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CBSE Class 12 Commerce Economics Determination Of Income And Employment Complete Notes

CBSE Class 12 Commerce Economics Determination Of Income And Employment : The CBSE goal of the Academic, Training, Innovation and Research unit of Central Board of Secondary Education is to achieve academic excellence by conceptualising policies and their operational planning to ensure balanced academic activities in the schools affiliated to the Board. The Unit strives to provide Scheme of Studies, curriculum, academic guidelines, textual material, support material, enrichment activities and capacity building programmed. The unit functions according to the broader objectives set in the National Curriculum Framework-2005 and in consonance with various policies and acts passed by the Government of India from time to time.

CBSE Class 12 Commerce Economics Determination Of Income And Employment Complete Notes

CBSE Class 12 Commerce Economics Determination Of Income And Employment : Economics is a field of study that has become increasingly relevant in our globalized, financialized society. The economy is part of our collective conscious and a buzzword that links personal finances to big business and international trade deals. Economics deals with individual choice, but also with money and borrowing, production and consumption, trade and markets, employment and occupations, asset pricing, taxes and much more. What then is the definition of economics? One way to think of it is the study of what constitutes rational human behavior in the endeavor to fulfill needs and wants given a world with scarce resources. In other words, economics tries to explain how and why we get the stuff we want or need to live. How much of it do we get? Who gets to have more? Who makes all this stuff? How is it made? These are the questions and decisions that economics concerns itself with.

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CBSE Class 12 Commerce Economics Determination Of Income And Employment Complete Notes

CBSE Class 12 Commerce Economics Determination Of Income And Employment : The complete classical model of income and employment determination in an economy in Fig. 3.7. In panel (a) of this figure labour market equilibrium is shown wherein it will be seen that the intersection of demand for and supply of labour determines the real wage rate (W0/P0 ).

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At this equilibrium real wage rate the amount of labour employed is N1; and, as explained above, this is full employment level. As depicted in panel (b) of the figure this full employment level of labour N1 produces Y1 level of output (or income).

CBSE Class 12 Commerce Economics Determination Of Income And Employment : In panel (c) of Figure 3.7 we have drawn 45° line that is used to transfer the level of output on the vertical axis in panel (b) to the horizontal axis of panel (c). In panel (d) we have shown the determination of price level through intersection of the curves of aggregate demand for and aggregate supply of output, as explained by the quantity theory of money. In the classical theory, aggregate supply curve AS is a vertical straight line at full-employment level of output YF.

Determination of Income and Employement: Complete Classial Model

CBSE Class 12 Commerce Economics Determination Of Income And Employment : Thus, given constant velocity of money V, the quantity of money M0 will determine the expenditure or aggregate demand equal to M0V according to which aggregate demand curve (with flexible prices) is AD0. It will be seen from panel (d) of Fig. 3.7 that intersection of vertical aggregate supply curve AS at fully-employment level output YF and aggregate demand curve AD0 determines the price level P0. With price level at P0, the money wage rate is W0 so that W0/P0 is the real wage rate as determined by the intersection of demand for and supply of labour [see panel (a) of Fig. 3.7].

Now, a relevant question is how this equilibrium level of real wage rate, prices, employment and output (income) will change following the increase in the quantity of money. Suppose the quantity of money increases from M0 to M1 with the given capital stock (as we are considering the short-run case) and the labour force being already fully employed, the output cannot increase. Therefore, as depicted in panel (d) following the increase in money supply to M1, aggregate demand or expenditure will increase to M1 V and thereby causing aggregate demand curve to shift to AD1. As a result, price level rises from P0 to P1.

However, as explained above, with the given money wage rate W0, the rise in price level from P0 to P1 will cause a fall in real wage rate. As will be seen from panel (a), with the rise in price level to P1 real wage rate falls to W0/P1.

CBSE Class 12 Commerce Economics Determination Of Income And Employment : This will cause temporary disequilibrium in the labour market. At the lower real wage rate W0/P1, more labour is demanded than is supplied. Given the competition among the firms, this excess demand for labour will cause the money wage rate to rise to W1 level so that the real wage is bid up to the original level W1/P1 = W0/P0.

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With the real wage rate being quickly restored to the original level, employment of labour NF and total output or income YF will remain unaffected. To sum up, the result of increase in money supply is to raise money wages and prices in equal proportion, leaving real wages, employment and output unaffected. The results of decrease in money supply can be similarly worked out.

CBSE Class 12 Commerce Economics Determination Of Income And Employment Complete Notes

CBSE Class 12 Commerce Economics Determination Of Income And Employment :  Given the amount of capital, technology and quality of labour, a country’s national income, i.e., the total output of goods and services, can be increased by increasing employment. Therefore, the larger the national income of a country the larger the volume of employment; and the smaller the national income, the smaller the volume of employment. Thus, in the short run, the factors that would determine the economy’s level of national income would also determine its level of employment. Hence, the theory of income determination is also called the theory of employment.

Principle of Effective Demand:

CBSE Class 12 Commerce Economics Determination Of Income And Employment : Keynes’s theory of income and employment is based on the Principle of Effective Demand. However, in order to be able to understand this principle, it is necessary first to know the concepts of Aggregate Supply and Aggregate Demand. It should not be difficult to see that, in the individual firm, employment will depend on the entrepreneur’s ideas about how many men he must employ to maximise profits.

Similarly, in the economy as a whole, employment will depend on the decision of all individual employers, added together, about how many men to employ in order to maximise profits. The main factors which determine the level of employment in the economy as a whole, according to Keynes, are Aggregate Supply and Aggregate Demand.

Aggregate Supply:

CBSE Class 12 Commerce Economics Determination Of Income And Employment : In an economy, all entrepreneurs, taken together, employ a certain total number of labour, who in turn produce a certain quantity of output. The total cost of producing the output by that number of men is called the ‘aggregate supply price.’ It is easily understandable that unless entrepreneurs as a whole expect to cover their costs (aggregate supply price) when they employ, say X men, they will not consider it worth-while employing so much labour, and employment will be reduced.

On the other hand, if they expect to receive more than their costs (aggregate supply price), they will wish to employ more men and employment will then be increased. “At any given level of employment of labour, aggregate supply price is therefore the total amount of money which all the entrepreneurs in the economy, taken together, must expect to receive from the sale of the output produced by that given number of men, if it is to be just worth employing them.”

In this way, corresponding to each possible level of employment in the economy, there will be a different aggregate supply price. We can thus construct for the economy an aggregate supply price schedule and also draw an aggregate supply price curve (see curve AS in Fig. 38.1).

http://cdn.economicsdiscussion.net/wp-content/uploads/2014/07/clip_image00232.jpg

Aggregate Demand:

CBSE Class 12 Commerce Economics Determination Of Income And Employment : Now let us take the demand side. When a certain number of labour is employed by all the entrepreneurs, taken together, and a certain quantity of output is produced by them and is sold, it fetches a certain amount of money. How much it will fetch will depend on the state of demand in the economy. The expected receipts of entrepreneurs by the sale of total output when a given volume of employment is offered to workers is called the Aggregate Demand Price.

In other words, the “aggregate demand price at any level of employment is the amount of money which all the entrepreneurs in the economy taken, together really do expect that they will receive if they sell the output produced by this given number of labour.”

In the definitions of Aggregate Supply Price (AS) given in the preceding section and that of Aggregate Demand Price (AD) given in this section, the words “must expect to receive” and “do really expect that they will receive” occur. The distinction between the two must be clearly understood.

In AS the entrepreneurs must recover their cost, otherwise they will not employ that number of men. In AD, however, the idea is that the demand is such that the entrepreneurs do expect to receive that amount of money by the sale of goods produced by that number of men.

Like the aggregate supply price, there will be a different aggregate demand price for different levels of employment in the economy. We can thus construct for the economy an aggregate demand price schedule and also draw an aggregate demand price curve (see curve AD in Fig. 38.1).

Determination of the Equilibrium Level of Employment:

CBSE Class 12 Commerce Economics Determination Of Income And Employment : In Figure 38.1, aggregate demand curve (AD) and aggregate supply curve (AS) have been drawn. Along the X-axis are measured the number of men employed, and along the Y-axis are shown the various amounts of receipts received by all entrepreneurs in the economy, taken together, from the sale of output. To put it alternatively, these receipts of the entrepreneurs are the different levels of expenditure incurred by the community on purchasing the entrepreneurs’ output.

Let us take the AS curve first. It shows, for each possible volume of receipts by entrepreneurs from the sale of output, how many men it would be just worth employing. For example, if entrepreneurs expected to receive Rs. OM’, it would just pay them to employ ON’ men. Now look at AD curve.

This shows how much money the community would actually spend on the outputs produced by the different volumes of employ­ment, i.e., how much money entrepreneurs really do expect to receive when they employ various numbers of men. For example, if ON’ men are employed, entrepreneurs would expect to receive Rs. OM from selling the output produced.

Effective Demand:

We are now in a position to understand the principle of effective demand. We owe the concept of ‘effective demand’ to the late Lord Keynes. It is quite different from the term ‘aggregate demand’ as used by Keynes. We have seen that the aggregate demand of an economy is different at different levels of employment or, in other words, we can construct an aggregate demand schedule for the economy. But at which aggregate demand will the economy be in equilibrium?

As we have seen in the preceding section, the economy is in equilibrium at that level of employment at which the aggregate demand curve intersects the aggregate supply curve or at which aggregate demand in the economy is equal to aggregate supply. That aggregate demand at which the economy is in equilibrium is called Effective Demand.

Thus, “Effective Demand is that aggregate demand price which becomes effective, because it is equal to aggregate supply price and thus represents a position of ‘short-run’ equilibrium.” It is distinguished in this way from all other points on the aggregate demand schedule. It represents an equilibrium position which actually is realized, while at all other point’s aggregate demand is either greater or less than aggregate supply.

Equilibrium at Less Than Full Employment:

A very important point about ‘effective demand’ is that owing to certain causes, it may be deficient so that the economy can be in short-run equilibrium and yet there may be considerable unemployment.While the full employment level is ON”, effective demand or the equilibrium level of employment is at ON, when NN” number of men are still unemployed. Keynes greatly emphasised this point and, in this way, was able satisfactorily to explain the existence of prolonged unemployment.

On the other hand, the earlier economists (classical) had wrongly assumed that the aggregate demand was always large enough to equal the aggregate supply price corresponding to full employment. With the help of his principle of effective demand, Keynes was able to show that the above assumption of the classical economists was wrong and that the economy could be in equilibrium and yet suffer from substantial volume of unemployment.

The above analysis has a great practical importance. It suggests the right method of removing unemployment, viz., the Government taking suitable steps to raise effective demand to the level of aggregate supply which corresponds to full employment.

Outline of Keynes’s Theory of Income and Employment:

We have seen above that in any economy effective demand represents the amount of money actually being spent on the entire output of the economy. In other words, effective demand represents the value of the national output and since national output consists of two types of goods—consumption goods and investment goods—the value of national output is equal to the demand for or expenditure on consumption goods plus demand for or expenditure on investment goods.

But it is easy to see that in an economy, one man’s expenditure is some other people’s income. We can, therefore, look upon effective demand also as the income or receipts of all the factors of production, since all the money which entrepreneurs receive must be paid out in the form of wages, rent, interest and profit. Effective Demand thus equals the national income, i.e., the incomes or receipts of all members of the-community.

We can therefore sum up as under:

Effective Demand = National Income

=Value of National Output = Expenditure on Consumption Goods + Ex­penditure on Investment Goods.

Now this should give some indication of Keynes’s theory of income and employment. We have seen that income and employment depend upon effective demand and effective demand depends on consumption demand plus invest­ment demand.

Keynes therefore proceeded to analyse in detail the factors on which consumption and investment demands depended and in doing so developed certain other new concepts, viz., propensity to consume, investment multiplier, marginal efficiency of capital and liquidity preference. It may take us too far to explain all these Keynesian concepts.

We shall therefore content ourselves with presenting the Keynesian theory of income and employment in a summary form in terms of the following propositions:

(i) In an economy, in the short run, its total income depends on the volume of employment.

(ii) Total employment depends on total effective demand and, in equili­brium; aggregate demand is equal to aggregate supply.

(iii) Aggregate supply depends on physical and technical conditions of production and, in the short run, these do not often change. Hence it is changes in aggregate demand that bring about changes in income and employment.

(iv) Effective demand is made up of (a) consumption demand, and (b) investment demand.

(v) Consumption demand depends on propensity to consume. In the short run, propensity to consume is relatively stable.

(vi) Propensity to consume being relatively stable, investment demand or investment expenditure has a crucial role in determining the level of employ­ment.

(vii) Investment demand depends on (a) the marginal efficiency of capital, and (b) the rate of interest. Since the rate of interest is relatively stable, marginal efficiency of capital is of crucial importance.

(viii) The marginal efficiency of capital depends on (a) the businessmen’s expectations of profit yields, and (b) the replacement cost of capital assets.

(ix) The rate of interest depends on: (a) the quantity of money, and (b) the state of liquidity preference.

(x) In the short run, the rate of interest is relatively stable; therefore the marginal efficiency of capital is by far the more important determinant of investment, which, as pointed out above, plays a strategic role in determining the level of income and employment in an economy.

Keynesian Theory in a Chart:

The Keynesian theory outlined above can also be presented in the form of a chart as under:http://cdn.economicsdiscussion.net/wp-content/uploads/2014/07/clip_image00416.jpg

CBSE Class 12 Commerce Economics Determination Of Income And Employment Complete Notes

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