CA Foundation · Paper 4 · Business Economics

Chapter 6 · Unit 2 The keynesian theory of determination of national income

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Question 1

According to Keynes, the equilibrium level of national income is determined at the point where:

Saving equals investment plus taxes Aggregate demand equals aggregate supply Consumption equals income Money supply equals money demand

Correct Answer: Aggregate demand equals aggregate supply.
In the simple Keynesian model, income and employment are determined where planned aggregate expenditure is just enough to buy the output produced.

Question 2

In the Keynesian framework, effective demand refers to:

Desire for goods without purchasing power Demand created only by government expenditure That level of aggregate demand which is backed by actual spending and equals aggregate supply at equilibrium Demand for capital goods only

Correct Answer: That level of aggregate demand which is backed by actual spending and equals aggregate supply at equilibrium.
Keynes used the term effective demand for the demand that actually influences output and employment decisions.

Question 3

The aggregate demand function in a two-sector Keynesian economy is:

C + I C + S C + T + G W + R + I

Correct Answer: C + I.
In the simplest two-sector model, aggregate demand is the sum of consumption expenditure and investment expenditure.

Question 4

In the Keynesian theory, aggregate supply price means:

The price of one unit of final output The minimum money wage paid to labour The total expected receipts from selling output The minimum receipts needed to induce producers to employ a given number of workers

Correct Answer: The minimum receipts needed to induce producers to employ a given number of workers.
Aggregate supply price shows the proceeds entrepreneurs must expect to make employment worthwhile.

Question 5

If consumption increases by ₹80 when income increases by ₹100, the marginal propensity to consume is:

0.20 0.80 1.25 0.50

Correct Answer: 0.80.
MPC = change in consumption divided by change in income = 80/100 = 0.80.

Question 6

If MPC = 0.75, then marginal propensity to save will be:

0.25 0.75 1.75 Cannot be determined

Correct Answer: 0.25.
MPC + MPS = 1. So MPS = 1 - 0.75 = 0.25.

Question 7

The average propensity to consume is equal to:

Saving divided by income Change in consumption divided by change in income Consumption divided by income Income divided by consumption

Correct Answer: Consumption divided by income.
APC is the ratio of total consumption to total income at a given level of income.

Question 8

Which of the following is most consistent with Keynes's psychological law of consumption?

Consumption rises in the same proportion as income Consumption falls when income rises Income is always fully consumed Consumption rises with income, but by less than the rise in income

Correct Answer: Consumption rises with income, but by less than the rise in income.
This is the essence of Keynes's fundamental psychological law, and it implies positive but less than one MPC.

Question 9

The simple investment multiplier is:

1 / MPC 1 / MPS MPC / MPS MPS / MPC

Correct Answer: 1 / MPS.
Since MPS = 1 - MPC, the investment multiplier k = 1/(1 - MPC) = 1/MPS.

Question 10

If MPC = 0.60, the value of the multiplier will be:

2.5 1.6 4.0 5.0

Correct Answer: 2.5.
k = 1/(1 - 0.60) = 1/0.40 = 2.5.

Question 11

If an increase in investment of ₹200 crore leads to an increase in income of ₹800 crore, the multiplier is:

2 3 4 5

Correct Answer: 4.
Multiplier = change in income / change in investment = 800 / 200 = 4.

Question 12

Which of the following is treated as autonomous in the simple Keynesian model?

Induced consumption Savings arising from higher income Tax revenue linked to income Investment expenditure

Correct Answer: Investment expenditure.
In the simple model, investment is generally taken as autonomous, meaning it does not vary with current income.

Question 13

The 45° line in the Keynesian income-expenditure diagram represents points where:

Income equals expenditure Saving equals investment Consumption equals saving Aggregate supply is zero

Correct Answer: Income equals expenditure.
Every point on the 45° line satisfies Y = AE in the diagram.

Question 14

At the equilibrium level of income in a two-sector economy:

Consumption equals saving Planned saving equals planned investment MPC equals APC Income equals autonomous consumption

Correct Answer: Planned saving equals planned investment.
The saving-investment approach and the aggregate expenditure approach describe the same equilibrium.

Question 15

When aggregate demand exceeds aggregate supply at a given income level, firms tend to:

Reduce output Keep output unchanged permanently Increase output and employment Increase saving only

Correct Answer: Increase output and employment.
Excess demand signals that produced output is insufficient, so firms expand production.

Question 16

Underemployment equilibrium means an equilibrium:

Possible only in the long run Where all resources are fully employed Where prices keep falling endlessly Where income is in equilibrium but less than full-employment output

Correct Answer: Where income is in equilibrium but less than full-employment output.
Keynes argued that the economy can settle at an equilibrium even with unemployment due to deficient demand.

Question 17

Which assumption is commonly made in the simple Keynesian model of income determination?

Prices are assumed constant in the short run Output is fixed at full employment Interest rate is the only determinant of consumption There is no saving in the economy

Correct Answer: Prices are assumed constant in the short run.
This lets changes in demand affect output and employment rather than prices in the basic model.

Question 18

If the consumption function is C = 100 + 0.8Y, autonomous consumption is:

0.8 100 Y 80

Correct Answer: 100.
The intercept term in the consumption function is autonomous consumption.

Question 19

Given C = 50 + 0.75Y and I = 100, equilibrium income will be:

400 500 600 750

Correct Answer: 600.
At equilibrium, Y = C + I = 50 + 0.75Y + 100. So 0.25Y = 150 and Y = 600.

Question 20

If MPS is high, the value of the multiplier will generally be:

Low High Equal to one Negative

Correct Answer: Low.
Multiplier = 1/MPS. So a higher MPS means a smaller multiplier.

Question 21

Leakages in the circular flow reduce the value of the multiplier because they:

Increase induced investment Raise the marginal efficiency of capital Make aggregate supply perfectly elastic Reduce the re-spending of additional income

Correct Answer: Reduce the re-spending of additional income.
Every leakage such as saving, taxes or imports slows down the chain reaction of spending.

Question 22

Which one of the following will shift the aggregate demand function upward in the simple Keynesian model?

Fall in autonomous investment Rise in autonomous investment Rise in MPS with no other change Fall in consumption function intercept

Correct Answer: Rise in autonomous investment.
An increase in autonomous investment raises planned expenditure at each income level.

Question 23

The relation between APC and APS at any level of income is:

APC - APS = 1 APC × APS = 1 APC + APS = 1 APC = APS always

Correct Answer: APC + APS = 1.
Income is either consumed or saved. Therefore C/Y + S/Y = 1.

Question 24

If the economy is in equilibrium and firms notice unintended accumulation of inventories, then:

Actual output is greater than planned expenditure Planned expenditure is greater than actual output Investment has become zero MPC has become one

Correct Answer: Actual output is greater than planned expenditure.
Unintended stock accumulation means goods are not being sold as expected, so firms will reduce output.

Question 25

Which statement about the multiplier is correct?

It shows how income falls when savings rise directly It measures the change in investment caused by a change in income It works only under full employment conditions It shows how a change in autonomous spending leads to a multiple change in income

Correct Answer: It shows how a change in autonomous spending leads to a multiple change in income.
This is the basic meaning of the Keynesian multiplier process.

Question 26

If the multiplier is 5, the marginal propensity to consume must be:

0.20 0.80 0.50 0.25

Correct Answer: 0.80.
If k = 5, then 1/(1 - MPC) = 5. Therefore 1 - MPC = 0.20 and MPC = 0.80.

Question 27

If saving function is S = -40 + 0.2Y and planned investment is ₹60, equilibrium income will be:

200 300 500 600

Correct Answer: 500.
At equilibrium, S = I. So -40 + 0.2Y = 60, giving 0.2Y = 100 and Y = 500.

Question 28

According to Keynes, deficiency of aggregate demand may lead to:

Involuntary unemployment Automatic full employment Perfect wage flexibility Continuous inflation only

Correct Answer: Involuntary unemployment.
This is central to Keynesian theory: inadequate demand can keep willing workers unemployed.

Question 29

Which of the following best explains why the Keynesian aggregate expenditure curve is flatter than the 45° line?

Because prices are rising faster than output Because full employment has already been achieved Because APS is always negative Because induced consumption rises less than proportionately with income

Correct Answer: Because induced consumption rises less than proportionately with income.
Since MPC is less than one, aggregate expenditure increases with income but not one-for-one.

Question 30

If autonomous expenditure increases, equilibrium national income will rise by a multiple that depends mainly on:

Average propensity to save Marginal propensity to consume Rate of inflation only Population growth only

Correct Answer: Marginal propensity to consume.
The size of the multiplier is mainly governed by MPC. Higher MPC gives a larger multiplied rise in income.

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