Question

Discuss the effect of change in Aggregate Demand on Income and Output. OR Calculate Gross Value Added at Market prices of a Firm from the following data: Sales: Rs. 100 Lakh, Purchase: Rs. 40 Lakh, Opening Stock: Rs. 20 Lakh, Closing Stock: Rs. 25 Lakh

Hint:

For Value Added calculations, a common mistake is to forget the 'Change in Stock'. Always calculate the Value of Output first (Sales + Change in Stock) before subtracting the Intermediate Consumption (Purchases).

Answer 1

Step 1: Understanding the Concept:
According to Keynesian theory, the equilibrium level of income and output in the short run is determined by the level of Aggregate Demand (AD). Any change in AD will lead to a change in the equilibrium level of income and output.

Step 2: Effect of an Increase in Aggregate Demand (Inflationary Gap):
If there is an increase in AD (due to an increase in consumption, investment, or government spending), the AD curve shifts upwards. \begin{itemize} \item If the economy is below full employment: An increase in AD leads to a corresponding increase in the equilibrium level of output and income. Firms will increase production to meet the higher demand, which leads to more employment and income. \item If the economy is already at full employment: An increase in AD cannot be met by an increase in real output, as resources are already fully utilized. This situation creates an inflationary gap, where the excess demand pulls up the general price level, leading to inflation. \end{itemize}

Step 3: Effect of a Decrease in Aggregate Demand (Deflationary Gap):
If there is a decrease in AD, the AD curve shifts downwards. \begin{itemize} \item This creates a situation of deficient demand or a deflationary gap, where AD is less than the full employment level of output. \item In response, firms will have unsold stocks and will cut back on production. \item This leads to a fall in the equilibrium level of output and income. \item A decrease in production leads to a decrease in employment, causing involuntary unemployment. \end{itemize}

Step 4: Final Answer:
A change in aggregate demand has a direct impact on income and output. An increase in AD leads to an increase in income and output (if below full employment) or inflation (if at full employment). A decrease in AD leads to a decrease in income, output, and employment.
Solution (Calculation of Gross Value Added at Market Price):

Step 1: Understanding the Concept and Formula:
Gross Value Added at Market Price (\(GVA_{MP}\)) measures the contribution of a firm to the total output of the economy. It is the value of a firm's output minus the value of its intermediate consumption.
The formula is: \[ GVA_{MP} = \text{Value of Output} - \text{Intermediate Consumption} \] Where: \begin{itemize} \item Value of Output = Sales + Change in Stock \item Change in Stock = Closing Stock - Opening Stock \item Intermediate Consumption = Purchases of raw materials \end{itemize}

Step 2: Identifying the Given Values:
\begin{itemize} \item Sales = Rupees 100 Lakh \item Purchase (Intermediate Consumption) = Rupees 40 Lakh \item Opening Stock = Rupees 20 Lakh \item Closing Stock = Rupees 25 Lakh \end{itemize}

Step 3: Calculating Components and the Final Value:
First, calculate the Change in Stock: \[ \text{Change in Stock} = \text{Closing Stock} - \text{Opening Stock} \] \[ \text{Change in Stock} = 25 - 20 = \text{Rupees 5 Lakh} \] Next, calculate the Value of Output: \[ \text{Value of Output} = \text{Sales} + \text{Change in Stock} \] \[ \text{Value of Output} = 100 + 5 = \text{Rupees 105 Lakh} \] Finally, calculate the Gross Value Added at Market Price: \[ GVA_{MP} = \text{Value of Output} - \text{Intermediate Consumption} \] \[ GVA_{MP} = 105 - 40 = \text{Rupees 65 Lakh} \]

Step 4: Final Answer:
The Gross Value Added at Market Price (GVA at MP) of the firm is Rupees 65 Lakh.