Macro

Income & Employment

Medium

Determination of Income and Employment

When, at a particular price level, the aggregate demand for final goods equals the aggregate supply of final goods, the final goods or product market reaches its equilibrium. Aggregate demand for final goods consists of ex ante consumption, ex ante investment, government spending etc. The rate of increase in ex ante consumption due to a unit increment in income is called marginal propensity to consume. For simplicity, we assume a constant final goods price and constant rate of interest over the short run to determine the level of aggregate demand for final goods in the economy. We also assume that the aggregate supply is perfectly elastic at this price. Under such circumstances, aggregate output is determined solely by the level of aggregate demand. This is known as the effective demand principle. An increase (decrease) in autonomous spending causes aggregate output of final goods to increase (decrease) by a larger amount through the multiplier process.

A decrease in autonomous spending causes aggregate output of final goods to .................... through the multiplier process.

Increase by small amount.

Decrease by large amount.

Equal increase.

Increase by large amount.

✅ Correct Option: 2

Option 1 -> A decrease in autonomous spending would not cause output to increase; it causes a decrease.

Option 2 -> When autonomous spending decreases, the multiplier effect amplifies this initial decrease, causing aggregate output to fall by a larger amount than the original decrease in spending.

Option 3 -> A decrease in autonomous spending causes a decrease (not an increase) in output, and the change is amplified by the multiplier.

Option 4 -> A decrease in autonomous spending leads to a decrease in output, not an increase.

Hence, Option 2: Decrease by large amount -> The multiplier process works in both directions. When autonomous spending (government spending, investment, or autonomous consumption) decreases, it triggers a chain reaction: reduced spending leads to lower income for others, who then reduce their spending, and so on. The multiplier formula (1/(1-MPC) or 1/MPS) is greater than 1, meaning the total decrease in aggregate output will be larger than the initial decrease in autonomous spending. For example, if the multiplier is 4 and autonomous spending falls by $100, aggregate output will decrease by$ 400. -> correct

Question 46

The equilibrium in the final goods or production market reaches when .......

Question 47

Consumption, investment and government spending are the major components of ......?

Question 48

In the short run, to determine the level of aggregate demand for final goods in the economy, what will be the affect on price and rate of interest?

Question 49

Effective demand principle situation occurs when _________

A decrease in autonomous spending causes aggregate output of final goods to .................... through the multiplier process.

Solution

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