Class 12 Economics – Sample Paper (Chapter 4)
SECTION A — Objective Type Questions (1 × 10 = 10 marks)
Q1. Which of the following is the correct Keynesian consumption function?
Answer: (b) C = C₀ + cY
Q2. In a two-sector closed economy, equilibrium income is given by:
Answer: (d) All of the above
Q3. Marginal Propensity to Save (MPS) equals:
Answer: (b) 1 − c
Q4. The multiplier k is equal to:
Answer: (a) 1/(1 − c)
Q5. In the 45° diagram used for equilibrium determination, the 45° line represents:
Answer: (c) Points where Y = AE (Output = Planned Expenditure)
Q6. An increase in autonomous investment will:
Answer: (c) Increase equilibrium income by multiplier × ΔI
Q7. Which statement best describes the Paradox of Thrift?
Answer: (b) If everyone saves more during a recession, aggregate demand may fall and total saving may not increase.
Q8. If MPC = 0.75, what is the multiplier?
Answer: (a) 4 (since k = 1/(1 − 0.75) = 4)
Q9. In two-sector equilibrium Y = C + I, if C = 200 + 0.8Y and I = 600, equilibrium income is:
Answer: (c) 2000. (Solve: Y = 200 + 0.8Y + 600 → 0.2Y = 800 → Y = 4000? — wait check: 200+600=800; 0.2Y=800 => Y=4000. So correct answer is (a) 4000.)
Q10. Which of the following will reduce the value of the multiplier (holding other things constant)?
Answer: (c) Increase in marginal tax rate (t) — because it reduces the effective MPC out of disposable income and lowers k = 1/(1 − c(1 − t)).
SECTION B — Short Answer Questions (4 × 3 = 12 marks)
Q11. Define Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS). Give numerical example.
Answer: MPC (c) = ΔC / ΔY — the fraction of an additional unit of income spent on consumption. MPS = ΔS / ΔY = 1 − c.
Example: If income rises by ₹1000 and consumption rises by ₹700, MPC = 700/1000 = 0.7, MPS = 0.3.
Example: If income rises by ₹1000 and consumption rises by ₹700, MPC = 700/1000 = 0.7, MPS = 0.3.
Q12. Derive the equilibrium income formula for a two-sector model with C = C₀ + cY and autonomous investment I₀.
Answer: Equilibrium: Y = C + I = C₀ + cY + I₀ → Y − cY = C₀ + I₀ → Y(1 − c) = C₀ + I₀ → Y* = (C₀ + I₀)/(1 − c).
Q13. State three factors that determine investment (I).
Answer: (i) Expected rate of return/profitability of projects, (ii) Market interest rate (cost of borrowing), (iii) Business expectations/confidence and technological opportunities. (Also: capacity utilization, tax incentives.)
Q14. Briefly explain the 45° diagram method for finding equilibrium income.
Answer: Plot the 45° line (points where Y = AE). Plot Aggregate Expenditure (AE = C₀ + cY + I₀) which is an upward sloping line with slope c. The intersection of AE and the 45° line gives equilibrium income where planned spending equals output.
SECTION C — Long Answer Questions (3 × 6 = 18 marks)
Q15. Explain the concept of the multiplier. Derive the multiplier formula and compute the change in equilibrium income when autonomous investment increases by ₹1,200 if MPC = 0.75.
Answer:
The multiplier shows how an autonomous change in spending (ΔA) produces a multiplied change in equilibrium income (ΔY). Starting from Y = C₀ + cY + I₀, solve Y = (C₀ + I₀)/(1 − c). A change ΔA in (C₀ + I₀) gives ΔY = ΔA/(1 − c). Thus multiplier k = 1/(1 − c).
With c = 0.75, k = 1/(1 − 0.75) = 4. If ΔI = ₹1,200, ΔY = 4 × 1,200 = ₹4,800.
The multiplier shows how an autonomous change in spending (ΔA) produces a multiplied change in equilibrium income (ΔY). Starting from Y = C₀ + cY + I₀, solve Y = (C₀ + I₀)/(1 − c). A change ΔA in (C₀ + I₀) gives ΔY = ΔA/(1 − c). Thus multiplier k = 1/(1 − c).
With c = 0.75, k = 1/(1 − 0.75) = 4. If ΔI = ₹1,200, ΔY = 4 × 1,200 = ₹4,800.
Q16. Suppose in a two-sector economy C = 250 + 0.8Y and I = 900. (i) Find equilibrium income. (ii) Calculate consumption and saving at equilibrium. (iii) Explain briefly how an increase in autonomous consumption C₀ affects equilibrium income.
Answer:
(i) Y = C + I = 250 + 0.8Y + 900 → 0.2Y = 1150 → Y = 1150/0.2 = ₹5,750.
(ii) C = 250 + 0.8×5750 = 250 + 4600 = ₹4,850. Saving S = Y − C = 5750 − 4850 = ₹900.
(iii) An increase in C₀ shifts AE up; equilibrium income increases by multiplier × ΔC₀ (k = 1/(1 − c)). So a ₹1 increase in C₀ raises Y by k rupees.
(i) Y = C + I = 250 + 0.8Y + 900 → 0.2Y = 1150 → Y = 1150/0.2 = ₹5,750.
(ii) C = 250 + 0.8×5750 = 250 + 4600 = ₹4,850. Saving S = Y − C = 5750 − 4850 = ₹900.
(iii) An increase in C₀ shifts AE up; equilibrium income increases by multiplier × ΔC₀ (k = 1/(1 − c)). So a ₹1 increase in C₀ raises Y by k rupees.
Q17. Explain the Paradox of Thrift with a numerical illustration showing how an increase in collective saving propensity can reduce national income.
Answer:
Paradox: Individually, saving more is rational; collectively, if everyone increases MPS (reduces MPC), aggregate demand falls, lowering income and possibly reducing total saving.
Numerical: Suppose initially c = 0.8 → k = 5. With autonomous spending ΔA = 1000, ΔY = 5000. If people try to save more and c falls to 0.7 → k = 1/(1 − 0.7) = 3.33. For the same ΔA = 1000, ΔY = 3333 — income falls. Lower income may mean actual aggregate saving does not rise as expected despite higher MPS.
Paradox: Individually, saving more is rational; collectively, if everyone increases MPS (reduces MPC), aggregate demand falls, lowering income and possibly reducing total saving.
Numerical: Suppose initially c = 0.8 → k = 5. With autonomous spending ΔA = 1000, ΔY = 5000. If people try to save more and c falls to 0.7 → k = 1/(1 − 0.7) = 3.33. For the same ΔA = 1000, ΔY = 3333 — income falls. Lower income may mean actual aggregate saving does not rise as expected despite higher MPS.
SECTION D — Case Study / Application (5 marks)
The government of Country X faces high unemployment. It decides to launch a public works programme increasing government spending by ₹3,000 crore. The average marginal propensity to consume (MPC) in the economy is estimated at 0.6. At the same time, households, worried about future uncertainty, try to increase their saving, reducing MPC by 0.05.
(a) Calculate the multiplier before and after households increase saving. (1 mark)
Answer: Before: c = 0.6 → k = 1/(1 − 0.6) = 2.5. After: c = 0.55 → k = 1/(1 − 0.55) = 2.222… (≈2.22).
(b) Determine change in equilibrium income due to the public works programme before and after the change in MPC. (2 marks)
Answer: Before: ΔY = k × ΔG = 2.5 × 3000 = ₹7,500 crore. After: ΔY = 2.222… × 3000 ≈ ₹6,666.7 crore.
(c) Briefly explain policy implication of this result for the government. (2 marks)
Answer: The government’s fiscal stimulus is less effective if households simultaneously increase saving (MPC falls). To offset this, govt may increase the spending further or use complementary policies (tax cuts, transfer payments) to raise disposable income and support consumption.
Teacher/Examiner note: Use simple workings and show steps. Diagrams (45° line and AE) can be used for full credit where requested.