Question

Explain the effect of an increase in consumer income on the demand for a good.

- In your own words, explain the logic of the income-expenditure model. What determines the amount of real GDP demanded?

- Define the economy's potential output. What factors help determine potential output?

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Answer 1

ANS

The effect of consumers income with respect to increase or decrease in demand is called income effect .The increase in income or disposable income of the consumer increases the purchasing power of the consumer.So the income effect is different for different types of goods and those goods are -

Normal Goods- These are those goods whose demand increases as people's incomes and purchasing power rise ,these goods have positive elasticity of demand with respect to the income. For eg - the increase in income would lead to increase in demand of chocolates .

Inferior Goods - These are goods for which demand declines as consumers real incomes rise, or rises as incomes fall. These are basically low quality products ,like the demand of cheap clothes would rise if someone income falls.

B

The income and expenditure model states the relation between the income from the goods which is equal to the production and expenditure in the economy which is the summation of consumption and investment. It is assumed that the producer will produce only to the extent till which consumers will consume . The logic behind this model is to attain the equilibrium so that there is no wastage of resources. The amount of real gdp in the income model is identified at the point where Income is equal to the expenditure as in this point the demand is equal to supply.

C

The potential output is that quantity of output upto which the consumers are willing to make a purchase .This is the output level at the full equilibrium in the economy .It is also understood as natural gross domestic producct or it can be termed as the highest level of the GDP that could be sustaind in the economy over a long period of time.The four factors that affect the potential output in the economy is the effective utilization of Land Labour,capital, and Entreprenuer. If these four factors are seem and their usage is planned accordingly then there will be potential output in the economy.