accounting values ex post and ex ante
TRANSCRIPT
■ Accounting Values Ex post and Ex ante
■ Ex Post : National Income Accounts: Actual / realized
■ Ex Ante : Planned / intended to Consume or Intended to Invest
■ Equilibrium Income and Output = Planned Output =
Actual/Effective Demand
■ Natural Level of GDP /Full Employment of Resources: Zero
involuntary unemployment
■ Wage Price Flexibility : Classical Economist / Wage Price Rigidity
: Keynesian Theory of Income determination
■ Involuntary Unemployment : Unemployment that exist when there
is deficit demand = Actual/Effective Demand < Planned Output
leads to increase in unused inventories and creates deflationary gap
■ Keynesian Theory of Income and Output Determination :
Establishes relationship between aggregate income and aggregate
demand at underemployment and overemployment
■ Keynesian economics was developed by the British economist
John Maynard Keynes during the 1930s in an attempt to
understand the Great Depression.
■ Keynes advocated increased government expenditures and lower
taxes to stimulate demand and pull the global economy out of the
Depression.
■ Subsequently, the term “Keynesian economics” was used to refer
to the concept that optimal economic performance can be achieved
and economic slumps can be prevented by influencing aggregate
demand through activist stabilization and economic intervention
policies by the government.
■ Keynesian economics is considered to be a “demand-side” theory
that focuses on changes in the economy over the short run.
■ According to classical theory, if aggregate demand in the economy
fell, the resulting weakness in production and jobs would
precipitate a decline in prices and wages.
■ A lower level of inflation and wages would induce employers to
make capital investments and employ more people, stimulating
employment and restoring economic growth.
■ Aggregate supply curve describes, for each given price level, the
quantity of output firms are willing to supply
■ Upward sloping since firms are willing to supply more output
at higher prices
■ Aggregate demand curve shows the combinations of the price level
and the level of output at which the goods and money markets are
simultaneously in equilibrium
■ Downward sloping since higher prices reduce the value of
the money supply, which reduces the demand for output
■ Intersection of AS and AD curves determines the equilibrium level
of output and price level
Spending determines income, but income also determines spending.
Equilibrium is reached when actual income equals intended
spending,
Y = C + I + G + (X-M)
National Income = Consumption +Investment + Government
Expenditure + (Exports-Imports)
This equilibrium condition can also be expressed in another way,
namely,
S + T + M = I + G + X
Savings+ Taxes+ Imports = Investment + Government Expenses
+ Exports
Intended withdrawals/leakages = Intended injections
In the Keynesian model of income determination discussed in this
chapter, the adjustment process from one equilibrium output level
to another is based on unintended inventory changes. These are
defined as the difference between actual output and aggregate
demand
Firms try to maintain an optimal inventory stock;
1. If (actual AD) Effective AD > AS (Planned Output)
2. Unplanned Inventory
3. Actual Production /Output
4. Employment
4. Total production = aggregate demand
# The largest part of aggregate demand comes from consumption
spending
C = a + bYD with 0 < b < 1
YD = Y - TA + TR
Yd = Disposable Income
TA = Tax
TR = Transfer Receipts
If we assume for simplicity that TA = TR = 0, it follows that YD =
Y, and thus the savings function can be derived from YD = C + S,
that is,
C= a +by
Or
S = - a + (1 - b) Y
(1 – b) is the marginal propensity to save.
Aggregate Demand =C+I (Two Sector Model )
Aggregate Supply
Equilibrium in Two Sector Model AD= AS or C+I =C+S
Equilibrium Savings (leakages) = Investment(injection)
Change in Autonomus Investment : Multiplier and National
Income
Increase in Autonomous investment increases consumption
demand and income in the economy
In underdeveloped countries Multiplier Impact is high but value
is low due to lack of productivity efficiency of labour and capital
In other words, any increase in autonomous Investment spending by
I will increase national income by Y = [1/(1 - c)](I) =k
K = Y/I = 1/(1-MPC) = 1/(MPS) Multiplier
The output in the economy is a multiple of the increase or decrease
in investment spending.
The Maximum value of multiplier is infinity; if MPC=1
For example, a Rupees 1 million increase in the total amount of
investment in an economy will set off a chain reaction of increases in
expenditures.
Those who produce the goods and services that are ultimately
purchased as a result of the Rupees 100 million investment will
realize the Rupees100 million as increases in their incomes.
If they, in turn, collectively spend about 0.5 of that additional
income, then a total of Rupees 50 million further 25 million
followed by 12.5 million and so on .
K = Y/I = 1/(1-MPC) = 1/(MPS)
K=1/1-0.5 = k= 1/0.5 = 2
Income will increase from 100ˣ 2= Rupees 200 million
Increase in National Income will be Rupees 200 million with 100
million investments
Note:
Increase in income due to increase in initial investment, does not go
on endlessly. The process of income propagation slows down and
ultimately comes to halt. The decline in income is due to leakages.
Due to leakages
If MPS is higher multiplier impact will be less. Similarly there are
other leakages that results in lowering down the consumption
expenditure for example:
1. Progressive taxes results in reducing the impact of increase in
income
2. High Liquidity Preference and low MPC
3. Excess of Inventory investment and high reliance on Imports
4. Investment in existing financial products, shares, bonds,
Government securities
5. High debt obligations
6. High Retained earnings of Corporate
7. Scarcity of Supply despite high consumption demand
8. Economy is at full employment hence increase in demand would
lead to inflation in the economy
# Illustration 1
In an economy, every time income rises, 75 percent of rise in income
is spent on consumption. If the investment in the economy increases
by Rs 750 million
a. Find change in Income
b. Change in saving
Question: If savings function= -10 +0.2Y, I= 50 crore
Find Equilibrium level of Income, consumption and if investment
increases by INR 5 crore. Find new level of income and consumption
-10 +0.2Y =50
0.2Y=60
Y = 60/0.2
Y= 300 crore
Y= C+S
300= C+50
C=250
Given ∆I= 5 crore
MPS = 0.2
MPC = 1- MPS
MPC= 0.8
K= 1/ (1-MPC) = ∆Y/ ∆I
K= 5 = ∆Y/ 5
25 crore = ∆Y
New Income = 300+ 25 = 325 Crore
Increase in consumption = ∆Y ×MPC
= 25 × 0.8
=20.0 crore
Equilibrium of Income and Output in Three Sector Model
Y = C+I+G (AS= AD)
S+T= I+G (Leakages = Injections) Government expenses
increases national income from y to y1 . This is government
expenditure multiplier
Numerical
At Equilibrium Y= C+I+G
Government Transfer Payments and its impact on Income
The formula and size of the expenditure multiplier is always
determined by the particular model of the expenditure sector that is
being used.
If Government expenditure increases by 5 percent
Tax rate increases by 5 percent
Disposable income will remain unchanged.
There is no induced increase in consumption, as the effect of higher
taxes exactly offsets the effect of the income expansion, leaving
disposable income unchanged.
Four Sector Model
Y= C+I+G+(X-M)
Product Market = Production of goods and services and purchase of
goods and services
Factor Market = Factor services rendered and factor payments
made
Four Sector Model and Impact of Imports on National Income
Import Function = Imports =M (constant) + mY
m( is marginal propensity to import) = ∆Y/ ∆ m
Foreign Trade Multplier
Y= C+I+G+X-M Aggregate Supply = Aggregate Demand
S+T+M= I+G+X Leakages = Injections
Higher the value of ‘m’ (propensity to import) lower will be the
impact of Investment and government expenditure on the
national income of the country. Direct effect on Income and
induced effect on consumption of domestic goods results in lower
domestic production. Increase in imports per unit of the income
leads to leakages in the economy.
Question:
Due to recession in an economy, government expenditure increases
by INR 6 billion, if MPC =0.8 compute the increase in GDP (2
Marks)
Government Expenditure Multiplier = ∆Y/∆G = 1/ (1-MPC)
Question : If Consumption = 200+ 0.60 Yd
Government Spending = 150 crore
# Comment on the following statement:
“When aggregate demand falls below the current output level, an
unintended inventory accumulation occurs and the economy is no
longer in equilibrium.”
Deflationary Gap and Inflationary Gap is with respect to full
employment
If Aggregate Demand < Aggregate Supply at full employment:
Economy is performing at less than the real GDP or Potential
GDP or at full employment. Desired investment < actual
investment as well as unintended inventories are more.
Involuntary unemployment will increase.
If Aggregate Demand > Aggregate Supply at full employment:
Economy is performing at more than the real GDP or Potential
GDP or at full employment. No increase in real output and real
income but due to increase in price level nominal output and
nominal income will increase.