CBSE Class 12 Macroeconomics Unit 3: Determination of Income and Employment – Complete Notes

CBSE Class 12 Economics | Macroeconomics | Unit 3 | Board Exam 2026–27

If you are preparing for CBSE Class 12 Economics, Unit 3 Determination of Income and Employment is an important chapter for both theory and numerical questions. This chapter explains how income, output and employment are determined in an economy.

In these notes, you will learn Aggregate Demand (AD), Aggregate Supply (AS), Consumption and Saving, APC, MPC, APS, MPS, Equilibrium Output, Investment Multiplier, Excess Demand, Deficient Demand and their corrective measures in simple and student-friendly language.

📚 CBSE Class 12 Macroeconomics Unit 3 – Topics Covered

Aggregate Demand and Aggregate Supply
Two-Sector Model
Propensity to Consume and Save
APC, MPC, APS and MPS
Short-Run Equilibrium Output
Full Employment and Involuntary Unemployment
Investment Multiplier
Excess Demand and Inflationary Gap
Deficient Demand and Deflationary Gap
Fiscal and Monetary Measures to Correct Demand Gaps
Important Formulas
Board Exam Numerical Questions

1. Aggregate Demand (AD)

What is Aggregate Demand?

Aggregate Demand (AD) refers to the total planned expenditure on goods and services in an economy during a given period.

In simple words:

Aggregate Demand is the total amount that people, firms, government and foreigners plan to spend on goods and services.

Components of Aggregate Demand

In a general economy, Aggregate Demand has four major components:

Component	Meaning
C	Private Final Consumption Expenditure
I	Investment Expenditure
G	Government Final Consumption Expenditure
X – M	Net Exports

Therefore:

AD = C + I + G + (X – M)

However, in the two-sector model, there is no government and foreign sector.

Therefore:

AD = C + I

2. Two-Sector Model

A two-sector economy consists of:

Households
Firms

It assumes that:

There is no government sector.
There is no foreign sector.
The economy is a closed economy.

Therefore:

AD = C + I

Where:

C = Consumption expenditure

I = Investment expenditure

Example

Suppose:

C = ₹800 crore

I = ₹200 crore

Then:

AD = C + I

AD = ₹800 crore + ₹200 crore

AD = ₹1,000 crore

3. Aggregate Supply (AS)

Meaning of Aggregate Supply

Aggregate Supply (AS) refers to the total value of goods and services that firms plan to produce during a given period.

In a two-sector economy:

AS = C + S

Where:

C = Consumption
S = Saving

We also know:

Y = C + S

Therefore:

AS = Y

This means that Aggregate Supply is equal to National Income (Y) in the simple two-sector model.

⭐ Important Relationship Between AD and AS

At equilibrium:

AD = AS

Since:

AD = C + I

and:

AS = C + S

Therefore:

C + I = C + S

After cancelling C:

I = S

Therefore, equilibrium can be determined by two approaches:

AD-AS Approach → AD = AS

Saving-Investment Approach → S = I

4. Propensity to Consume

The word propensity means the tendency or willingness to do something.

Propensity to Consume means the tendency of households to spend their income on consumption.

There are two important concepts:

Average Propensity to Consume (APC)
Marginal Propensity to Consume (MPC)

5. Average Propensity to Consume (APC)

Meaning

APC shows the proportion of total income that is spent on consumption.

Formula

APC = C / Y

Where:

C = Consumption
Y = Income

Example

Income = ₹10,000

Consumption = ₹8,000

Therefore:

APC = 8,000 / 10,000

APC = 0.8 or 80%

This means that the household spends 80% of its income on consumption.

Important Features of APC

APC is the ratio of consumption to income.
APC can be greater than 1.
APC can be equal to 1.
APC can be less than 1.
APC generally falls as income increases when consumption rises less than proportionately.

6. Marginal Propensity to Consume (MPC)

Meaning

MPC measures the proportion of additional income that is spent on additional consumption.

Formula

MPC = ΔC / ΔY

Where:

ΔC = Change in consumption
ΔY = Change in income

Example

Income increases from ₹10,000 to ₹12,000.

Therefore:

ΔY = ₹2,000

Consumption increases from ₹8,000 to ₹9,500.

Therefore:

ΔC = ₹1,500

So:

MPC = 1,500 / 2,000

MPC = 0.75

Therefore, 75% of the additional income is spent on additional consumption.

Range of MPC

0 ≤ MPC ≤ 1

This is an important point for CBSE numerical and conceptual questions.

7. Average Propensity to Save (APS)

Meaning

APS shows the proportion of total income that is saved.

Formula

APS = S / Y

Where:

S = Saving
Y = Income

Example

Income = ₹10,000

Saving = ₹2,000

Therefore:

APS = 2,000 / 10,000

APS = 0.2 or 20%

Why Can APS Be Negative?

APS can be negative when consumption is greater than income.

For example:

Income = ₹5,000

Consumption = ₹6,000

Saving:

S = Y – C

S = ₹5,000 – ₹6,000

S = –₹1,000

Therefore:

APS = –1,000 / 5,000

APS = –0.2

Negative saving is called dissaving.

8. Marginal Propensity to Save (MPS)

Meaning

MPS shows the proportion of additional income that is saved.

Formula

MPS = ΔS / ΔY

Where:

ΔS = Change in saving
ΔY = Change in income

Example

Additional income = ₹5,000

Additional saving = ₹1,000

Therefore:

MPS = 1,000 / 5,000

MPS = 0.2

9. Relationship Between APC and APS

We know:

Y = C + S

Divide both sides by Y:

Y/Y = C/Y + S/Y

Therefore:

1 = APC + APS

Hence:

⭐ APC + APS = 1

Therefore:

APC = 1 – APS

APS = 1 – APC

Numerical Example

Income = ₹20,000

Consumption = ₹15,000

Saving = ₹5,000

APC

APC = C/Y

= 15,000 / 20,000

= 0.75

APS

APS = S/Y

= 5,000 / 20,000

= 0.25

Therefore:

APC + APS = 0.75 + 0.25 = 1

10. Relationship Between MPC and MPS

We know:

ΔY = ΔC + ΔS

Dividing by ΔY:

1 = ΔC/ΔY + ΔS/ΔY

Therefore:

⭐ MPC + MPS = 1

Hence:

MPC = 1 – MPS

MPS = 1 – MPC

Example

If:

MPC = 0.8

Then:

MPS = 1 – 0.8

MPS = 0.2

11. Short-Run Equilibrium Output

Meaning of Equilibrium

Short-run macroeconomic equilibrium occurs when planned Aggregate Demand is equal to Aggregate Supply at a given level of output.

In the simple Keynesian model, the price level is assumed to be fixed in the short run.

Equilibrium Condition

AD = AS

In a two-sector economy:

C + I = Y

or:

C + I = C + S

Therefore:

I = S

12. AD-AS Approach to Equilibrium

Suppose:

C = 100 + 0.8Y

and:

I = ₹200 crore

Equilibrium condition:

Y = C + I

Substitute the values:

Y = 100 + 0.8Y + 200

Y = 300 + 0.8Y

Y – 0.8Y = 300

0.2Y = 300

Therefore:

Y = ₹1,500 crore

Hence, equilibrium income is ₹1,500 crore.

13. Saving-Investment Approach

According to the Saving-Investment approach:

Equilibrium occurs when planned Saving = planned Investment.

Therefore:

S = I

If:

S > I

there is a tendency for firms to reduce production and income.

If:

S < I

there is a tendency for firms to increase production and income.

14. Full Employment

Meaning

Full employment refers to a situation where all people who are willing and able to work at the prevailing wage rate are able to get employment.

Important Point

Full employment does not mean that zero unemployment exists.

Temporary, frictional or voluntary unemployment may still exist.

The important feature is the absence of involuntary unemployment.

15. Involuntary Unemployment

Involuntary unemployment occurs when a person:

is willing to work,
is able to work,
is ready to work at the prevailing wage rate,

but cannot find employment.

Example

A person is willing and capable of working but cannot get a job because sufficient employment opportunities are not available.

This is involuntary unemployment.

16. Investment Multiplier

Meaning

The Investment Multiplier shows how much the level of income changes due to a change in investment.

Formula

k = ΔY / ΔI

Where:

k = Investment Multiplier
ΔY = Change in income
ΔI = Change in investment

How Does the Multiplier Work?

Suppose investment increases by ₹100 crore.

The initial investment creates income for producers and workers.

They spend a part of this additional income on consumption.

This consumption expenditure becomes income for others.

The second group again spends a part of its additional income.

The process continues.

Therefore, the final increase in national income is greater than the initial increase in investment.

Multiplier Process

Increase in Investment

↓

Increase in Income

↓

Increase in Consumption

↓

Further Increase in Income

↓

Further Increase in Consumption

↓

Final Multiple Increase in Income

17. Relationship Between Multiplier and MPC

The investment multiplier is:

k = 1 / (1 – MPC)

Since:

MPS = 1 – MPC

Therefore:

k = 1 / MPS

Thus:

Higher MPC → Higher Multiplier

Higher MPS → Lower Multiplier

18. Multiplier Numerical Questions

Example 1: Find Multiplier

MPC = 0.8

Formula:

k = 1/(1 – MPC)

k = 1/(1 – 0.8)

k = 1/0.2

k = 5

Example 2: Find Multiplier from MPS

MPS = 0.25

k = 1/MPS

k = 1/0.25

k = 4

Example 3: Find Change in Income

Increase in investment = ₹500 crore

MPC = 0.75

First calculate multiplier:

k = 1/(1 – 0.75)

k = 4

Now:

ΔY = k × ΔI

ΔY = 4 × ₹500 crore

ΔY = ₹2,000 crore

Example 4: Find MPC

ΔY = ₹4,000 crore

ΔI = ₹1,000 crore

First:

k = ΔY/ΔI

k = 4,000/1,000

k = 4

We know:

k = 1/(1 – MPC)

Therefore:

4 = 1/(1 – MPC)

So:

1 – MPC = 0.25

Therefore:

MPC = 0.75

19. Excess Demand

Meaning

Excess Demand occurs when Aggregate Demand is greater than the level of Aggregate Demand required to achieve full employment.

In simple words:

Excess Demand means total spending in the economy is more than the amount required to maintain full-employment output.

Excess demand creates an:

Inflationary Gap

20. Inflationary Gap

The inflationary gap is the amount by which Aggregate Demand exceeds the Aggregate Demand required for full employment.

Effects of Excess Demand

Excess demand may result in:

Inflationary pressure
Increase in prices
Increase in demand for goods and services
Pressure on available resources
Shortage of goods in some situations

In the short run, increased demand may raise output and employment until full employment is reached. Beyond full employment, the major effect is upward pressure on prices.

21. Measures to Correct Excess Demand

To correct excess demand, the objective is to reduce Aggregate Demand.

There are two major policies:

A. Fiscal Policy

1. Decrease in Government Spending

Government Spending ↓ → AD ↓

2. Increase in Taxes

Higher taxes reduce disposable income.

Taxes ↑ → Disposable Income ↓ → Consumption ↓ → AD ↓

Therefore:

To Correct Excess Demand:

Government Spending ↓

Taxes ↑

22. Monetary Policy to Correct Excess Demand

The central bank can reduce credit and money supply.

1. Increase in Repo Rate

Repo Rate ↑ → Cost of Borrowing ↑ → Credit ↓ → AD ↓

2. Increase in Bank Rate

A higher bank rate makes borrowing more expensive and can reduce credit expansion.

3. Increase in CRR

CRR ↑ → Lending Capacity of Banks ↓ → Credit ↓ → AD ↓

4. Increase in SLR

SLR ↑ → Funds Available for Lending ↓ → Credit ↓ → AD ↓

5. Sale of Government Securities

The central bank sells securities through open market operations.

Sale of Securities → Money/Credit ↓ → AD ↓

6. Increase in Margin Requirement

A higher margin requirement reduces the borrowing capacity against securities.

23. Deficient Demand

Meaning

Deficient Demand occurs when Aggregate Demand is less than the level required to achieve full employment.

In simple words:

Deficient Demand means total spending in the economy is insufficient to purchase the output corresponding to full employment.

Deficient demand creates a:

Deflationary Gap

24. Deflationary Gap

The deflationary gap is the amount by which Aggregate Demand falls short of the Aggregate Demand required to maintain full employment.

Example

AD required for full employment = ₹10,000 crore

Actual AD = ₹9,000 crore

Therefore:

Deflationary Gap = ₹10,000 crore – ₹9,000 crore

Deflationary Gap = ₹1,000 crore

25. Effects of Deficient Demand

Deficient demand can cause:

Fall in production
Fall in employment
Increase in involuntary unemployment
Lower income
Lower consumption
Deflationary pressure
Underutilisation of resources

26. Measures to Correct Deficient Demand

To correct deficient demand, the objective is to increase Aggregate Demand.

A. Fiscal Policy

1. Increase in Government Spending

Government Spending ↑ → AD ↑

2. Reduction in Taxes

Lower taxes increase disposable income.

Taxes ↓ → Disposable Income ↑ → Consumption ↑ → AD ↑

Therefore:

To Correct Deficient Demand:

Government Spending ↑

Taxes ↓

27. Monetary Policy to Correct Deficient Demand

The central bank can increase the availability of credit.

1. Decrease in Repo Rate

Repo Rate ↓ → Cost of Borrowing ↓ → Credit ↑ → AD ↑

2. Decrease in Bank Rate

Lower bank rate can encourage borrowing and credit expansion.

3. Decrease in CRR

CRR ↓ → Lending Capacity ↑ → Credit ↑ → AD ↑

4. Decrease in SLR

SLR ↓ → Funds Available for Lending ↑ → Credit ↑ → AD ↑

5. Purchase of Government Securities

The central bank purchases securities through open market operations.

Purchase of Securities → Money/Credit ↑ → AD ↑

6. Decrease in Margin Requirement

A lower margin requirement increases the borrowing capacity against securities.

28. Excess Demand vs Deficient Demand

Basis	Excess Demand	Deficient Demand
Meaning	AD is greater than required at full employment	AD is less than required at full employment
Gap	Inflationary Gap	Deflationary Gap
Main Problem	Inflationary pressure	Unemployment and deflationary pressure
Output	May rise up to full employment	Falls below full-employment output
Employment	Tends to increase up to full employment	Tends to decrease
Government Spending	Decrease	Increase
Taxes	Increase	Decrease
Repo Rate	Increase	Decrease
Bank Rate	Increase	Decrease
CRR	Increase	Decrease
SLR	Increase	Decrease
OMO	Sale of securities	Purchase of securities
Margin Requirement	Increase	Decrease

29. Important Formula Sheet

Aggregate Demand

AD = C + I
(Two-sector economy)

Aggregate Supply

AS = C + S

National Income

Y = C + S

Therefore:

AS = Y

Average Propensity to Consume

APC = C/Y

Average Propensity to Save

APS = S/Y

Marginal Propensity to Consume

MPC = ΔC/ΔY

Marginal Propensity to Save

MPS = ΔS/ΔY

Relationship

APC + APS = 1

Relationship

MPC + MPS = 1

Equilibrium

AD = AS

Saving-Investment Equilibrium

S = I

Investment Multiplier

k = ΔY/ΔI

Multiplier from MPC

k = 1/(1 – MPC)

Multiplier from MPS

k = 1/MPS

Change in Income

ΔY = k × ΔI

30. CBSE Board Exam Quick Revision

Before your CBSE Economics examination, remember these important points:

✅ AD = C + I in a two-sector economy.

✅ AS = C + S = Y

✅ Equilibrium occurs when AD = AS.

✅ Saving-Investment equilibrium occurs when S = I.

✅ APC = C/Y

✅ APS = S/Y

✅ MPC = ΔC/ΔY

✅ MPS = ΔS/ΔY

✅ APC + APS = 1

✅ MPC + MPS = 1

✅ 0 ≤ MPC ≤ 1

✅ APS can be negative because of dissaving.

✅ k = 1/MPS

✅ k = 1/(1 – MPC)

✅ Higher MPC means a higher multiplier.

✅ Excess Demand creates an Inflationary Gap.

✅ Deficient Demand creates a Deflationary Gap.

✅ Excess Demand → Government Spending ↓ and Taxes ↑

✅ Deficient Demand → Government Spending ↑ and Taxes ↓

31. Important CBSE Questions for Practice

Very Short Answer Questions

What is Aggregate Demand?
Write the formula for AD in a two-sector economy.
What is Aggregate Supply?
Define APC.
Write the formula for MPC.
Why can APS be negative?
State the relationship between APC and APS.
State the relationship between MPC and MPS.
What is investment multiplier?
What is involuntary unemployment?

Short Answer Questions

Explain the components of Aggregate Demand.
Explain the two-sector model.
Differentiate between APC and MPC.
Differentiate between APS and MPS.
Explain the relationship between MPC and MPS.
Explain full employment and involuntary unemployment.
Explain the working of investment multiplier.
Explain excess demand and inflationary gap.
Explain deficient demand and deflationary gap.
Explain fiscal measures to correct excess and deficient demand.

Numerical Practice

Calculate APC and APS when income is ₹50,000 and consumption is ₹40,000.
If MPC is 0.8, calculate MPS.
If MPS is 0.25, calculate the multiplier.
If investment increases by ₹1,000 crore and MPC is 0.75, calculate the increase in income.
If ΔY = ₹5,000 crore and ΔI = ₹1,000 crore, calculate the multiplier and MPC.

Conclusion

Determination of Income and Employment is an important unit of CBSE Class 12 Macroeconomics. The most important areas for examination are AD-AS equilibrium, APC and APS, MPC and MPS, Investment Multiplier, Excess Demand, Deficient Demand and their corrective measures.

Students should learn the formulas and also understand the economic logic behind them. Regular practice of numerical questions can make this unit much easier and help you score better in the CBSE Class 12 Economics Board Examination.

⭐ Learn the Formula → Understand the Concept → Practise Numericals → Score Better!

📚 Also Read - Important for 2026:
👉 Class 12 All Chapters Notes
👉 Class 11 Commerce Notes

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