Key takeaways
- Ex ante means planned; ex post means actual. Equilibrium needs ex ante demand to equal ex ante supply.
- Consumption function: C = C + cY, where c is the marginal propensity to consume (MPC), and MPC + MPS = 1.
- With fixed prices, equilibrium output is Y* = A ÷ (1 − c), where A is total autonomous spending: output is set by demand (effective demand).
- The multiplier = ΔY ÷ ΔA = 1 ÷ (1 − c) = 1 ÷ MPS. A higher MPC means a bigger multiplier.
- Paradox of thrift: if everyone tries to save more, income falls and total saving does not rise.
This page is part of the Introductory Macroeconomics chapter list for Class 12 Economics. It turns Keynes's idea from Chapter 1 into a working model.
4.1Ex Ante and Ex Post
Ex post values are actual values recorded after the event, as in national accounts. Ex ante values are planned or intended values. A producer may plan to add ₹100 to stock but end up adding less if sales are unexpectedly high. Equilibrium output depends on plans, so the model uses ex ante consumption, investment and demand.
Suppose a shopkeeper plans to add goods worth ₹100 to her stock this year (planned investment). If an unexpected rush of buyers takes away goods worth ₹30 from that stock, her actual addition to inventory is only ₹70. Ex ante investment was ₹100; ex post investment is ₹70. The gap is an unintended change in inventories.
The consumption function
Planned consumption depends on income:
| Measure | Formula | Relationship |
|---|---|---|
| Marginal propensity to consume (MPC) | ΔC ÷ ΔY | MPC + MPS = 1 |
| Marginal propensity to save (MPS) | ΔS ÷ ΔY | |
| Average propensity to consume (APC) | C ÷ Y | APC + APS = 1 |
| Average propensity to save (APS) | S ÷ Y |
Investment and aggregate demand
For simplicity, firms are assumed to plan the same investment every year, so ex ante investment is autonomous: I = I. In a two-sector economy, aggregate demand is planned consumption plus planned investment:
If planned output exceeds planned demand, unsold goods pile up as unintended inventory accumulation. Ex post, output still equals consumption plus investment, because the unsold stock is counted in actual investment; but the economy is not in equilibrium. A government adds its spending G to demand and its taxes T reduce disposable income, as Chapter 5 shows.
4.2Movement Along a Curve Versus Shift of a Curve
A change in the variable on the horizontal axis causes a movement along a curve. A change in any other parameter shifts the curve. In AD = A + cY, a change in income Y moves the economy along the AD line; a change in autonomous spending A shifts the line parallel, and a change in c swings it.
The AD line has the form of a straight line, b = ε + m·a, where ε is the intercept and m the slope. For AD, the intercept is A and the slope is c. Two kinds of parametric shift follow:
- Intercept change: a rise in A, for example higher autonomous investment, shifts the AD line up in parallel.
- Slope change: a rise in c makes the AD line steeper, swinging it upward around the intercept; a fall in c swings it downward.
Only a change in Y itself is a movement along the given AD line.
4.3The Short Run Fixed Price Analysis of the Product Market
When prices and the interest rate are fixed and firms can supply any amount at that price, output is decided entirely by demand. Equilibrium is where the aggregate demand line crosses the 45° line, so planned demand equals output. A rise in autonomous spending raises equilibrium output by a multiple of itself.
A point on the aggregate demand curve
The 45° line shows every point where output equals aggregate demand. Setting Y = AD gives Y = A + cY, so:
Since aggregate supply is perfectly elastic at the fixed price, whatever is demanded is produced. Output is determined by the level of aggregate demand: this is the effective demand principle.
Effects of an autonomous change on equilibrium demand
When autonomous investment rises, the AD line shifts up. At the old output there is now excess demand: inventories run down and firms raise production. Output keeps rising until the new AD line meets the 45° line. The rise in output is larger than the rise in investment.
The multiplier mechanism
Extra investment of ₹30 is first spent on goods, raising output and income by ₹30. With MPC = 0.75, income earners spend ₹22.50 of it, which becomes someone else's income; they spend 75% of that, and so on. The rounds shrink but add up to a finite total:
The paradox of thrift
If all households decide to save a larger share of income (MPS rises, MPC falls), the AD line swings down. Output and income fall until saving again equals the unchanged autonomous investment. Total saving ends up no higher, or even lower, than before, while income is lower. What is prudent for one family becomes harmful when everyone does it at once.
Excess and deficient demand
The CBSE syllabus also asks about demand relative to full employment. If aggregate demand at full-employment output is higher than that output, there is excess demand (an inflationary gap): prices tend to rise. If it is lower, there is deficient demand (a deflationary gap): output and employment fall short of full employment. Governments correct these with fiscal tools, such as changing spending or taxes, and the central bank with monetary tools, such as changing interest rates or reserve ratios.
Worked Examples
Example 1: MPC, MPS, APC and APS
- Given
- Consumption function C = 60 + 0.75Y; income Y = ₹400 crore.
- Formula
- APC = C ÷ Y; APS = S ÷ Y; MPS = 1 − MPC
- Steps
- C = 60 + 0.75 × 400 = 360. S = 400 − 360 = 40. APC = 360 ÷ 400 = 0.9; APS = 0.1. MPC = 0.75; MPS = 0.25.
- Answer
- APC = 0.9, APS = 0.1, MPC = 0.75, MPS = 0.25. APC is higher than MPC because of autonomous consumption.
Example 2: Equilibrium output and the multiplier
- Given
- C = ₹60 crore; I = ₹90 crore; MPC = 0.75. Then investment rises by ₹30 crore.
- Formula
- Y* = A ÷ (1 − c); ΔY = ΔA ÷ (1 − c)
- Steps
- A = 60 + 90 = 150. Y* = 150 ÷ 0.25 = 600. Check: C = 60 + 450 = 510; C + I = 600. Multiplier = 4; ΔY = 30 × 4 = 120; new Y* = 720.
- Answer
- Y* = ₹600 crore, rising to ₹720 crore.
Example 3: The paradox of thrift in numbers
- Given
- A = 150 (C = 60, I = 90). MPC falls from 0.75 to 0.70 as people try to save more.
- Formula
- Y* = A ÷ (1 − c); S = Y − C
- Steps
- Before: Y = 600, C = 510, S = 90. After: Y = 150 ÷ 0.30 = 500; C = 60 + 0.7 × 500 = 410; S = 500 − 410 = 90.
- Answer
- Income falls by ₹100 crore, but total saving stays at ₹90 crore.
Common Mistakes
- Writing the multiplier as 1 ÷ MPC. It is 1 ÷ (1 − MPC), that is, 1 ÷ MPS.
- Confusing ex post equality (always true) with equilibrium (ex ante equality).
- Calling a change in income a shift of the AD line. It is a movement along the line.
- Assuming APC equals MPC. With positive autonomous consumption, APC is higher than MPC.
- Saying the multiplier works in reverse only for investment. Any fall in autonomous spending lowers output by a multiple.
10 Important Questions for Class 12 Board and School Examinations
Questions are written in original words. Marks are shown beside each question.
Q1If the marginal propensity to save is 0.2, the investment multiplier is: (A) 2 (B) 4 (C) 5 (D) 8 1 mark · MCQ
(C) 5. Multiplier = 1 ÷ MPS = 1 ÷ 0.2 = 5.
Q2Assertion (A): The value of the multiplier rises when MPC rises. Reason (R): A higher MPC means a larger share of each round of income is spent again. Choose: (a) both true, R explains A; (b) both true, R does not explain A; (c) A true, R false; (d) A false, R true. 1 mark · Assertion-reason
(a) Both are true and R correctly explains A. Larger re-spending in each round adds more to total income.
Q3Distinguish between ex ante and ex post investment. 3 marks
Ex ante investment is planned investment; ex post investment is actual investment.
- Ex ante is what firms intend to add to capital and stocks.
- Ex post includes unintended changes in inventories.
- They differ when sales turn out higher or lower than expected.
Example: a firm plans to add ₹50 to stock but adds ₹40 after brisk sales; ex ante = 50, ex post = 40.
Q4What is a parametric shift of a line? How does the AD line shift when (i) MPC falls and (ii) autonomous investment rises? 3 marks
A parametric shift is a shift of a line caused by a change in its intercept or slope, not in the variable on the axis.
- (i) A fall in MPC lowers the slope, so AD swings downward.
- (ii) A rise in autonomous investment raises the intercept, so AD shifts up in parallel.
- A change in income is only a movement along AD.
Example: AD = 100 + 0.8Y becoming AD = 120 + 0.8Y is a parallel shift.
Q5What is meant by effective demand? 3 marks
Effective demand is the level of aggregate demand at which the economy is in equilibrium, and it determines output when prices are fixed.
- With fixed prices, supply is perfectly elastic.
- So producers supply whatever is demanded.
- Equilibrium output = A ÷ (1 − c) depends only on demand.
Example: if autonomous demand rises, output rises with no change in price.
Q6Explain the working of the investment multiplier with an example. 4 marks
The multiplier is the ratio of the change in output to the change in autonomous spending, and it works through repeated rounds of spending.
- First round: extra investment raises income by the same amount.
- Induced spending: people spend a share (MPC) of the extra income.
- Further rounds: each round is MPC times the previous one.
- Total: ΔY = ΔI ÷ (1 − MPC).
Example: ΔI = 100 and MPC = 0.8 give ΔY = 500.
Output rises over successive rounds of 100, 80, 64 and so on, which sum to 500.
Q7Explain the paradox of thrift. 4 marks
The paradox of thrift says that if everyone tries to save more, total saving does not rise and income falls.
- Higher MPS: consumption falls at every income level.
- AD swings down: excess supply appears and stocks pile up.
- Output falls: through the multiplier, income falls.
- Saving unchanged: saving returns to equal unchanged investment.
Example: MPC falling from 0.75 to 0.7 cuts income from 600 to 500, with saving still 90.
Thrift is a virtue for one household but harms the economy when all save at once, since lower demand cuts everyone’s income.
Q8Explain how equilibrium output is determined in the fixed-price model. What happens when planned output exceeds aggregate demand? 6 marks
Equilibrium output is where aggregate demand equals output, shown by the intersection of the AD line with the 45° line.
- AD = A + cY, an upward-sloping line flatter than 45°.
- The 45° line shows all points where AD = Y.
- Equilibrium: Y* = A ÷ (1 − c).
- If output exceeds AD, unsold goods add to inventories unintentionally.
- Firms cut production, so output falls towards Y*.
- If AD exceeds output, stocks run down and firms raise production.
Thus output adjusts to demand until planned spending equals output.
To the left of Y*, AD exceeds output, so stocks fall and output rises; to the right, output exceeds AD, so output falls. With A = 100 and c = 0.8, Y* = 500.
Q9Explain excess demand and deficient demand, and state two measures to correct each. 6 marks
Excess demand occurs when aggregate demand exceeds output at full employment; deficient demand occurs when it falls short.
| Basis | Excess demand | Deficient demand |
|---|---|---|
| Gap | Inflationary gap | Deflationary gap |
| Effect | Rising prices | Falling output and employment |
| Fiscal measure | Cut spending, raise taxes | Raise spending, cut taxes |
| Monetary measure | Raise interest rates or CRR | Lower interest rates or CRR |
In each case, policy moves aggregate demand back towards full-employment output.
Excess demand opens an inflationary gap, since output cannot rise beyond full employment, so prices do. Deficient demand opens a deflationary gap, where output and jobs fall short. Fiscal measures act through government spending and taxes, while monetary measures act through the RBI’s control of interest rates and reserve requirements. The remedy depends on the multiplier and on the size of the gap.
Q10Autonomous expenditure (consumption plus investment) is ₹60 crore, MPS is 0.25 and income is ₹300 crore. Is the economy in equilibrium? If not, find equilibrium income. 4 marks · Numerical
The economy is not in equilibrium: demand of ₹285 crore falls short of output of ₹300 crore, and equilibrium income is ₹240 crore.
Given: A = 60; MPS = 0.25, so MPC = 0.75; Y = 300.
Formula: AD = A + cY; Y* = A ÷ (1 − c).
Steps: AD = 60 + 0.75 × 300 = 285 < 300, so there is excess supply. Y* = 60 ÷ 0.25 = 240.
Final answer: not in equilibrium; Y* = ₹240 crore.
10 Points for State PSC and UPSC Aspirants
- Keynes's principle of effective demand rejects Say's law (“supply creates its own demand”) for the short run.Why it matters: the classical–Keynesian contrast is a standard theory question.Source: NCERT Introductory Macroeconomics
- Private final consumption expenditure is the largest component of India's GDP by the expenditure method.Why it matters: shows why the MPC matters so much for Indian growth.Source: MoSPI, National Accounts Statistics
- Union Budget 2026-27 proposed raising public capital expenditure to ₹12.2 lakh crore, from ₹2 lakh crore in FY2014-15.Why it matters: public investment is the textbook's autonomous spending in policy form.Source: Union Budget 2026-27 speech, 1 February 2026
- In real economies the multiplier is smaller than 1 ÷ MPS because taxes and imports are further leakages (Chapters 5 and 6).Why it matters: frequent analytical question in mains.Source: NCERT Introductory Macroeconomics
- V.K.R.V. Rao argued that the Keynesian multiplier works weakly in an underdeveloped economy because output, especially farm output, cannot expand quickly with demand.Why it matters: an Indian economist's critique, often cited in answers.Source: V.K.R.V. Rao, “Investment, Income and the Multiplier in an Underdeveloped Economy” (1952)
- Unintended inventory changes are visible in national accounts as change in stocks within gross capital formation.Why it matters: links ex ante and ex post to real data.Source: MoSPI, National Accounts Statistics
- An inflationary gap calls for contractionary policy; a deflationary gap calls for expansionary policy.Why it matters: policy-matching questions.Source: NCERT Introductory Macroeconomics
- The paradox of thrift explains why higher household saving during a slowdown can deepen it.Why it matters: useful in essays on consumption-led growth.Source: NCERT Introductory Macroeconomics
- RBI's flexible inflation targeting uses interest rates to manage excess demand pressure on prices.Why it matters: links the model to Chapter 3.Source: Reserve Bank of India
- Demand-driven programmes such as MGNREGA (2005 Act) put income into rural hands when private demand weakens.Why it matters: an Indian example of supporting aggregate demand.Source: Union Budget documents
These are revision notes, not official predictions of exam content.
Quick Revision
- Ex ante = planned; ex post = actual.
- C = C + cY; MPC + MPS = 1; APC + APS = 1.
- AD = A + cY; A = C + I.
- Equilibrium: Y* = A ÷ (1 − c).
- Change in Y: movement; change in A or c: shift.
- Multiplier = 1 ÷ (1 − MPC) = 1 ÷ MPS.
- Paradox of thrift: more saving, lower income, same saving.
- Excess demand: inflationary gap; deficient demand: deflationary gap.
Related Glossary Terms and Chapters
Glossary:
Multiplier Marginal propensity to consume Aggregate demand
Related chapters: The Government: Functions and Scope, which adds government spending and tax multipliers; Open Economy Macroeconomics, which adds imports to the multiplier. From Class 11: Indian Economy 1950-1990, Correlation.
Sources
- NCERT textbooks: Introductory Macroeconomics, Class 12, National Council of Educational Research and Training. Syllabus reference. Accessed 23 October 2026.
- Budget 2026-2027: Speech of the Minister of Finance (PDF), Ministry of Finance, 1 February 2026. Accessed 23 October 2026.
- Economic Survey, Ministry of Finance, Government of India. Accessed 23 October 2026.
- Monetary Policy Statements, Reserve Bank of India. Accessed 23 October 2026.
- Ministry of Statistics and Programme Implementation (National Accounts Statistics). Official statistics.
About this page
Drafted with AI assistance from the NCERT chapter structure, in original words. Content is checked and approved by Dr. Anamika Shrivastava, PhD Economics, before publication. Read how this site works or send a correction.
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