CDS Economics · National Income, Growth and Development Indicators
Macroeconomic Theory
The classical and Keynesian views of employment, the later ideas CDS names with their authors, and the economic curves and what each one plots.
Why this matters
Fourteen CDS questions, half of them HARD. Most are a name matched to an idea: who said employment depends on effective demand, who proposed the natural rate of unemployment, which curve plots tax rates against revenue.
Concept 1 of 3: Classical economics and Keynes
The classical economists trusted markets to clear: if workers were idle, wages would fall until firms hired them again. The Great Depression of the 1930s broke that faith. Keynes argued that output and jobs are set by total spending in the economy, and that when private spending is too low the government should spend more, even by borrowing.
Definition
The two views:
- Classical theory (Adam Smith, J. B. Say, Ricardo): Say's law, supply creates its own demand. Wages, prices and interest rates are flexible, so the economy returns to full employment by itself. Any unemployment is temporary.
- Keynes, The General Theory of Employment, Interest and Money (1936): employment depends on effective demand, the point where aggregate demand meets aggregate supply. The economy can stay stuck below full employment.
- Keynes's cure for a slump: the state spends more than it collects, which is deficit financing.
- Recessionary (deflationary) gap: equilibrium real GDP below potential GDP. Inflationary gap: equilibrium real GDP above it.
- Crowding out: government borrowing raises interest rates and pushes private investment down. Crowding in: public investment (roads, power, logistics) raises the returns on private projects and pulls private investment up.
| Idea | Who or what | Meaning |
|---|---|---|
| Unemployment is temporary | Classical school | Flexible wages and prices restore full employmentQ CDS 2016 (II): classical theory treats departures from full employment as purely temporary. |
| Employment depends on effective demand | J. M. Keynes | Aggregate demand meets aggregate supplyQ |
| Deficit financing | J. M. Keynes | Spend beyond revenue to lift demand in a slumpQ CDS 2022 (I): Keynes first mooted deficit financing. |
| Recessionary gap | Output below potential | Resources lie idleQ |
| Crowding in | Public investment | Raises private investmentQ CDS 2026 (II): crowding in is public investment leading to more private investment. |
Practice this conceptself-check · 4 quick reps
The same idea in a real exam question:
CDS · 2019 · CDS (I) 2019 — General Knowledge · Q40Moderate
Example 1 · National Income, Growth and Development Indicators · Macroeconomic Theory
According to John Maynard Keynes, employment depends upon
Effective demand, not aggregate demand alone
For Keynes, employment is fixed by effective demand: the point where the aggregate demand and aggregate supply schedules meet. Aggregate demand by itself is the distractor.
Crowding in is the opposite of crowding out
Crowding out: public borrowing displaces private investment. Crowding in: public investment raises private investment. Lower private borrowing or a smaller fiscal deficit is not crowding in.
Concept 2 of 3: Later ideas and their authors
After Keynes, economists asked sharper questions. How do people decide how much to consume over a lifetime? Can a government buy lower unemployment with a little more inflation for ever? CDS asks you to match each answer to the name behind it.
Definition
The names:
- Milton Friedman (with Edmund Phelps): the natural rate of unemployment (late 1960s). The Phillips curve trade-off between inflation and unemployment holds only in the short run. Friedman also gave the permanent income hypothesis and led monetarism.
- A. W. Phillips (1958): the original Phillips curve. R. G. Lipsey extended it.
- Consumption theories: absolute income (Keynes: consumption follows current income), relative income (Duesenberry), life cycle (Modigliani, Ando and Brumberg: consumption depends on lifetime resources, the return on them and the person's age), permanent income (Friedman).
- Capital deepening: more capital per worker. Capital widening: more capital only in step with more workers.
- Geoffrey Kay, Development and Underdevelopment (1975): capital created underdevelopment 'not because it exploited the underdeveloped world, but because it did not exploit it enough'.
| Idea | Author |
|---|---|
| Natural rate of unemployment | Milton Friedman (and Edmund Phelps)Q |
| Phillips curve | A. W. Phillips |
| Relative income hypothesis | James Duesenberry |
| Life cycle hypothesis | Franco Modigliani, Albert Ando, Richard BrumbergQ CDS 2019 (I): consumption depending on resources, the return on capital and age is the life cycle hypothesis. |
| Permanent income hypothesis | Milton Friedman |
| Capitalism underdeveloped the periphery by not exploiting it enough | Geoffrey KayQ |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2018 · CDS (II) 2018 — General Knowledge · Q54Hard
Example 2 · National Income, Growth and Development Indicators · Macroeconomic Theory
The natural rate of unemployment hypothesis was advocated by
Phillips drew the curve, Friedman limited it
The natural rate idea came from Friedman and Phelps, as a criticism of the long-run Phillips curve. Phillips and Lipsey are the names of the original curve.
Deepening is per worker
Capital deepening raises capital per worker. Adding capital just to equip new workers, with the ratio unchanged, is capital widening.
Concept 3 of 3: The economic curves
Each famous curve in economics plots one thing against another. If you remember the two axes, you can answer any match-the-list question: inflation against unemployment is Phillips, tax rate against revenue is Laffer.
Definition
The curves and indicators:
- Lorenz curve: cumulative share of income against cumulative share of people; it measures inequality. The Gini coefficient comes from it and runs from 0 (perfect equality) to 1 (perfect inequality).
- Phillips curve: inflation against unemployment.
- Engel curve: income against spending on a good; the share spent on food falls as income rises (Engel's law).
- Laffer curve: tax rate against tax revenue; past some rate, higher taxes bring in less.
- 45-degree line: through the origin, where X = Y. Reading 'equal' off it assumes both variables are in the same unit.
- Credit to GDP ratio: the standard gauge of where an economy stands in the financial cycle (credit booms and busts).
| Curve | Plots |
|---|---|
| Lorenz curve | Inequality of income or wealthQ CDS 2019 (II): the Gini coefficient measures income inequality. |
| Phillips curve | Inflation and unemployment |
| Engel curve | Income and the share spent on food |
| Laffer curve | Tax rate and tax revenue |
| 45-degree line | X equals Y, with both in the same unitQ |
| Credit to GDP ratio | Position in the financial cycleQ CDS 2025 (II): credit to GDP, not the fiscal deficit, tracks the financial cycle. |
Practice this conceptself-check · 4 quick reps
The same idea in a real exam question:
CDS · 2021 · CDS (II) 2021 — General Knowledge · Q69Moderate
Example 3 · National Income, Growth and Development Indicators · Macroeconomic Theory
Match List I with List II and select the correct answer using the code given below the lists :
Code :
| List I (Curve) | List II (Indication) |
|---|---|
| A. Lorenz curve | 1. Inflation and employment |
| B. Phillips curve | 2. Tax rates and tax revenue |
| C. Engel curve | 3. Inequality in distribution of income or wealth |
| D. Laffer curve | 4. Income and proportion of expenditure on food |
The Gini measures inequality, not poverty
A country can have a low Gini and many poor people if nearly everyone is poor. The Gini is about how evenly income is shared, not how much there is.
Phillips is inflation, Laffer is tax
Phillips: inflation and unemployment. Laffer: tax rate and tax revenue. Engel: income and food spending. Swapping these is the match-list trap.
Summary — formulas & gotchas at a glance
A revision cheat-sheet for the formulas and gotchas above. Click any concept name to jump back to its full explanation.
Reference tables (3)
Classical economics and Keynes5 rows
| Idea | Who or what | Meaning |
|---|---|---|
| Unemployment is temporary | Classical school | Flexible wages and prices restore full employmentQ CDS 2016 (II): classical theory treats departures from full employment as purely temporary. |
| Employment depends on effective demand | J. M. Keynes | Aggregate demand meets aggregate supplyQ |
| Deficit financing | J. M. Keynes | Spend beyond revenue to lift demand in a slumpQ CDS 2022 (I): Keynes first mooted deficit financing. |
| Recessionary gap | Output below potential | Resources lie idleQ |
| Crowding in | Public investment | Raises private investmentQ CDS 2026 (II): crowding in is public investment leading to more private investment. |
Later ideas and their authors6 rows
| Idea | Author |
|---|---|
| Natural rate of unemployment | Milton Friedman (and Edmund Phelps)Q |
| Phillips curve | A. W. Phillips |
| Relative income hypothesis | James Duesenberry |
| Life cycle hypothesis | Franco Modigliani, Albert Ando, Richard BrumbergQ CDS 2019 (I): consumption depending on resources, the return on capital and age is the life cycle hypothesis. |
| Permanent income hypothesis | Milton Friedman |
| Capitalism underdeveloped the periphery by not exploiting it enough | Geoffrey KayQ |
The economic curves6 rows
| Curve | Plots |
|---|---|
| Lorenz curve | Inequality of income or wealthQ CDS 2019 (II): the Gini coefficient measures income inequality. |
| Phillips curve | Inflation and unemployment |
| Engel curve | Income and the share spent on food |
| Laffer curve | Tax rate and tax revenue |
| 45-degree line | X equals Y, with both in the same unitQ |
| Credit to GDP ratio | Position in the financial cycleQ CDS 2025 (II): credit to GDP, not the fiscal deficit, tracks the financial cycle. |
Watch out for (6)
- Effective demand, not aggregate demand alone→ Classical economics and Keynes
- Crowding in is the opposite of crowding out→ Classical economics and Keynes
- Phillips drew the curve, Friedman limited it→ Later ideas and their authors
- Deepening is per worker→ Later ideas and their authors
- The Gini measures inequality, not poverty→ The economic curves
- Phillips is inflation, Laffer is tax→ The economic curves
Test yourself on National Income, Growth and Development Indicators
20 past CDS questions from this chapter, timed at 20 minutes and marked the way the exam marks it. You see your score and every answer the moment you finish. Free to start.