Posted by Anjali Kaur on Oct 13, 2020

How to solve problems on AD-AS?

The trick to solve problems on AD-AS is to remember all the formulas:

S = -c + sY (-c is dissavings, s = MPS, Y = National Income)

C = c + bY (c is autonomous consumption, b = MPC, Y = National Income)

AS = C + S (C is consumption expenditure, S is Savings)

Y = AD = C + I (C is consumption expenditure, I is Investment expenditure)

I =   Autonomous Investment

APC = C/Y

APS = S/Y

APC + APS = 1

MPC = Change in C/ Change in Y

MPS = Change in S/ Change in Y

MPC + MPS = 1

 Let’s learn more about it

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Let’s solve some problems:

1. In an economy, S = -100 + 0.6 Y, I = 1100. Calculate equilibrium level of income, savings and consumption expenditure.

Solution. Equilibrium level of income is same as the national income.

In case of equilibrium S = I

-100 + 0.6 Y = 1100

0.6 Y = 1100 + 100

0.6 Y = 1200

Y = 1200/0.6

Y = 2000

Now, find S

S = -100 + 0.6 X 2000

S = -100 + 1200

S = 1100

Now, find consumption expenditure:

Y = C + I

2000 = C + 1100

C = 900

2. C = 50 + 0.5 Y, I = 200. Find equilibrium level of national income and consumption expenditure.

Solution. Use Y = C + I

Y = 50 + 0.5 Y + 200

Y – 0.5 Y = 250

0.5 Y = 250

Y = 250/0.5

Y = 500

Now, find C

C = 50 + 0.5 x 500

C = 300

3. An economy is in equilibrium. Calculate MPS, if: Y = 10000, Autonomous Consumption = 500 and C = 8000.

Solution. Use Consumption expenditure equation:

C = c + b Y

8000 = 500 + b (10000)

7500 = b x 10000

7500/10000 = b

b = MPC = 0.75

We know, MPC + MPS = 1

0.75 + MPS = 1

MPS = 1 – 0.75

MPS = 0.25

4. An economy is in equilibrium. Calculate autonomous consumption, if Income = 10000, MPS = 0.2 & Investment = 1500.

Solution. Since economy is in equilibrium: S = I

S = I = 1500

Use savings equation:

S = -c + s Y

1500 = -c + 0.2 x 10000

1500 = -c + 2000

1500 – 2000 = -c

-500 = -c

c = 500 which is the autonomous consumption.

Test Yourself

  1. In an economy, the equilibrium level of income is 900 and the dissavings is -100. If MPS = 0.3, consumption expenditure in this economy will be 500? True or False.
  2. If in an economy, C = 100 + 0.75 Y and I = 150. Estimate equilibrium level of income and consumption expenditure and savings.

Thank You for reading.

You can read the related post on macroeconomics:

Types of Employment Equilibrium

Concept of Short-Term Equilibrium

Aggregate Supply

Aggregate Demand

Introduction To Money

Central bank and its function

Process of credit creation

Precautions while calculating the national income

Real and nominal GDP

National income

National income formula list

Value-added method

Income method

Expenditure method

GDP and welfare

Domestic territory and national residents

Circular flow of income

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