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What is Fixed Price Model?

As per this model,

It is assumed that in short run,

Prices of Commodity remain Fixed

 

Hence, Suppliers are willing to supply whatever amount consumers will demand at a constant price

So, Aggregate Supply remains constant

Equilibrium Output under Fixed Price Model - Teachoo.jpg

How to Determine equilibrium Output under Fixed Price Model

As per this model,

Since Aggregate Supply remains constant

Equilibrium Output of final gods is determined solely by Aggregate Demand

 

Now, we know that

Aggregate Demand = Consumption Expenditure + investment Expenditure

AD = C + I

Note - This Investment Expenditure is Autonomous Expenditure

It does not vary with Income

So we can write it as

AD=C+Î

 

Also, we know that

Part of Consumption is Fixed and Part of consumption varies with Increase in Income

Equation of Consumption Function

it is represented by

C =Ĉ +b(Y)

where

C= Total Consumption

Ĉ = Autonomous Consumption

Y=Income

b=MPC

Hence, we have 2 equations

AD=C+Î

C =Ĉ +b(Y)

Putting the value of [2] in [1]

AD=C+Î

AD=Ĉ +b(Y) +Î

AD=Ĉ +Î + b(Y)

AD=Ā +b(Y)

 

Here Ā is total Autonomous Expenditure

it is total of Autonomous Investment Expenditure + Autonomous Consumption Expenditure

Ā = Ĉ + Î

 

SUMMARY

Now, we know that

equilibrium Point is determined at a point where

AD=AS

Now ,Value of AS Does not change (we follow fixed price model)

But Value of AD Can change (as it depends upon Autonomous Consumption as AD=Ā +b(Y)

How to Determine equilibrium Output under Fixed Price Model - Teachoo.JPG

What is A in Fixed Price Model - Teachoo.JPG

Summary OF Fixed Price Model - Teachoo.JPG

Graph Presentation

On X Axis, we represent Income or Output

On Y Axis, we show Demand

We draw AD curve starting from Point Ā1 (which is Autonomous Consumption)

Hence, equilibrium Point is determined at Point E where AD and AS Curves intersects

 

Now ,Value of AS Does not change (we follow fixed price model)

But Value of AD Can change (as it depends upon Autonomous Consumption as AD=Ā +b(Y)0

Suppose Autonomous Expenditure increases from Point Ā1 to Point Ā2,due to which AD Shifts to AD1

In this case, Equilibrium Point also changes from E to E1

Hence, Equilibrium Output also changes from OY to OY1

Graph Presentation Fixed Price Model - Teachoo.JPG

Example Sandeep Garg Page 8.8

In this question, we are given

MPS=0.2

Income=Y=300 Crores

Also, total of Autonomous and Consumption Expenditure=50 Crores

It means

Ā =300 Crores

 

We need to Find AD

Now we know that

AD=C+Î

AD=Ĉ +b(Y) +Î

AD=Ĉ +Î+b(Y)

AD=Ā +b(Y)

 

We are given value of A an Y

First we need to find b(MPC)

 

Step 1

WE KNOW THAT

MPC+MPS=1

MPC+0.2=1

MPC=1-0.2

MPC=0.8

b=0.8

 

Step 2

AD=Ā +b(Y)

AD=50 +0.8*300

AD=50 +240

AD=290 Crores

 

NCERT Questions

Question 5

Measure the level of ex-ante aggregate demand when autonomous investment and consumption expenditure

(A) is Rs 50 crores, and MPS is 0.2 and level of income (Y) is Rs 4000 crores.

State whether the economy is in equilibrium or not (cite reasons).

View Answer

Other Books

Question 1

National Income = 1000

MPC = 0.7

Autonomous Consumption and Investment Expenditure = Ā = 200

Identify whether economy is in equilibrium or not?

View Answer

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Transcript

Equilibrium Output under Fixed Price Model AD=AS Price of Commodity does not change Suppliers are willing to supply whatever amount consumers will demand at a constant price So, Aggregate Supply remains constant It means AD = AS and AS Doesn’t Change So Equilibrium Output is determined by AD only How to Determine equilibrium Output under Fixed Price Model We know that, at equilibrium Point AD=AS Since AS remains constant Equilibrium Output of final gods is determined solely by AD Now, we know that AD=C+Î Also, Equation of Consumption function is C =Ĉ +b(Y) Hence, we have 2 equations AD = C+Î (1) C = Ĉ +b(Y) (2) Putting the value of [2] in [1] AD = C+Î AD = Ĉ +b(Y) + Î AD = Ĉ +Î + b(Y) AD = Ā + b(Y) What is Ā in Fixed Price Model Here Ā is total Autonomous Expenditure it is total of Autonomous Investment Expenditure + Autonomous Consumption Expenditure Ā = Ĉ + Î Summary OF Fixed Price Model Equilibrium Point is determined at a point where AD = AS Now ,Value of AS Does not change (we follow fixed price model) But Value of AD Can change Now, this Value of AD depends upon Autonomous Expenditure This is because AD = Ā + b(Y) Graph Presentation Fixed Price Model Now ,Value of AS Does not change (we follow fixed price model) But Value of AD Can change (as it depends upon Autonomous Consumption as AD = Ā + b(Y)0 Suppose Autonomous Expenditure increases from Point Ā1 to Point Ā2,due to which AD Shifts to AD1 In this case, Equilibrium Point also changes from E to E1 Hence, Equilibrium Output also changes from OY to OY1

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CA Maninder Singh is a Chartered Accountant for the past 12 years. He also provides Accounts Tax GST Training in Delhi, Kerala and online.