, value or term.
- 2 marks: a definition with an example, or a value with working.
- 3 marks: a short schedule completed, or three linked points.
- 5 marks: parts answered in order with schedules, described diagrams and reasons.