Suppose, following data is presented, for an imaginary economy:
Autonomous Consumption = ₹100 crore
Marginal Propensity to Consume = 0.6
Investment = ₹200 crore.
Identify which of the following is the correct value of national income?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → ₹750 crore
To find the correct value of national income, we can use the Keynesian model's equilibrium condition where National Income (Y) equals Aggregate Demand (AD). In a simple economy with autonomous consumption, induced consumption, and investment, the aggregate demand is given by:
AD = C + I
Where: C = Consumption , I = Investment
The consumption function is given by:
C = Autonomous Consumption + (Marginal Propensity to Consume * Y)
C =$\bar C$ + cY
Given: Autonomous Consumption ($\bar C$) = ₹100 crore
Marginal Propensity to Consume (c) = 0.6
Investment (I) = ₹200 crore
Substitute the consumption function into the aggregate demand equation:
AD = ($\bar C$ + cY) + I
At equilibrium, Y = AD: i.e Y = $\bar C$ + cY + I
Y = 100 + 0.6Y + 200
Y = 300 + 0.6Y
Y - 0.6Y = 300
0.4Y = 300
Y = 750 Crore