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Increase of Propensity to Consume (Inc in MPC)

It means consumers start spending more percentage of income

Example

Suppose a person was earning 10000 and earlier spending 7000

Now he is earning same 10000 but he is spending 8000

This extra spending leads to higher consumption expenditure and hence more demand

Reason 1 for Excess Demand - Teachoo.JPG

Reduction in Taxes

If Tax Rates decrease, disposable income increases, hence person spends more

Example

Suppose a person was earning 50000 and paying tax 10000,his net take home salary (or disposable income) was 500000-10000=40000

Suppose govt reduced taxes to Rs 4000

So now his disposable income became 50000 - 4000 = 46000

Since, his disposable income exceeds by 6000 (46000-40000), he still spend more

This extra spending leads to higher consumption expenditure and hence more demand

Reason 2 for Excess Demand - Teachoo.jpg

Increase in Govt Spending

Govt may increase public expenditure in budget

Hence, govt will be spending more and purchasing goods and service

This extra spending leads to higher consumption expenditure and hence more demand

Reason 3  for Excess Demand - Teachoo.jpg

Change in interest Rates

If interest rates on borrowings reduce, it will lead to less interest expense and more income

If Int rates on investment increases, it will lead to more int income

This additional income will lead to more spending

This extra spending leads to higher consumption expenditure and hence more demand

Reason 4A  for Excess Demand - Teachoo.jpg

Reason 4B  for Excess Demand - Teachoo.jpg

Fall in Import

If we import less goods and services and purchase more from within country

Income of economy will rise

This additional income will lead to more spending

This extra spending leads to higher consumption expenditure and hence more demand

Reason 5  for Excess Demand - Teachoo.jpg

Increase in Exports

If we export more, it will lead to additional income for the economy

This additional income will lead to more spending

This extra spending leads to higher consumption expenditure and hence more demand

Reason 6  for Excess Demand - Teachoo.jpg

Deficit Financing

It is a situation when govt spends more than it earns

In this case, govt fills the gap by printing new currency or borrowing

In this case, govt spends more and excess currency enters the market

This extra spending leads to higher consumption expenditure and hence more demand

Reason 7  for Excess Demand - Teachoo.jpg

NCERT Questions

No questions in this part

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Question 1

How does excess demand occur because of change in tax rate?

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Transcript

Reason 1 for Excess Demand -Increase to Propensity to Consume (Inc in MPC) Earlier Now Income Earned Amount Spent MPC 10000 7000 0.7 10000 8000 0.8 Higher Spending Is due to Higher Consumption Expenditure(C) of Household It leads to Higher AD (as AD = C + I) Reason 2 for Excess Demand -Reduction in Taxes Earlier Now Gross Salary Less Tax Net Salary Amount Spent 50000 10000 40000 30000 50000 2000 48000 36000 Lower Taxes Higher Disposable income Higher Spending Higher Consumption Expenditure(C) of Household Higher AD (as AD = C + I) Reason 3 for Excess Demand -Increase in Govt Spending Suppose there are 3 sectors of economy - Households, Firm & Govt Consumption Expenditure of Households (C) Investment Expenditure (I) Govt Expenditure (G) Total Aggregate Demand 30000 40000 50000 120000 30000 40000 60000 130000 Increase in Govt Spending More goods and service Purchase Higher Investment Expenditure(I) of Firms Reason 4B for Excess Demand - Change in Interest Rates - Increase in interest Income FD Made Int Rate Interest Earned 1000000 6% 60000 1000000 7% 70000 Interest Rate on Investment Increased More income Earned More Amount Available for Spending Higher Investment Expenditure(I) of Firms Higher AD (as AD = C + I) Reason 5 for Excess Demand - Fall in Import Total Spending out of which Local goods Imported Goods 500000 300000 200000 500000 400000 100000 Fall in Import More domestic goods produced More Income of Domestic Firms Higher Consumption Expenditure of households More Amount available for spending for firms (Investment Expenditure) Higher AD (as AD=C+I) Reason 6 for Excess Demand - Increase in Exports Export Sales Income Received from Abroad 500000 500000 600000 600000 More Income of Domestic Firms Higher Consumption Expenditure of households (C) + More Amount available for investment for firms (Higher I) Higher AD (as AD = C + I) Reason 7 for Excess Demand - Deficit Financing Govt Revenue Less Govt Expenditure Surplus (Deficit) 10000 8000 2000 10000 11000 -1000 Increase in Govt Spending (Govt Expenditure or G) + More Income of Households Increase in Consumption Expenditure of Households Higher AD (as AD=C+I+G) (Assuming 3 sector economy)

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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.