Question

Give reasons or explain.

1) Investment demand is not the sole determinant of aggregate demand.
2) Saving may be used in future for unforeseen contingencies.
3) There are many subjective factors determining consumption function.
4) Aggregate demand is a positive function of the level of employment and output.
5) The Propensity to Consume means consumption function.

Answer 1

1) Investment demand is not the sole determinant of aggregate demand. Apart from investment demand, consumption demand, government demand, exports and imports are also the components of aggregate demand.

AD = C + I + G + (X – M)
Where,
Demand by households - Private consumption expenditure (C)
Demand by firms - Private investment expenditure (I)
Demand by government - Government expenditure (G)
Demand by foreign sector- Net exports (X – M)
Where, X is exports and M is imports.

2) Savings are that part of the income which are not consumed and are kept aside to be used in the future. For any financial contingencies, savings can act as a helpful source of finance. Savings also act as a vital source of funds at the time of future emergencies.

3) Consumption function is affected by many subjective factors or the psychological factors. Such factors vary from person to person and are based on a person’s personal decisions. According to Keynes, there are eight subjective motives which prevent an individual from current consumption.
i. Motive of precaution: People save money for the future in order to meet unexpected expenditure.
ii. Motive of foresightedness: People cut down their spending in order to meet future requirements for money. For examples, requirements for higher education, marriage, buying a house etc.
iii. Motive of improvement: Individuals cut down their expenditure to improve their standard of living.
iv. Motive of independence: As per this motive, man saves more in order to depict more power and independence.
v. Motive of pride: Another motive that prevents people from spending is the wish to maintain the same economic standard in the future. Providing some wealth to their future generations or making donations gives them a feeling of pride.
vi. Motive of enterprise: People prevent current consumption and save for the purpose of investing. Under this motive, people save to invest in a profitable enterprise.
vii. Motive of calculation: Under this motive, people save to invest in shares and debentures in order to increase their income.
viii. Motive of avarice: Some people have a habit of not spending even on necessities. As a result, the consumption function decreases.

4) Aggregate demand or Aggregate Demand Function (ADF) is a positive function of the level of employment and output as, when the level of employment and output increases, it results in an increase in the income of workers. This increase in income leads to an increase in expenditure of workers and thereby increases the aggregate demand.
Aggregate demand function or aggregate demand can be written as AD = f(N) where,

AD is Aggregate Demand
N is employment and output
f represents the functional relationship between the aggregate demand and the level of output and employment.

The following diagram depicts the positive relationship between aggregate demand, employment and output.

5) Consumption function is also known as ‘Propensity to Consume’. It depicts a relation between the consumption and the income, which means that it depicts how a change in the income causes a change in the consumption pattern of an individual.

C = f(Y)
Where,
C represents consumption expenditure
Y represents aggregate income; and
f represents the functional relationship between the consumption expenditure and the level of the disposable income.