Income Determination and Multiplier
Chapter 7 gave you all the INGREDIENTS — the Consumption Function, Saving Function and Investment Function. Now you put them together to answer the biggest question in Keynesian economics: at WHAT exact level does National Income settle? And here is the true magic — a SMALL rise in Investment does not create an EQUAL rise in Income. It creates a MUCH BIGGER one, through the famous Investment Multiplier. This is one of the most numerical-heavy, board-exam-critical chapters of the year.
30MCQs
30Quiz Qs
FreeAlways
📌 The Big Idea
Two Roads, One Destination: Equilibrium Income
In Income Theory, the EQUILIBRIUM level of National Income can be found using TWO completely equivalent approaches — like two roads leading to the exact same destination. Master BOTH, because exam questions randomly test either one (or ask you to prove they give the same answer).
8.1 & 8.2 Determination of Equilibrium Level
Mnemonic: “AD-AS Twins” — Two Approaches, Same Answer
Approach 1: AD = AS Approach (Income-Expenditure Approach)
Approach 2: S = I Approach (Saving-Investment Approach)
Approach 1: AD = AS Approach (Income-Expenditure Approach)
Approach 2: S = I Approach (Saving-Investment Approach)
① Approach 1: AD = AS (Income-Expenditure Approach)
📌 Definition
Equilibrium: Where Planned Spending Meets Planned Production
The economy is in EQUILIBRIUM when planned Aggregate Demand (AD = C + I) EXACTLY EQUALS planned Aggregate Supply (AS = Y). At this income level, firms are producing EXACTLY what buyers plan to purchase — there is NO unplanned build-up or depletion of inventory, so firms have NO reason to change their production level.
Deriving the Equilibrium Formula
Setting AD = AS: Y = C + I
Substituting the Consumption Function C = C̄ + cY:
Y = C̄ + cY + I → Y − cY = C̄ + I → Y(1−c) = C̄ + I
Equilibrium Y = (C̄ + I) ÷ (1−c)
Setting AD = AS: Y = C + I
Substituting the Consumption Function C = C̄ + cY:
Y = C̄ + cY + I → Y − cY = C̄ + I → Y(1−c) = C̄ + I
Equilibrium Y = (C̄ + I) ÷ (1−c)
📌 Worked Example: Finding Equilibrium Income
Given: C = 100 + 0.75Y and I = Rs 50 (constant, autonomous)
Step 1: Set Y = C + I: Y = 100 + 0.75Y + 50
Step 2: Y = 150 + 0.75Y
Step 3: Y − 0.75Y = 150 → 0.25Y = 150
Step 4: Y = 150 ÷ 0.25 = Rs 600
At Y = Rs 600, the economy is in EQUILIBRIUM — total planned spending (C+I) exactly equals total planned output (Y).
② Approach 2: S = I (Saving-Investment Approach)
📌 Definition
Equilibrium: Where Planned Saving Meets Planned Investment
The economy is in EQUILIBRIUM when planned (EX-ANTE) Saving EXACTLY EQUALS planned (EX-ANTE) Investment. Recall from Chapter 7: this is precisely the “Ex-ante S = Ex-ante I” equilibrium CONDITION you already learned!
Why AD=AS and S=I Are MATHEMATICALLY THE SAME CONDITION
Since AD = C + I, and AS = C + S
Setting AD = AS: C + I = C + S
Cancelling “C” from both sides: I = S
This PROVES that the S=I approach is NOT a different rule — it is the SAME equilibrium condition as AD=AS, just expressed differently (with consumption cancelled out algebraically).
Since AD = C + I, and AS = C + S
Setting AD = AS: C + I = C + S
Cancelling “C” from both sides: I = S
This PROVES that the S=I approach is NOT a different rule — it is the SAME equilibrium condition as AD=AS, just expressed differently (with consumption cancelled out algebraically).
📌 Worked Example: Same Answer via S=I Approach
Using the SAME data: C = 100 + 0.75Y, so S = −100 + 0.25Y (derived using S=Y−C). I = Rs 50 (constant).
Step 1: Set S = I: −100 + 0.25Y = 50
Step 2: 0.25Y = 50 + 100 = 150
Step 3: Y = 150 ÷ 0.25 = Rs 600
EXACTLY the same equilibrium income (Rs 600) as the AD=AS approach — confirming both methods are mathematically identical routes to the same destination.
The Disequilibrium Adjustment Mechanism (What Happens When NOT in Equilibrium?)
Mnemonic: “AD > AS: Stock DOWN, Production UP” • “AD < AS: Stock UP, Production DOWN”
↑
When AD > AS (Planned Spending EXCEEDS Planned Output)
Buyers want to purchase MORE than firms are currently producing. This causes an UNPLANNED DEPLETION (fall) in inventory/stock — firms sell MORE than expected, drawing down their stock levels below the planned amount. Firms RESPOND by INCREASING production to restock and meet the higher demand. This raises Y (National Income) — the economy moves UPWARD toward a NEW, higher equilibrium.
↓
When AD < AS (Planned Spending is LESS THAN Planned Output)
Buyers purchase LESS than firms are producing. This causes an UNPLANNED ACCUMULATION (rise) in inventory/stock — unsold goods pile up above the planned level. Firms RESPOND by DECREASING production (since they are stuck with excess unsold stock). This lowers Y (National Income) — the economy moves DOWNWARD toward a NEW, lower equilibrium.
This is the “invisible hand” that pulls the economy toward equilibrium: Any gap between AD and AS shows up as UNPLANNED inventory changes, which firms react to by adjusting PRODUCTION (and hence income) — a self-correcting process that continues UNTIL AD = AS is restored.
8.3 Concept of Investment Multiplier
📌 Definition
The Multiplier = How Much MORE Income a Little Extra Investment Creates
The Investment Multiplier (k) measures the RATIO of the CHANGE in equilibrium National Income (ΔY) to the CHANGE in Investment (ΔI) that CAUSED it. It shows how a SMALL initial increase in investment leads to a MUCH LARGER final increase in national income.
Master Formula: k = ΔY ÷ ΔI = 1 ÷ (1−MPC) = 1 ÷ MPS
Since MPC + MPS = 1, both formulas (1−MPC and MPS) give the exact same result.
Since MPC + MPS = 1, both formulas (1−MPC and MPS) give the exact same result.
Deriving the Multiplier Formula
From the Equilibrium formula: Y = (C̄+I) ÷ (1−c)
If Investment CHANGES by ΔI (with C̄ and c unchanged), the new equilibrium income changes by:
ΔY = ΔI ÷ (1−c)
Therefore: k = ΔY ÷ ΔI = 1 ÷ (1−c) = 1 ÷ (1−MPC) = 1 ÷ MPS
The Round-by-Round Multiplier Process (Just Like Credit Creation in Chapter 6!)
📌 Worked Example: How Rs 100 of New Investment Becomes Rs 500 of New Income
Assume MPC = 0.8 (so MPS = 0.2), and Investment INCREASES by ΔI = Rs 100:
Round 1: Firms spend Rs 100 more on capital goods → this Rs 100 becomes INCOME for workers/suppliers in the capital goods industry.
Round 2: These workers, with MPC=0.8, spend 80% of their new Rs 100 income → Rs 80 of NEW consumption spending → becomes income for ANOTHER set of people.
Round 3: That group spends 80% of their new Rs 80 → Rs 64 of new spending → becomes income for yet another group.
...this continues infinitely, in a decreasing GEOMETRIC PROGRESSION...
Total Increase in Income = ΔI × k = Rs 100 × [1÷(1−0.8)] = Rs 100 × [1÷0.2] = Rs 100 × 5 = Rs 500
The ORIGINAL Rs 100 of new investment has been transformed into Rs 500 of total new income — this is the “multiplier effect.” Notice the STRIKING similarity to the Money/Credit Multiplier from Chapter 6 (1÷LRR) — BOTH are examples of the SAME mathematical idea: an initial injection re-circulates through the economy in ever-smaller rounds, governed by a geometric series.
Relationship Between MPC/MPS and the Size of the Multiplier
| MPC | MPS (=1−MPC) | Multiplier k = 1÷MPS | Interpretation |
|---|---|---|---|
| 0.5 | 0.5 | k = 1÷0.5 = 2 | People save HALF of extra income — SMALL multiplier |
| 0.75 | 0.25 | k = 1÷0.25 = 4 | Moderate MPC — MODERATE multiplier |
| 0.8 | 0.2 | k = 1÷0.2 = 5 | High MPC (people spend most extra income) — LARGE multiplier |
| 0.9 | 0.1 | k = 1÷0.1 = 10 | Very high MPC — VERY LARGE multiplier |
KEY RELATIONSHIP: Higher MPC (or Lower MPS) → BIGGER Multiplier
This makes intuitive sense: if people SPEND a LARGER fraction of every extra rupee they earn (high MPC), that spending circulates through MORE rounds before “leaking” into savings, creating a BIGGER cumulative effect on total income.
This makes intuitive sense: if people SPEND a LARGER fraction of every extra rupee they earn (high MPC), that spending circulates through MORE rounds before “leaking” into savings, creating a BIGGER cumulative effect on total income.
Boundary Values of the Multiplier
Min
Minimum Possible Multiplier: k = 1
This occurs ONLY when MPC = 0 (people save 100% of any extra income, spending NONE of it). Then k = 1÷(1−0) = 1÷1 = 1 — meaning ΔY = ΔI exactly, with NO further multiplier rounds happening at all (the process stops after Round 1).
Max
Theoretical Maximum: k → ∞ (Infinity)
This occurs ONLY when MPC = 1 (people spend 100% of any extra income, saving NONE). Then k = 1÷(1−1) = 1÷0, which is MATHEMATICALLY UNDEFINED (approaches infinity). This is a purely THEORETICAL limiting case — in reality, MPC is always somewhat less than 1, since people save at least SOME fraction of extra income.
Real-world range: Since 0 < MPC < 1 in practice (people neither spend nor save 100% of extra income), the REALISTIC multiplier value is ALWAYS GREATER THAN 1 — confirming why it is called a “multiplier” (the final effect on income is ALWAYS bigger than the initial injection of investment).
⚡ Quick Recall — Chapter 8: Income Determination and Multiplier
Two equivalent equilibrium approaches: AD=AS (Y=C+I) and S=I. Setting AD=AS and cancelling C from both sides PROVES I=S is the same condition.
Equilibrium Y formula: Y = (C̄+I) ÷ (1−c), derived by substituting the Consumption Function into Y=C+I.
Disequilibrium adjustment: AD>AS → unplanned inventory DEPLETION → firms INCREASE production → Y rises. AD<AS → unplanned inventory ACCUMULATION → firms DECREASE production → Y falls.
Investment Multiplier: k = ΔY÷ΔI = 1÷(1−MPC) = 1÷MPS. Total ΔY = ΔI × k.
Multiplier process = round-by-round geometric series, exactly parallel to the Money/Credit Multiplier from Chapter 6 (1÷LRR) — same mathematical logic, different context.
Higher MPC (lower MPS) → BIGGER multiplier. Minimum k=1 (when MPC=0). Theoretical maximum k→∞ (when MPC=1, unrealistic). Realistic k is always >1.
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30 MCQs — Income Determination and Multiplier
Equilibrium via AD=AS and S=I approaches, disequilibrium adjustment mechanism, and Investment Multiplier numericals. Q25–Q30 are CUET-level.
📚 Questions 1 to 30
1
The AD = AS approach to determining equilibrium National Income states that equilibrium occurs when:
APlanned Aggregate Demand (C+I) EXACTLY EQUALS planned Aggregate Supply (Y) — at this point, firms are producing exactly what buyers plan to purchase, with no unplanned inventory changes
BConsumption always equals Investment
CGovernment spending equals tax revenue
DExports always equal Imports
Answer: A — Planned AD equals planned AS. Equilibrium under the AD=AS (Income-Expenditure) approach occurs when Y = C+I — the value that firms PLAN to produce (Aggregate Supply) exactly matches what buyers PLAN to spend (Aggregate Demand). At this precise income level, there is NO unplanned build-up or depletion of inventory, so firms have NO incentive to change their production level in the next period — the economy is “at rest.”
2
📋 CASE: Given C = 100 + 0.75Y and I = Rs 50, find the equilibrium level of National Income using the AD=AS approach:
AY = Rs 150
BY = Rs 600 — Setting Y=C+I: Y=100+0.75Y+50 → Y−0.75Y=150 → 0.25Y=150 → Y=600
CY = Rs 500
DY = Rs 400
Answer: B — Y = Rs 600. Step 1: Y = C+I = 100+0.75Y+50. Step 2: Y = 150+0.75Y. Step 3: Y−0.75Y = 150 → 0.25Y = 150. Step 4: Y = 150÷0.25 = Rs 600. At this equilibrium income, C = 100+0.75(600) = 100+450 = Rs 550, and total AD = C+I = 550+50 = Rs 600 = Y, confirming equilibrium.
3
The S = I approach to determining equilibrium National Income states that equilibrium occurs when:
APlanned (Ex-ante) Saving EXACTLY EQUALS planned (Ex-ante) Investment — this is the SAME “Ex-ante S = Ex-ante I” equilibrium condition covered in Chapter 7
BConsumption equals zero
CNational Income equals zero
DSaving always equals Consumption
Answer: A — Planned Saving equals planned Investment. This directly connects to Chapter 7 Ex-ante S = Ex-ante I equilibrium condition. When households PLANNED saving exactly matches firms PLANNED investment, there is no tendency for income to change — the leakage from the circular flow (saving) is EXACTLY offset by the injection (investment), keeping the flow of income stable at this level.
4
Which of the following BEST explains WHY the AD=AS approach and the S=I approach are MATHEMATICALLY EQUIVALENT (give the same equilibrium answer)?
ASince AD = C+I and AS = C+S, setting AD=AS gives C+I = C+S; CANCELLING the identical “C” term from both sides directly yields I = S — proving S=I is simply a SIMPLIFIED, algebraically equivalent version of the SAME AD=AS condition
BThey are actually different conditions that coincidentally give similar numerical answers by chance
CThe government mandates that both approaches must match by law
DConsumption is always zero, making the two approaches trivially identical
Answer: A — Algebraic cancellation of C proves the equivalence. AD = C+I (total planned spending). AS = C+S (total planned output, which equals income, split into consumption and saving). Setting AD=AS: C+I = C+S. Since “C” appears IDENTICALLY on both sides, it CANCELS OUT algebraically, leaving simply I = S. This is not a coincidence — it is a direct MATHEMATICAL CONSEQUENCE of the definitions of AD and AS, proving these are NOT two different rules but ONE underlying condition expressed in two equivalent forms.
5
📋 CASE: Using C = 100 + 0.75Y (so S = −100 + 0.25Y) and I = Rs 50, verify the equilibrium income using the S=I approach:
AY = Rs 400
BY = Rs 600 — Setting S=I: −100+0.25Y=50 → 0.25Y=150 → Y=600, EXACTLY matching the AD=AS approach answer
CY = Rs 200
DY = Rs 800
Answer: B — Y = Rs 600 (matches AD=AS approach exactly). Step 1: Set S=I: −100+0.25Y = 50. Step 2: 0.25Y = 50+100 = 150. Step 3: Y = 150÷0.25 = Rs 600. This is EXACTLY the same equilibrium income found using the AD=AS approach in an earlier question, confirming both approaches lead to the identical destination — as expected, since they are algebraically equivalent conditions.
6
📋 CASE: At a certain income level, planned Aggregate Demand (Rs 800 crore) EXCEEDS planned Aggregate Supply (Rs 750 crore). What happens NEXT in the economy?
AFirms experience an UNPLANNED DEPLETION of inventory (selling more than expected); firms respond by INCREASING production; National Income RISES toward a new, higher equilibrium
BFirms experience unplanned inventory accumulation and decrease production
CNothing changes; the economy remains permanently at this income level
DPrices immediately fall to restore balance, with no change in output
Answer: A — Inventory depletion, firms increase production, income rises. When AD (Rs 800 crore) EXCEEDS AS (Rs 750 crore), buyers are trying to purchase MORE than firms currently produce. This causes firms STOCK/INVENTORY to fall UNEXPECTEDLY (unplanned depletion) as they sell more than anticipated. Firms interpret this as a signal of strong demand and RESPOND by INCREASING production to restock and meet this higher demand — this raises National Income, moving the economy toward a NEW, higher equilibrium where AD once again equals AS.
7
📋 CASE: At a certain income level, planned Aggregate Supply (Rs 900 crore) EXCEEDS planned Aggregate Demand (Rs 850 crore). What happens NEXT in the economy?
AFirms experience an UNPLANNED ACCUMULATION of inventory (unsold goods pile up); firms respond by DECREASING production; National Income FALLS toward a new, lower equilibrium
BFirms experience unplanned inventory depletion and increase production
CThe economy remains permanently unchanged at this income level
DWages automatically rise to restore balance
Answer: A — Inventory accumulation, firms decrease production, income falls. When AS (Rs 900 crore) EXCEEDS AD (Rs 850 crore), firms are producing MORE than buyers want to purchase. Unsold goods pile up as UNPLANNED INVENTORY ACCUMULATION (stock rises above the planned level). Firms respond by REDUCING production (since they are stuck with excess unsold inventory) — this lowers National Income, moving the economy toward a NEW, lower equilibrium where AD once again equals AS.
8
The Investment Multiplier (k) is defined by which formula?
Ak = ΔI ÷ ΔY
Bk = ΔY ÷ ΔI = 1 ÷ (1−MPC) = 1 ÷ MPS
Ck = MPC × MPS
Dk = MPC − MPS
Answer: B — k = ΔY÷ΔI = 1÷(1−MPC) = 1÷MPS. The Multiplier measures how MUCH TOTAL INCOME CHANGES (ΔY) for a GIVEN change in Investment (ΔI). Since equilibrium Y = (C̄+I)÷(1−c), a change in Investment causes ΔY = ΔI÷(1−c), giving k = ΔY÷ΔI = 1÷(1−c) = 1÷(1−MPC). Since MPC+MPS=1, this equals 1÷MPS — both formulas give IDENTICAL results.
9
📋 CASE: If MPC = 0.8, what is the value of the Investment Multiplier (k)?
Ak = 0.8
Bk = 1 ÷ (1−0.8) = 1÷0.2 = 5
Ck = 1.8
Dk = 0.2
Answer: B — k = 5. k = 1÷(1−MPC) = 1÷(1−0.8) = 1÷0.2 = 5. This means every Rs 1 of NEW investment ultimately leads to Rs 5 of NEW total income in the economy, through the multiplier round-by-round spending process. Alternatively: MPS = 1−0.8 = 0.2, and k = 1÷MPS = 1÷0.2 = 5, confirming the same answer via the MPS route.
10
📋 CASE: If the Multiplier (k) = 5 and Investment increases by Rs 200 crore, what is the TOTAL increase in National Income (ΔY)?
AΔY = Rs 40 crore (dividing instead of multiplying)
BΔY = ΔI × k = Rs 200 crore × 5 = Rs 1,000 crore
CΔY = Rs 200 crore (no multiplier effect applied)
DΔY = Rs 205 crore
Answer: B — ΔY = Rs 1,000 crore. ΔY = ΔI × k = Rs 200 crore × 5 = Rs 1,000 crore. This demonstrates the POWER of the multiplier effect — the initial Rs 200 crore investment injection ultimately generates a MUCH LARGER Rs 1,000 crore increase in total national income, as the initial spending circulates through multiple rounds of the economy (recall the round-by-round process, mirroring the Chapter 6 Credit Multiplier).
11
📋 CASE: If MPS = 0.25, what is the value of the Investment Multiplier?
Ak = 0.25
Bk = 1 ÷ MPS = 1 ÷ 0.25 = 4
Ck = 4.25
Dk = 0.75 (using 1−MPS instead of 1÷MPS)
Answer: B — k = 4. k = 1÷MPS = 1÷0.25 = 4. This means every Rs 1 of new investment ultimately generates Rs 4 of new total income. Note the common trap in Option D — students sometimes mistakenly calculate “1−MPS” (which would give MPC, not the multiplier) instead of correctly calculating “1÷MPS.”
12
Which relationship correctly describes how a CHANGE in MPC affects the size of the Investment Multiplier?
AA HIGHER MPC (people spend a larger fraction of extra income) leads to a BIGGER multiplier, since spending circulates through MORE rounds before “leaking” into savings, creating a larger cumulative effect on total income
BA higher MPC always leads to a SMALLER multiplier
CMPC has NO effect on the size of the multiplier
DThe multiplier is completely independent of consumer spending behaviour
Answer: A — Higher MPC means bigger multiplier. Since k = 1÷(1−MPC), as MPC INCREASES (approaching 1), the denominator (1−MPC) gets SMALLER, making the OVERALL fraction (k) LARGER. Intuitively: if people spend MORE of every extra rupee they earn (high MPC), that spending gets passed on and RE-SPENT by others in MORE subsequent rounds before eventually “leaking” into savings — creating a bigger cumulative multiplier effect on total national income.
13
What is the MINIMUM possible value of the Investment Multiplier, and under what condition does it occur?
AMinimum k = 1, occurring ONLY when MPC = 0 (people save 100% of any extra income, spending NONE of it) — meaning ΔY = ΔI exactly, with no further multiplier rounds happening
BMinimum k = 0, occurring when MPC = 1
CMinimum k is always negative
DThe multiplier has no minimum value; it can be any real number
Answer: A — Minimum k=1, when MPC=0. If MPC=0 (people save ALL of any extra income, spending nothing), then k = 1÷(1−0) = 1÷1 = 1. This means ΔY = ΔI exactly — the initial investment creates an EQUAL increase in income, but the process STOPS after the very first round, since nobody spends any of their new income to trigger a second round. This is the theoretical FLOOR value of the multiplier — it can never be LESS than 1 in this standard Keynesian model.
14
Why is MPC = 1 considered an UNREALISTIC (purely theoretical) boundary case for the multiplier formula?
ABecause MPC=1 would mean people spend 100% of EVERY extra rupee earned, saving absolutely NOTHING; in reality, people almost always save AT LEAST some fraction of additional income, making MPC=1 an extreme, unrealistic limiting case that would make the multiplier formula mathematically undefined (division by zero)
BBecause MPC can never be calculated in any real economy
CBecause MPC=1 is illegal under government regulations
DBecause MPC=1 always results in a multiplier of exactly zero
Answer: A — MPC=1 is unrealistic since people rarely spend 100% of extra income; the formula becomes undefined. If MPC=1, then k = 1÷(1−1) = 1÷0, which is MATHEMATICALLY UNDEFINED (division by zero, often described as “approaching infinity”). In REAL economies, people virtually ALWAYS save SOME portion of any additional income they receive (even if a small amount) — this makes MPC=1 a purely theoretical, unrealistic BOUNDARY case, never actually observed in practice. This is why realistic multiplier values are always FINITE (though potentially quite large if MPC is very high, like 0.9 or 0.95).
15
The Investment Multiplier process is described as happening in “rounds” through the economy. Which concept from an EARLIER chapter follows the EXACT SAME mathematical logic (a geometric series)?
AThe Money/Credit Multiplier from Chapter 6 (Banking) — where an initial bank deposit gets re-lent and re-deposited in decreasing rounds, governed by the formula 1÷LRR, EXACTLY parallel to the Investment Multiplier formula 1÷MPS
BThe Barter System from Chapter 5
CThe Circular Flow of Income from Chapter 1 has no mathematical connection to the multiplier
DThe GDP Deflator formula from Chapter 4
Answer: A — Money/Credit Multiplier from Chapter 6 follows the same geometric series logic. Both processes share an IDENTICAL mathematical structure: an initial INJECTION (a bank deposit in Chapter 6, or new Investment here) triggers a chain of DECREASING rounds of activity (re-lending in banking; re-spending in the multiplier), governed by a FIXED RATIO at each stage (the reserve ratio LRR in banking; the savings ratio MPS here). Both use the SAME geometric series formula structure: Total Effect = Initial Injection × [1÷(the leakage ratio)]. This parallel (1÷LRR for money creation vs 1÷MPS for income creation) is a powerful way to remember BOTH concepts.
16
📋 CASE: Given C = 200 + 0.6Y and I = Rs 80, find the equilibrium level of National Income:
AY = Rs 280
BY = Rs 700 — Setting Y=C+I: Y=200+0.6Y+80 → Y−0.6Y=280 → 0.4Y=280 → Y=700
CY = Rs 466.67
DY = Rs 800
Answer: B — Y = Rs 700. Step 1: Y = 200+0.6Y+80 = 280+0.6Y. Step 2: Y−0.6Y = 280 → 0.4Y = 280. Step 3: Y = 280÷0.4 = Rs 700. Verification: C at Y=700 is 200+0.6(700) = 200+420 = Rs 620. AD = C+I = 620+80 = Rs 700 = Y, confirming equilibrium.
17
📋 CASE: Using the SAME data as the previous question (C = 200+0.6Y, I=Rs 80), what is the Investment Multiplier?
Ak = 0.6
Bk = 1÷(1−0.6) = 1÷0.4 = 2.5, since MPC = 0.6 in this Consumption Function
Ck = 700÷80 = 8.75
Dk = 0.4
Answer: B — k = 2.5. From the Consumption Function C = 200+0.6Y, the MPC (coefficient of Y) is 0.6. Multiplier k = 1÷(1−MPC) = 1÷(1−0.6) = 1÷0.4 = 2.5. This means if Investment increases by any amount, the resulting increase in equilibrium income will be 2.5 TIMES that investment increase.
18
📋 CASE: If Investment in the previous scenario (C=200+0.6Y, k=2.5) increases from Rs 80 to Rs 120 (an increase of Rs 40), what is the NEW equilibrium level of income?
ANew Y = Rs 740 (just adding the Rs 40 increase directly)
BNew Y = Rs 800 — ΔY = ΔI × k = 40 × 2.5 = Rs 100; New Y = Old Y + ΔY = 700 + 100 = Rs 800
CNew Y = Rs 720
DNew Y = Rs 900
Answer: B — New Y = Rs 800. Step 1: ΔI = Rs 120−Rs 80 = Rs 40. Step 2: ΔY = ΔI × k = 40 × 2.5 = Rs 100. Step 3: New equilibrium Y = Old Y + ΔY = Rs 700 + Rs 100 = Rs 800. VERIFICATION using the direct formula: Y = (200+120)÷(1−0.6) = 320÷0.4 = Rs 800, confirming the multiplier-based calculation is correct. This shows how the multiplier lets you quickly calculate the NEW equilibrium WITHOUT re-deriving the entire equation from scratch.
19
In the AD=AS graphical approach (45° line diagram), what does the 45° line itself represent?
AAll points where Aggregate Supply (Y) equals itself — i.e., ALL possible points where output=income; the equilibrium is found where the AD curve (C+I) INTERSECTS this 45° line
BThe exact path of Consumption alone, without any relation to Investment
CThe Government spending line only
DA line that shows Investment always equals zero
Answer: A — The 45° line represents AS=Y (output equals income) at every point. On a graph with Income/Output (Y) on the X-axis and Aggregate Demand/Supply on the Y-axis, the 45° LINE represents ALL points where the Y-axis value EQUALS the X-axis value — i.e., every point where Aggregate Supply (Y) is plotted against itself. The AD curve (C+I, which rises with income due to the consumption function) is drawn separately. The point where the AD curve CROSSES this 45° line is the EQUILIBRIUM income — the ONLY point where planned spending exactly matches planned output.
20
📋 CASE: An economy MPS is 0.4. If the government wants to increase National Income by Rs 500 crore through investment spending, how MUCH new investment (ΔI) is needed?
AΔI = Rs 500 crore (assuming multiplier equals 1)
BΔI = Rs 200 crore — Multiplier k = 1÷0.4 = 2.5; Using ΔY=ΔI×k: 500 = ΔI×2.5 → ΔI = 500÷2.5 = Rs 200 crore
CΔI = Rs 1,250 crore
DΔI = Rs 300 crore
Answer: B — ΔI = Rs 200 crore. Step 1: Calculate the multiplier: k = 1÷MPS = 1÷0.4 = 2.5. Step 2: Use the formula ΔY = ΔI × k, and solve for ΔI: ΔI = ΔY÷k = 500÷2.5 = Rs 200 crore. This demonstrates a PRACTICAL POLICY application — the government only needs to inject Rs 200 crore of NEW investment (much LESS than the Rs 500 crore desired total income increase), because the multiplier effect will amplify this initial injection into the full Rs 500 crore increase in national income.
21
📋 CASE: At an income level of Rs 500, planned Saving is Rs 30 and planned Investment is Rs 50. Is the economy in equilibrium? If not, what will happen?
ANOT in equilibrium, since S(30) ≠ I(50); since I > S, this is equivalent to AD > AS (excess demand), causing unplanned inventory depletion, so firms will INCREASE production and Income will RISE
BThe economy IS in equilibrium since both S and I are positive numbers
CNOT in equilibrium; Income will FALL since Investment is higher than Saving
DThis scenario is impossible and cannot occur in any economy
Answer: A — Not in equilibrium; I>S means AD>AS, so income will RISE. Since S(Rs 30) does NOT equal I(Rs 50), the economy is NOT in equilibrium. When I > S, this corresponds EXACTLY to the AD > AS condition (recall: AD=C+I, AS=C+S; if I>S, then AD>AS). This causes UNPLANNED INVENTORY DEPLETION (firms selling more than the planned level, since total spending including investment exceeds total planned output) — firms respond by INCREASING production, causing Income to RISE toward a new equilibrium where S will rise to match I.
22
📋 CASE: At a certain income level, planned Saving is Rs 80 and planned Investment is Rs 60. What will happen to National Income?
ASince S(80) > I(60), this is equivalent to AS > AD (deficient demand); unplanned inventory ACCUMULATES, firms DECREASE production, and National Income will FALL toward a new equilibrium
BNational Income will RISE, since Saving is higher than Investment
CNational Income remains completely unchanged
DThis scenario indicates the economy is already in perfect equilibrium
Answer: A — S>I means AS>AD; income will FALL. When S > I, this corresponds to AS > AD (since AS=C+S and AD=C+I; if S>I, then AS>AD). Total planned SAVING (a withdrawal from spending) exceeds total planned INVESTMENT (an injection), meaning planned spending falls SHORT of planned output. This causes UNSOLD GOODS to accumulate as unplanned inventory, prompting firms to CUT production — National Income FALLS until a new equilibrium is reached where S once again equals I (at a LOWER income level).
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Which of the following BEST describes the PURPOSE of the Investment Multiplier concept in economic policy-making?
AIt shows policymakers that a RELATIVELY SMALL government/private investment injection can generate a MUCH LARGER total increase in national income and employment, making targeted investment spending a POWERFUL tool for economic stimulus during downturns
BIt proves that government spending has no effect on the economy whatsoever
CIt shows that Investment and Consumption are entirely unrelated concepts
DIt demonstrates that increasing MPC always REDUCES total national income
Answer: A — Small investment injections create large income effects, useful for stimulus policy. The Multiplier concept has HUGE practical significance for economic policy: it shows that governments do NOT need to spend an amount EQUAL to their desired increase in national income — a SMALLER, well-targeted investment (in infrastructure, public projects etc.) can trigger a MUCH LARGER cumulative rise in total income and employment through the round-by-round spending process. This is the theoretical foundation for GOVERNMENT STIMULUS PACKAGES during recessions, where relatively modest public investment is expected to generate outsized economic recovery effects.
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📋 CASE: An economy MPC = 0.5. Investment increases by Rs 300 crore. Calculate the Multiplier and the Total increase in National Income:
Ak = 0.5; ΔY = Rs 150 crore
Bk = 1÷(1−0.5) = 1÷0.5 = 2; ΔY = ΔI×k = 300×2 = Rs 600 crore
Ck = 2.5; ΔY = Rs 750 crore
Dk = 1.5; ΔY = Rs 450 crore
Answer: B — k=2; ΔY=Rs 600 crore. Step 1: k = 1÷(1−MPC) = 1÷(1−0.5) = 1÷0.5 = 2. Step 2: ΔY = ΔI × k = Rs 300 crore × 2 = Rs 600 crore. This is the SMALLEST realistic multiplier scenario among typical exam values (since MPC=0.5 is relatively low), showing that even a MODEST MPC still DOUBLES the effect of any investment injection on national income.
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[CUET Level] Assertion (A): The AD=AS approach and the S=I approach can give DIFFERENT equilibrium income values for the same economy.
Reason (R): AD=AS simplifies algebraically to I=S by cancelling the common Consumption term from both sides.
Reason (R): AD=AS simplifies algebraically to I=S by cancelling the common Consumption term from both sides.
ABoth A and R are true, and R correctly explains A
CA is FALSE (both approaches ALWAYS give the SAME equilibrium value, never different values, for the same underlying economy data); R is TRUE (correctly explains the algebraic derivation) — and R actually DISPROVES A, since if AD=AS simplifies EXACTLY to I=S, they cannot possibly give different answers
BBoth A and R are true, but R does not correctly explain A
DA is true but R is false
Answer: C — A is false; R is true and actually disproves A. A is FALSE: the two approaches ALWAYS give the IDENTICAL equilibrium income for the same underlying economic data — they are NOT capable of giving different answers, since one is derived DIRECTLY from the other through simple algebra. R is TRUE: it correctly explains that AD=AS (i.e., C+I=C+S) simplifies to I=S by cancelling C. Since R proves the two conditions are ALGEBRAICALLY IDENTICAL, it directly CONTRADICTS (disproves) the claim in A that they could give different results.
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[CUET Level] Assertion (A): A lower MPS always results in a SMALLER Investment Multiplier.
Reason (R): The Multiplier formula is k = 1/MPS, an INVERSE relationship between k and MPS.
Reason (R): The Multiplier formula is k = 1/MPS, an INVERSE relationship between k and MPS.
ABoth A and R are true, and R correctly explains A
CA is FALSE (a LOWER MPS actually results in a LARGER, not smaller, multiplier, precisely BECAUSE of the inverse relationship); R is TRUE (correctly states the inverse formula k=1/MPS) — and R actually proves A is WRONG, since an inverse relationship means lower MPS gives HIGHER k, not lower
BBoth A and R are true, but R does not correctly explain A
DA is true but R is false
Answer: C — A is false; R is true and proves A wrong. A is FALSE: a LOWER MPS actually leads to a LARGER (not smaller) multiplier. R is TRUE: k=1/MPS IS an inverse relationship — but an INVERSE relationship means as MPS DECREASES, k (the multiplier) INCREASES (e.g., MPS=0.5 gives k=2; MPS=0.2 gives k=5 — a LOWER MPS produces a HIGHER k). Since R correctly describes an inverse relationship, it directly CONTRADICTS A claim that lower MPS gives a smaller multiplier — R actually proves A is incorrect.
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[CUET Level — Incorrect Pair] Which of the following formula pairs is INCORRECTLY matched?
AEquilibrium condition (AD=AS approach) — Y = C + I
BEquilibrium condition (S=I approach) — Planned Saving = Planned Investment
CInvestment Multiplier formula — k = MPC ÷ MPS — INCORRECT: the correct formula is k = 1 ÷ MPS (or equivalently, 1 ÷ (1−MPC)), NOT “MPC divided by MPS”
DDisequilibrium (AD>AS) — Unplanned inventory depletion, production increases
Answer: C is incorrectly matched. The CORRECT Investment Multiplier formula is k = 1÷MPS (or equivalently 1÷(1−MPC)) — NOT “MPC÷MPS.” This is a common calculation ERROR students make when confusing the multiplier formula with other ratio-based concepts. For example, if MPC=0.75 and MPS=0.25: the CORRECT multiplier is 1÷0.25=4, while the INCORRECT “MPC÷MPS” would wrongly give 0.75÷0.25=3 — a completely different (and wrong) answer. Options A, B and D are all correctly stated.
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[CUET Level — Case] 📋 Given: C = 150 + 0.8Y, I = Rs 100. Find the (I) Equilibrium Income, (II) Multiplier, and (III) NEW equilibrium Income if I rises to Rs 150:
AEquilibrium Y=Rs 1,000; k=5; New Y=Rs 1,100
BEquilibrium Y: 0.2Y=250, Y=Rs 1,250; k=1/(1-0.8)=5; ΔI=50, ΔY=50×5=250; New Y=1,250+250=Rs 1,500
CEquilibrium Y=Rs 1,250; k=4; New Y=Rs 1,450
DEquilibrium Y=Rs 800; k=5; New Y=Rs 1,000
Answer: B — Equilibrium Y=Rs 1,250; k=5; New Y=Rs 1,500. Step 1: Y=C+I: Y=150+0.8Y+100=250+0.8Y → 0.2Y=250 → Y=Rs 1,250. Step 2: k=1÷(1−0.8)=1÷0.2=5. Step 3: ΔI=150−100=Rs 50; ΔY=50×5=Rs 250; New Y=1,250+250=Rs 1,500. VERIFICATION: New Y directly = (150+150)÷0.2 = 300÷0.2 = Rs 1,500, confirming the multiplier-shortcut method matches the direct recalculation.
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[CUET Level — Case] 📋 An economy is currently at Y=Rs 400, where planned AD=Rs 420 and planned AS=Rs 400. A student claims: “Since Y already equals AS, the economy is in equilibrium.” Evaluate this claim:
AThe claim is CORRECT, since Y and AS are equal at Rs 400
BThe claim is INCORRECT — equilibrium requires AD=AS (not just Y=AS, which is true by DEFINITION always, since AS=Y); here AD(420)≠AS(400), so the economy is NOT in equilibrium; since AD>AS, unplanned inventory will deplete and Income will RISE toward a new, higher equilibrium
CThe claim is correct because AD is a completely irrelevant variable
DEquilibrium cannot be determined without knowing the exact MPC value
Answer: B — The claim is incorrect; equilibrium requires AD=AS, not just Y=AS. This tests a subtle but CRITICAL misconception: “Y=AS” is TRUE BY DEFINITION at EVERY income level (since Aggregate Supply IS defined as equal to National Income, Y, at ANY level of output) — this is NOT a special equilibrium condition, just a basic identity. TRUE equilibrium requires AD=AS SPECIFICALLY. Here, AD(Rs 420) does NOT equal AS(Rs 400) — since AD>AS, there will be UNPLANNED inventory depletion, prompting firms to INCREASE production, and Income will RISE beyond Rs 400 toward a NEW equilibrium where AD will finally equal AS.
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[CUET Level — Comprehensive] 📋 Four statements about Income Determination and Multiplier. Identify ALL correct ones: (I) The AD=AS and S=I approaches are algebraically equivalent conditions. (II) A HIGHER MPC always results in a SMALLER multiplier. (III) When AS>AD, firms experience unplanned inventory accumulation and REDUCE production. (IV) The theoretical minimum value of the multiplier is 1, occurring when MPC=0.
AAll four are correct
B(I), (III) and (IV) are correct; ONLY (II) is incorrect (a HIGHER MPC actually results in a LARGER, not smaller, multiplier, since k=1/(1−MPC) increases as MPC rises)
COnly (I) and (II) are correct
DOnly (IV) is correct; the rest are incorrect
Answer: B — (I), (III) and (IV) are correct; (II) is incorrect. (I) CORRECT: AD=AS simplifies to I=S by cancelling the common C term — proven algebraically. (II) INCORRECT: a HIGHER MPC leads to a LARGER (not smaller) multiplier, since k=1/(1−MPC) — as MPC rises toward 1, the denominator shrinks, making k grow larger. (III) CORRECT: when AS>AD, unsold goods accumulate as unplanned inventory, prompting firms to cut production. (IV) CORRECT: the theoretical minimum multiplier is exactly 1, occurring only when MPC=0 (no further spending rounds occur beyond the initial injection).
Chapter 8 — Live Quiz
30 questions · Income Determination and Multiplier · Equilibrium via AD=AS and S=I, disequilibrium adjustment, Multiplier numericals · Instant feedback
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