Determination of Income and Employment Class 12: Equilibrium, Multiplier and Gaps

What Determination of Income and Employment is about

Weightage: This chapter is Unit 3, Determination of Income and Employment (Part A Introductory Macroeconomics), which carries 12 of the 80 theory marks.Source: CBSE Economics (030) syllabus 2026-27, Unit 3 Determination of Income and Employment

In real board papers: asked in 2 of the 2 board papers we hold (2026 to 2026), on average 8 marks per paper. See the questions

Key concepts

Aggregate demand and its components

NCERT section 4.1

Aggregate demand is the total planned expenditure on final goods and services in an economy during a period, at each level of income.

• Two-sector economy: $AD=C+I$.
• Four-sector economy: $AD=C+I+G+(X-M)$.

Ex ante values are planned; ex post values are actual (realised). When sales turn out lower or higher than expected, unplanned changes in inventories make actual investment differ from planned investment. Investment is taken as autonomous (given) in the short run: $I=\bar{I}$.

Aggregate supply is the total output planned by producers; in the short-run model it is shown by the 45° line, where every point has AD equal to output.

Worked example

Suppose consumption is ₹800 crore, investment ₹300 crore, government spending ₹200 crore, exports ₹120 crore and imports ₹150 crore. Find AD. [1 mark]

Try it first, then show the solutionSolution

1. $AD=C+I+G+(X-M)=800+300+200+(120-150)$.

Answer: ₹1,270 crore

Consumption function: APC, MPC, APS, MPS

NCERT section 4.1

$C=\bar{C}+cY$: $\bar{C}$ is autonomous consumption (consumed even at zero income, financed by past savings or borrowing) and $cY$ is induced consumption.

• $APC=C/Y$; $APS=S/Y$; $APC+APS=1$. APC can exceed 1 at low income (dissaving).
• $MPC=\Delta C/\Delta Y$; $MPS=\Delta S/\Delta Y$; $MPC+MPS=1$; $0\le MPC\le 1$.
• Saving function: $S=-\bar{C}+(1-c)Y$.
• Break-even point: income where $C=Y$ (saving zero, APC = 1).

Propensities

Y	C	S	APC = C/Y	APS = S/Y	MPC = ΔC/ΔY	MPS = ΔS/ΔY
0	50	−50	—	—	—	—
100	125	−25	1.25	−0.25	0.75	0.25
200	200	0	1	0	0.75	0.25
300	275	25	0.92	0.08	0.75	0.25

Worked example

Using the table, find MPC, MPS, APC at Y = 300 and the break-even income. [3 marks]

Try it first, then show the solutionSolution

1. $MPC=75/100=0.75$; $MPS=0.25$.
2. $APC$ at 300 $=275/300=0.92$.
3. Break-even: C = Y at Y = 200.

Answer: MPC 0.75, MPS 0.25, APC 0.92, break-even income 200.

Short-run equilibrium output

NCERT section 4.2, 4.3, 4.3.1

With fixed prices and interest rate, equilibrium income is where AD = AS (planned spending = output) or, equivalently, S = I (planned saving = planned investment).

$Y=\bar{C}+cY+\bar{I}\Rightarrow Y=\frac{\bar{C}+\bar{I}}{1-c}$.

Adjustment: if AD > output, firms' inventories fall below planned levels, so they raise output and employment until AD = output. If AD < output, unplanned inventories pile up, so output falls.

Schedule for C = 100 + 0.8Y and I = 200 (₹ crore)

Y	C	S = Y − C	I	AD = C + I
0	100	−100	200	300
500	500	0	200	700
1,000	900	100	200	1,100
1,500	1,300	200	200	1,500
2,000	1,700	300	200	1,900

Worked example

Suppose $C=100+0.8Y$ and $I=200$ (₹ crore). Find equilibrium income, consumption and saving, and check by both approaches. [4 marks]

Try it first, then show the solutionSolution

1. AD-AS: $Y=100+0.8Y+200\Rightarrow 0.2Y=300\Rightarrow Y=1500$.
2. $C=100+0.8\times 1500=1300$; $S=1500-1300=200$.
3. S-I check: $S=-100+0.2Y=I=200\Rightarrow Y=1500$.

Answer: Y = ₹1,500 crore; C = ₹1,300 crore; S = I = ₹200 crore.

Investment multiplier and its working

NCERT section 4.3.2, 4.3.3

Multiplier $k=\frac{\Delta Y}{\Delta I}=\frac{1}{1-MPC}=\frac{1}{MPS}$. It ranges from 1 (MPC = 0) to infinity (MPC = 1).

Mechanism: an increase in investment raises the incomes of those who produce the investment goods. They spend a part (MPC) of it on consumption, which becomes income for others, who again spend a part, and so on. Income rises in diminishing rounds whose sum is $\Delta I\times \frac{1}{1-MPC}$.

Multiplier rounds, MPC = 0.75, ΔI = ₹500 crore

Round	Increase in income (₹ crore)	Increase in consumption (₹ crore)
Round 1	500	375
Round 2	375	281.25
Round 3	281.25	210.94
Round 4	210.94	158.20
…	…	…
Total	2,000	1,500

Worked example

Suppose MPC is 0.75 and investment rises by ₹500 crore. Find the multiplier and the increase in income, and show the first rounds. [4 marks]

Try it first, then show the solutionSolution

1. $k=1/(1-0.75)=4$; $\Delta Y=500\times 4=2000$.
2. Multiplier rounds, MPC = 0.75, ΔI = ₹500 crore

   Round	Increase in income (₹ crore)	Increase in consumption (₹ crore)
   Round 1	500	375
   Round 2	375	281.25
   Round 3	281.25	210.94
   Round 4	210.94	158.20
   …	…	…
   Total	2,000	1,500

3. Sum: $500\times (1+0.75+0.75^2+...)=500/0.25=2000$: same answer.

Answer: k = 4; ΔY = ₹2,000 crore (of which ΔC = ₹1,500 crore).

Full employment and involuntary unemployment

NCERT section 4.4

Full employment is the level of income at which all factors of production willing to work at the going wage are employed. There may still be frictional or structural unemployment, but no involuntary unemployment.

Involuntary unemployment exists when people are willing and able to work at the prevailing wage but do not find work. In the Keynesian model, equilibrium can occur at less than full employment because AD is insufficient: the economy rests there unless demand rises.

Worked example

Suppose a skilled worker is willing to work at the current wage but cannot find a job because factories are cutting production for lack of orders. What kind of unemployment is this and why? [1 mark]

Try it first, then show the solutionSolution

1. Willing and able at the prevailing wage but unemployed due to low demand.

Answer: Involuntary unemployment caused by deficient demand.

Excess demand and deficient demand

NCERT section 4.4

Deficient demand: AD falls short of AS at the full-employment level of output. The shortfall is the deflationary gap. Effects: output and employment fall below full employment (involuntary unemployment); unplanned inventories pile up; prices tend to fall in the long run.

Excess demand: AD exceeds AS at the full-employment level. The excess is the inflationary gap. Since output cannot rise beyond full employment, the main effect is a rise in the price level (inflation); output and employment do not rise.

Worked example

Suppose $C=100+0.8Y$, $I=200$, and full-employment output is ₹2,000 crore. Find AD at full employment, the gap, and the extra investment needed. [4 marks]

Try it first, then show the solutionSolution

1. $AD$ at $Y_f$ $=100+0.8\times 2000+200=1900$.
2. Deflationary gap $=2000-1900=100$.
3. Equilibrium is 1,500, below 2,000. With k = 5, extra investment needed = (2,000 − 1,500) ÷ 5 = ₹100 crore: equal to the gap.

Answer: AD at Yf = ₹1,900 crore; deflationary gap ₹100 crore; ₹100 crore of extra spending closes it.

Measures to correct excess and deficient demand

NCERT section CBSE syllabus: Unit 3 measures

Measure	For deficient demand	For excess demand
Government spending (fiscal)	Increase spending on public works	Reduce spending
Taxes (fiscal)	Reduce taxes to raise disposable income	Raise taxes
Bank rate / repo rate (monetary)	Lower	Raise
CRR, SLR (monetary)	Lower	Raise
Open market operations (monetary)	Buy securities	Sell securities
Margin requirement (monetary)	Lower	Raise

Fiscal measures change AD directly through G or through disposable income and C; monetary measures change the cost and availability of credit and hence C and I. Each change works through the multiplier.

Worked example

Suppose an economy has excess demand. Explain how (i) raising taxes and (ii) selling securities in the open market can reduce it. [3 marks]

Try it first, then show the solutionSolution

1. (i) Higher taxes cut disposable income, so consumption and AD fall.
2. (ii) Selling securities absorbs bank reserves, so credit and investment fall.
3. Lower AD closes the inflationary gap.

Answer: Both reduce AD (through C and I), easing inflation.

Determination of Income and Employment in real life

Each concept, met in an everyday situation. Read the situation, answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Topics in this chapter

• Propensity to Consume and Save
• Investment Multiplier
• Equilibrium Output: AD = AS and S = I
• Full Employment, Excess Demand and Deficient Demand

Determination of Income and Employment: key facts

Aggregate demand

$AD=C+I$ (two-sector); $AD=C+I+G+(X-M)$

Consumption and saving functions

$C=\bar{C}+cY$; $S=-\bar{C}+(1-c)Y$

Propensities

APC + APS = 1; MPC + MPS = 1; MPC = ΔC/ΔY

Equilibrium income

$Y=\frac{\bar{C}+\bar{I}}{1-c}$; AD = AS or S = I

Investment multiplier

$k=\frac{1}{1-MPC}=\frac{1}{MPS}$; ΔY = k × ΔI

Gaps

Deflationary gap = Yf − AD at Yf; inflationary gap = AD at Yf − Yf

Determination of Income and Employment: diagrams to practise

Practise each one on paper: draw it from the checklist, then tick off every label.

How the board asks Determination of Income and Employment

The question patterns to expect, and the method that works for each.

Tricks to remember Determination of Income and Employment

Short memory aids. Say each one aloud once, then use it on a question the same day.

• One minus MPC

  k = 1/(1 − MPC) = 1/MPS.

  Use it when: Multiplier.

• Pairs add to one

  APC + APS = 1; MPC + MPS = 1.

  Use it when: Propensity questions.

• Gaps live at Yf

  Measure inflationary and deflationary gaps at full-employment output.

  Use it when: Diagrams.

• Spend more, tax less, cheaper money

  Cure for deficient demand; reverse for excess demand.

  Use it when: Measures.

Determination of Income and Employment: board-level solved questions

Ordered from board level to HOTS. Cover the solution, write your own, then compare step by step.

Case-study practice (Section E style)

Read the situation, then answer every part. In the board paper this is a 4-mark question split into 1 + 1 + 2 marks.

Where the marks are

How a typical answer is split into step marks. Show every step: a right final answer alone rarely earns full marks.

Where students lose marks in Determination of Income and Employment

The slips examiners see most often, and what to write instead.

• ✗Mistake: Using APC instead of MPC in the multiplier

  Similar names.

  ✓Do this: k uses MPC (changes), not APC (averages).

  Usually costs: 1-2 marks.

• ✗Mistake: Measuring gaps at the equilibrium point

  Reading the diagram wrongly.

  ✓Do this: Inflationary and deflationary gaps are measured at full-employment output.

  Usually costs: 1-2 marks.

• ✗Mistake: Saying excess demand raises output and employment

  Forgetting full employment.

  ✓Do this: Beyond full employment, excess demand raises prices, not output.

  Usually costs: 1 mark.

• ✗Mistake: Drawing AD steeper than the 45° line

  Careless slope.

  ✓Do this: Slope of AD = MPC < 1, so it is flatter.

  Usually costs: 1 mark in diagrams.

• ✗Mistake: Mixing measures for the two situations

  Memorising without logic.

  ✓Do this: Deficient demand: expand (spend more, tax less, cheaper credit). Excess demand: contract.

  Usually costs: 1-2 marks.

NCERT exercise guide: Determination of Income and Employment

What each exercise in the NCERT chapter tests, how to approach it, and a question of the same kind solved step by step. Questions here are written in our own words.

Determination of Income and Employment: previous year questions

• Asked in 2 of the 2 board papers we hold (2026 to 2026), on average 8 marks per paper; 8 questions in all, counting OR alternatives. In 4 of 4 sample papers.

Counted from the real papers on our previous year papers page, not estimated. Average marks are over every board paper we hold, with an OR pair counted once. Chapter tags are ours.

Solved board questions from Determination of Income and Employment

Real questions from recent papers. Try each one first, then open our step-by-step solution with marks per step.

Every Determination of Income and Employment question, by year

Practice questions on Determination of Income and Employment

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

1. Q1 · 1 mark · MCQBoard level

   The sum of MPC and MPS is:
   (a) 0
   (b) 1
   (c) greater than 1
   (d) depends on income

   Hint

   Income is consumed or saved.

   Answer

   (b) 1

2. Q2 · 1 mark · MCQBoard level

   Which of these can be greater than one?
   (a) MPC
   (b) MPS
   (c) APC
   (d) none

   Hint

   Dissaving at low income.

   Answer

   (c) APC

3. Q3 · 3 marks · Short answerBoard level

   Distinguish between ex ante and ex post investment.

   Hint

   Planned vs actual.

   Answer

   Ex ante is planned investment; ex post is actual investment, which includes unplanned changes in inventories. They are equal only at equilibrium.

4. Q4 · 3 marks · Short answerBoard level

   Explain the meaning of involuntary unemployment and deficient demand.

   Hint

   Willing at prevailing wage.

   Answer

   Involuntary unemployment: people willing and able to work at the prevailing wage cannot find jobs. Deficient demand: AD at full-employment output is less than that output, so equilibrium is below full employment.

5. Q5 · 3 marks · Short answerHarder board level

   Suppose saving function is $S=-50+0.25Y$ and investment is ₹100 crore. Find equilibrium income and consumption.

   Hint

   S = I.

   Answer

   −50 + 0.25Y = 100 ⇒ Y = ₹600 crore; C = 600 − 100 = ₹500 crore.

6. Q6 · 3 marks · Short answerHarder board level

   Suppose MPS is 0.25. If income must rise by ₹600 crore, how much additional investment is needed?

   Hint

   k = 4.

   Answer

   ΔI = 600 ÷ 4 = ₹150 crore.

7. Q7 · 3 marks · Short answerHarder board level

   Suppose the equilibrium income is ₹4,000 crore, autonomous consumption ₹200 crore and MPC 0.75. Find investment.

   Hint

   Y = (C̄ + I)/(1 − c).

   Answer

   4,000 = (200 + I)/0.25 ⇒ I = ₹800 crore.

8. Q8 · 4 marks · Short answerHOTS / competency

   Suppose an economy with excess demand cuts taxes for political reasons. Using AD and the multiplier, explain what happens to prices and output.

   Hint

   Output at full employment.

   Answer

   Lower taxes raise disposable income and consumption, raising AD further above full-employment output. Output cannot rise beyond full employment, so the inflationary gap widens and prices rise faster.

9. Q9 · 1 mark · Assertion-reasonHOTS / competency

   Assertion (A): The value of the multiplier cannot be less than one.
   Reason (R): MPC lies between zero and one.
   (a) Both true and R explains A (b) Both true, R does not explain A (c) A true, R false (d) A false, R true

   Hint

   k = 1/(1 − MPC).

   Answer

   (a)

10. Q10 · 6 marks · Long answerHarder board level

    Explain, with a diagram described in words, how equilibrium is reached if AD exceeds AS at the current output.

    Hint

    Inventories and output.

    Answer

    Draw the 45° AS line and AD flatter than it; at an output to the left of E, AD lies above AS. Planned spending exceeds output, inventories fall below desired levels, firms raise output and employment, and income rises along the 45° line until AD = AS at E. Then planned saving equals planned investment.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1. 1.What is autonomous consumption?Show answer

   Consumption at zero income, independent of income.

2. 2.State the equilibrium condition in the two-sector model.Show answer

   AD = AS, or planned saving = planned investment.

3. 3.What is the multiplier if MPC is 0.9?Show answer

   10.

4. 4.What is the effective demand principle?Show answer

   In the short run with fixed prices, output is determined by aggregate demand.

5. 5.What is a deflationary gap?Show answer

   The amount by which AD falls short of AS at full-employment output.

6. 6.What happens to inventories when AD < AS?Show answer

   Unplanned inventories pile up and output falls.

7. 7.What is the slope of the consumption function?Show answer

   MPC.

8. 8.Name two fiscal measures for excess demand.Show answer

   Reduce government spending; raise taxes.

Quick revision checklist

The night before the exam: can you do each of these without looking?

• ☐Can you write AD for two and four sectors?
• ☐Can you compute APC, APS, MPC and MPS from a table?
• ☐Can you find break-even income?
• ☐Can you solve for equilibrium income two ways?
• ☐Can you explain how inventories bring equilibrium?
• ☐Can you derive k = 1/MPS?
• ☐Can you build a multiplier rounds table?
• ☐Can you compute inflationary and deflationary gaps at Yf?
• ☐Can you list fiscal and monetary measures for each gap?
• ☐Can you draw and label the Keynesian cross?

Determination of Income and Employment: frequently asked questions