(A) "Income of an economy increased from `20,000 to` 50,000 crore. Savings of the economy increased from `2,000 crore to` 10,000 crore."

(i) Calculate Average Propensity to Consume (APC) and Average Propensity to Save (APS), before and after the rise in income. (4)

(ii) Draw appropriate conclusion regarding the behaviour of Average Propensity to Consume (APC) as his income increases. (2)

OR

(B) "Under a study, examining the spending habits of a hypothetical economy, it was observed that even households with zero income managed to consume basic necessities. As the income of people increased, their consumption also increased, but not as rapidly as income." Based on the given text and common understanding, answer the following questions :

(i) Identify and elaborate the type of consumption indicated in the first para of the above text. (3)

(ii) Explain, the reason behind the positive slope of Aggregate Demand Curve. (3)

Q: (A) "Income of an economy increased from ` 20,000 to ` 50,000 crore. Savings of the economy increased from ` 2,000 crore to ` 10,000 crore." (i) Calculate Average Propensity to Consume (APC) and Average Propensity to Save (APS), before and after the rise in income. (4) (ii) Draw appropriate conclusion regarding the behaviour of Average Propensity to Consume (APC) as his income increases. (2) OR (B) "Under a study, examining the spending habits of a hypothetical economy, it was observed that even households with zero income managed to consume basic necessities. As the income of people increased, their consumption also increased, but not as rapidly as income." Based on the given text and common understanding, answer the following questions : (i) Identify and elaborate the type of consumption indicated in the first para of the above text. (3) (ii) Explain, the reason behind the positive slope of Aggregate Demand Curve. (3)

**(A)(i) Before the rise in income (Y₁ = ₹20,000 crore, S₁ = ₹2,000 crore):** - $C_1 = Y_1 - S_1 = 20,000 - 2,000$ = ₹18,000 crore - $APC_1 = C_1/Y_1 = 18,000/20,000$ = **0.9** - $APS_1 = S_1/Y_1 = 2,000/20,000$ = **0.1** **After the rise in income (Y₂ = ₹50,000 crore, S₂ = ₹10,000 crore):** - $C_2 = Y_2 - S_2 = 50,000 - 10,000$ = ₹40,000 crore - $APC_2 = C_2/Y_2 = 40,000/50,000$ = **0.8** - $APS_2 = S_2/Y_2 = 10,000/50,000$ = **0.2** **(A)(ii) Conclusion:** As income rises, APC **falls** (0.9 → 0.8) while APS **rises** (0.1 → 0.2). This is consistent with Keynes' Psychological Law of Consumption: as income increases, consumption also increases, but by a progressively smaller proportion of the additional income, since people devote a rising share of extra income to savings once basic needs are met. **(B)(i)** The first paragraph describes **Autonomous Consumption** — the minimum consumption expenditure incurred even at zero income, to meet basic survival needs. It is independent of the level of current income and is financed through past savings, borrowings, or dis-saving. In the consumption function $C = \bar{c} + bY$, autonomous consumption is represented by the positive intercept c̄. **(B)(ii)** The Aggregate Demand curve slopes upward (positively) because, as income (Y) rises, consumption expenditure (a component of AD) also rises — though by a smaller amount than the rise in income, since Marginal Propensity to Consume ($MPC = \Delta C/\Delta Y$) lies between 0 and 1. Since $AD = C + I = \bar{c} + bY + I$, and b (MPC) is positive, AD increases as Y increases, giving the AD curve its positive slope, with MPC as its slope value.

Q: Why does APC + APS always equal 1?

Because income is, by definition, either consumed or saved: $Y = C + S$. Dividing through by Y gives $C/Y + S/Y = 1$, i.e., $APC + APS = 1$, for any level of income.

Q: What is the difference between autonomous and induced consumption?

Autonomous consumption is the fixed minimum consumption incurred even at zero income (survival spending, represented by the intercept c̄), while induced consumption is the additional consumption that rises with income, determined by the MPC (the slope b in $C = \bar{c} + bY$).

Determination of Income and Employment

Average Propensity to Consume/Save (OR) Autonomous Consumption and Slope of the Aggregate Demand Curve

Official Answer

(A)(i) Before the rise in income (Y₁ = ₹20,000 crore, S₁ = ₹2,000 crore):

$C_1 = Y_1 - S_1 = 20,000 - 2,000$ = ₹18,000 crore
$APC_1 = C_1/Y_1 = 18,000/20,000$ = 0.9
$APS_1 = S_1/Y_1 = 2,000/20,000$ = 0.1

After the rise in income (Y₂ = ₹50,000 crore, S₂ = ₹10,000 crore):

$C_2 = Y_2 - S_2 = 50,000 - 10,000$ = ₹40,000 crore
$APC_2 = C_2/Y_2 = 40,000/50,000$ = 0.8
$APS_2 = S_2/Y_2 = 10,000/50,000$ = 0.2

(A)(ii) Conclusion: As income rises, APC falls (0.9 → 0.8) while APS rises (0.1 → 0.2). This is consistent with Keynes' Psychological Law of Consumption: as income increases, consumption also increases, but by a progressively smaller proportion of the additional income, since people devote a rising share of extra income to savings once basic needs are met.

(B)(i) The first paragraph describes Autonomous Consumption — the minimum consumption expenditure incurred even at zero income, to meet basic survival needs. It is independent of the level of current income and is financed through past savings, borrowings, or dis-saving. In the consumption function $C = \bar{c} + bY$ , autonomous consumption is represented by the positive intercept c̄.

(B)(ii) The Aggregate Demand curve slopes upward (positively) because, as income (Y) rises, consumption expenditure (a component of AD) also rises — though by a smaller amount than the rise in income, since Marginal Propensity to Consume ( $MPC = \Delta C/\Delta Y$ ) lies between 0 and 1. Since $AD = C + I = \bar{c} + bY + I$ , and b (MPC) is positive, AD increases as Y increases, giving the AD curve its positive slope, with MPC as its slope value.

APCAPSPsychological Law of Consumptionautonomous consumptioninduced consumptionMPCconsumption functionaggregate demand curve

Marking Scheme

1Part A(i): 1 mark each for correctly computing C₁ and C₂; 1 mark each for correct APC₁/APS₁ and APC₂/APS₂ pairs (total 4 marks).
2Part A(ii): 2 marks for correctly concluding that APC falls (and APS rises) as income increases, linked to the Psychological Law of Consumption.
3Part B(i): 3 marks for identifying Autonomous Consumption and elaborating that it is income-independent, meets basic needs, and is the intercept term in the consumption function.
4Part B(ii): 3 marks for correctly linking the positive slope of the AD curve to MPC ( $0<MPC<1$ ) in the consumption function, $C = \bar{c}+bY$ .

Hint

Use $C = Y - S$ , then $APC = C/Y$ and $APS = S/Y$ ; note $APC+APS=1$ always; AD's positive slope comes from MPC in the consumption function.

Quick Oral Answer

APC falls from 0.9 to 0.8 and APS rises from 0.1 to 0.2 as income rises from ₹20,000 to ₹50,000 crore, consistent with Keynes' law; and the AD curve slopes upward because rising income raises consumption via a positive MPC, even though autonomous consumption itself stays fixed regardless of income.

Analysis & Explanation

Part (A) tests the mechanical application of $APC = C/Y$ and $APS = S/Y$ along with the crucial identity $C = Y - S$ (since $Y = C + S$ ). The key conceptual takeaway examiners look for is linking the falling APC to Keynes' Psychological Law of Consumption — richer economies save a larger fraction of each additional rupee of income, not because they consume less in absolute terms (consumption still rose from 18,000 to 40,000 crore) but because savings rise even faster proportionally.

Part (B) distinguishes autonomous consumption (income-independent, the intercept term) from induced consumption (income-dependent, driven by MPC). The positive slope of the AD curve is directly inherited from the consumption function's positive slope (MPC), since Investment (I) is typically assumed autonomous (constant) in the simple two-sector model, so all the responsiveness of AD to income changes comes through the consumption component.

Common exam trap: Students often forget that $APC + APS = 1$ always holds ( $0.9+0.1=1$ and $0.8+0.2=1$ here), which is a fast way to cross-check numerical answers.

Common Mistakes

1Computing APC/APS using Savings or Consumption directly without first deriving $C = Y - S$ correctly.
2Concluding that APC 'increases' with income by misreading the falling ratio, or forgetting $APC + APS = 1$ as a check.
3Confusing autonomous consumption (the intercept, present even at zero income) with induced consumption (the income-dependent part, $bY$ ).

Interesting Facts

Keynes' Psychological Law of Consumption also implies that as an economy's income rises, on aggregate its overall APS rises — a proposition sometimes cited as a partial explanation for high household savings rates in rapidly growing economies like India.

In the simple consumption function $C = \bar{c} + bY$ , if MPC (b) were ever ≥1, APC could never fall with income, contradicting the empirically well-supported Keynesian consumption behaviour.

The Aggregate Demand curve in the simple two-sector Keynesian model is often called the 'C+I line' and its 45-degree intersection with the Aggregate Supply line determines the equilibrium level of income.

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Frequently Asked Questions

Why does APC + APS always equal 1?

Because income is, by definition, either consumed or saved: $Y = C + S$ . Dividing through by Y gives $C/Y + S/Y = 1$ , i.e., $APC + APS = 1$ , for any level of income.

What is the difference between autonomous and induced consumption?

Autonomous consumption is the fixed minimum consumption incurred even at zero income (survival spending, represented by the intercept c̄), while induced consumption is the additional consumption that rises with income, determined by the MPC (the slope b in $C = \bar{c} + bY$ ).