Download - National Income Determination
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1
National Income Determination
Two approaches: To Determine National Income Equilibrium:
1.Total Approach.
2.Injection-Leakage Approach.
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Total Approach:
• Equilibrium may occur when planned aggregate expenditure is equivalent to planned output.
(AE=Y) or (AD = AS) (aggregate demand = aggregate supply).
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Leakage-Injection Approach: • Equilibrium also can be determined when: INJECTION = LEAKAGE
Injections are additional spending from: investments (I),
government purchases (G) and exports (X).
Leakages are withdrawals from: savings (S),
tax payment (T) and imports (M). • So, at equilibrium, (I+G+X = S+T+M) (INJECTION = LEAKAGE)
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DETERMINATION OF EQUILIBRIUM NATIONAL INCOME
• Aggregate demand is the total amount of expenditure on domestic goods and services.
AD= C + I + G + (X – M)
Y = C + I + G + (X – M)
The higher the level of aggregate demand or aggregate expenditure, the higher the level of output and employment.
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Components of Aggregate Expenditure:
1. CONSUMPTION, C = f (Yd)2. INVESTMENT, I = f (i, Y)3. GOVERNMENT EXPENDITURE, G4. NET EXPORT (X – M)
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1. Consumption and Saving
Disposable Income is used for Consumption spending and Saving. Yd = C + S
and, C = f (Yd), S = f (Yd) Both C and S is a function of income,Y and having a positive
relationships. ( Y rises, C and S also will rise).
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Given that;Consumption function: C = a + bYd
and Saving function: S = – a + (1 – b) Yd
There is (two)2 components of Consumption spending by households: C1, Autonomous Consumption = a
C2, Induced Consumption = bYd
Where, b is the Marginal Propensity to Consume
(MPC).
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Autonomous Consumption,C1 = a
is the vertical intercept of the consumption function,
It is the amount of consumption that would
occur even if the household earned nothing, Y=0. when Y= 0 (no income earned), C = a. (basic consumption for living).
C C = a + b Yd
a 0 Y
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Autonomous Consumption (a) and Induced Consumption (bY)
C1 = a is a fixed amount irrespective of the income earned,
is the part of consumption which does not vary with the level of income (Y increases but “a” is constant).
C2 = bY is an amount that depends on the disposable income,
is the amount of consumption spending by households that is induced by disposable income (Y increases, C2 increases).
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CONSUMPTION, C•Consumption function, C
C = a + bYd a Yd
The slope of consumption function is given by: b = C/ Y = Marginal Propensity to Consume (MPC)
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Consumption and Saving scheduleY C S 0 60 -60
100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140
With no income earned, Y = 0 , autonomous C = a = 60 and dissaving = - a = - 60.While Y = C + S , if Y = 0 , then C = - S.
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How is the increase in income will increase consumption?
Consumption is induced by the value of b (that is =
MPC),
since,
C = a + bY
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FOR EXAMPLE: Given that C = a + bY, therefore, if b = 0.6 , how large is the increase in consumption if there is an increase in income?Since C = a + 0.6Y, thus C will increase by 0.6Y , (given a = autonomous consumption) , so, C will increase by 60% out of total income, Y. Meaning that, for any increase in income, 40% can be saved and 60% will be spend on consumption.
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Consumption and Saving scheduleY C S 0 60 -60
100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140
In a 2-sector economy, C = a + bY .Since C = a + 0.6Y, and a = 60 thus C = 60 + 0.6Y.At income 200, C = 60 + 0.6(200) = 60 + 120 = 180 and Y = C + S so , S = Y – C = 200 -180 = 20.
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Changes in consumption when income change.
consumption
Y = CC = a + b Y
C Y
45°income
Note: b = C = 400
1000 1500
Y
500
400
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Changes in consumption when income change.
consumption Y = C
C = a + b Y C
Y
45°income
Note: b = C
= 400
1000 1500
Y
500
ea
400
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SAVINGS• Some part of income earned is saved.• two components of savings:
autonomous dissaving, S1 = – a induced saving, S2 = (1 – b)Ywhere,(1 – b) = Marginal Propensity to Save.
= S/Y = slope of saving function.
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Dissaving and saving.
Autonomous dissaving, (- a), is the amount that households draw out from their wealth to consume when no income earned.
Induced saving, (1 –b)Y, is the amount of saving that is induced by earnings of disposable income.
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Saving Function, S
Saving
Yd (output)
S = – a + (1– b)Yd
–a
0
(1 – b) is the slope of saving function = ΔS/ΔY
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Consumption & Saving Function,
C,S
Yd (output)
S = – a + (1– b)Yd
– a
0
C = a + bYd
a45º
e
Y = C + S,When S = 0,Y = C at the breakeven, point, e.
Y = C
Y = AD
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Note that:
MPC + MPS =1, thus MPS = (1 – MPC).If MPC = b and MPS = (1 – b),Then, b + (1 – b) = 1
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APC, APSThe fraction of income that is used for
consumption is the: Average Propensity to Consume (APC): APC = C YAnd, the fraction of income that is used for saving
is the: Average Propensity to Save (APS): APS = S Y and, at any level of income, APC + APS = 1
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MPC
INCOME,Y
CONSUMPTION, C C = a + bYd
∆C
∆Y
0 1600
1200
a
MPC = ∆C = 400
∆Y 600
is the slope of the consumption function.
1000
800
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MPC, APC
INCOME,Y
CONSUMPTION, C C = a + bYd
∆C
∆Y
0 1600
1200
a
MPC = ∆C = 400
∆Y 600 APC = TC = 1200 TY 1600
1000
800
TC
TY
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MPC, APC
INCOME,Y
CONSUMPTION, C C = a + bYd
0 1600
1200
a
MPC = ∆C = 400
∆Y 600 APC = TC = 1200 TY 1600
1000
800
TC
TY
TC
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Saving
Yd ( output)
S = – a + (1– b)Yd
–a
0
MPS = (1 – b) = ΔS/ΔY
is the slope of saving function.
ΔS
ΔY
MPS, APS
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Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
while, APS = TS/TY
ΔS
ΔYTS
TY
MPS, APS
TS
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Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
while, APS = TS/TY
TS
TY
MPS, APS
TS
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BREAK-EVEN INCOME is a situation when all the income is just nice
for consumption purposes while no saving at all.
thus, Y = C and S = 0.
S = - a + (1 – b)Y
C = a + bYe
C,S
Y45º
AS=AD
S < 0
S > 0
S = 0
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Activity
INCOME(Y) CONSMPTN (C) SAVING(S)0 140
200 260400 20600 500800
1000
1. Use the given data to answer the following questions.
a) Fill up the blank with appropriate values.
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b) What are the values of MPC and MPS?c) Write down the consumption function and saving function.d) What is the amount of break-even income?
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ANSWER
INCOME(Y) CONSMPTN (C) SAVING(S)0 140 140
200 260 60400 120 + 260 = 380 20600 500 100800 120 + 500 = 620 180
1000 120 + 620 = 740 260
1. Use the given data to answer the following questions.
a) Fill up the blank with appropriate values.
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b) What are the values of MPC and MPS? MPC = C = 260 - 140 = 0.6
Y 200 – 0
MPS = 1 – MPC = 1 – 0.6 = 0.4c) Write down the consumption function and saving function. C = 140 + 0.6Y S = - 140 + 0.4Y
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d) What is the amount of break-even income? is a point at e, when S = 0, so Y = C. S = - 140 + 0.4YSince S = 0, 0 = -140 + 0.4Y 140 = 0.4Y Y = 140/0.4 = 350
S = -140 + 0.4Y
C= 140 + 0.6Ye
C,S
Y45º
S = 0
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Activity 2
INCOME(Y) CONSMPTN (C) SAVING(S)0 140 140
200 260 60400 380 20600 500 100800 620 180
1000 740 260Calculate the APC and APS at each level of income.
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INCOME(Y)
CONSMPTN (C)
SAVING(S)
0 140 140200 260 60400 380 20600 500 100800 620 180
1000 740 260
APC APS
- -1.3 - 0.3
0.95 0.050.83 0.170.78 0.230.74 0.26
ANSWER:
The values for APC and APS at each level of income.
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2. INVESTMENT Investment is defined as the spending or purchase of plants, machineries,
buildings and inventories by firms for the purpose of producing goods and services.
two(2) types of investment spending: i) Autonomous Investment what firms may had intended to plan or desired or has been
fixed and does not depend on income.ii) Induced Investment actual investment expenditures used to produce newly produced
goods, and depends on the level of:
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Investment depends on the level of: I = f ( i,) interest rate, future expected profitability, income, technology, capacity and business taxes.
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1. Autonomous InvestmentAs assume by Keynes; - is a fixed investment that does not change with the change in
income, but ; there will be a shift in the autonomous horizontal function, up or
down when there’re other factors that affect it.
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1. Autonomous Investment Function Investment
I1
Autonomous
Investment I0
Diagram: Autonomous InvestmentA shift in autonomous investment upward to I1 may cause
by an increase in expected profit or a fall in interest rate but does not depend on income.
Income
refers as a fixed investment that does not change with the change in income.
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2. Induced Investment Functionreal interest rate (i)
I = f(i, e
)
I = f(i)
I’ I’’ Investment
Diagram: Induced InvestmentInduced investment has a negative relationship with real rate of interest.
If future profit is expected to increase, at any given level of real interest rate the investment function will increase and shift the curve to the right.
i1
i2
refers to an investment that changes with the interest rate, income or expected profitability etc.
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2. Induced Investment Function investment
I = f(Y)
Income
Diagram: Induced InvestmentInduced investment has a positive relationship with aggregate income.
Example is capital investment by the purchase of new plants and equipments.
is the actual investment that is induced by changes in income.
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Investment and Saving• Investment is an injection: could increase aggregate
expenditure (AD) and boost up economic growth (income).
Investment spending will multiply through the multiplier effect to increase income.
• Saving is a leakage: could lower aggregate expenditure (AD) and income.
Saving becomes an outflow of money (leakage) from an economy. It becomes a stock of money that is not spent.
• At equilibrium, Saving will be equal to Investment, ( S = I )
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Equilibrium in 2 sector economy
C,I
Yd (output)
045º
C + I
Y2
Y=AD
e2
equilibrium; Y = C + I (in 2 sector economy)
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Equilibrium in 2 sector economy
C,S,I
Yd (real output)
S = – a + (1– b)Yd
0I
Y2
e2S = I
In 2 sector econ; equilibrium; S = I
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1) If investment is 150 millions, calculate the equilibrium income and sketch a diagram to show this.
I = 150 C = 140 + 0.6YAnswer:At equilibrium (in 2 sector economy);(Using Total Approach): Y = C + I Y = 140 + 0.6Y + 150 Y – 0.6Y = 290 0.4Y = 290 Y = 290/0.4 Y = 725
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Y = AD
C + I
Y
C,I
e
Ye = 72545º
ANSWER:
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3. GOVERNMENT EXPENDITURE
Government Expenditure
Income Diagram: Autonomous Government Expenditure
G1
G0
G will be autonomously fixed according to Government Budget Policy for each year.
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4. NET EXPORT (X – M)
Export is an injection and could increase the national income through the foreign trade multiplier, but import is a leakage.
Thus, net export (X-M), means the real foreign sector minus the total import of goods and services into the economy.
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FULL EMPLOYMENT Equilibrium
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•full employment equilibrium is an ideal objective because at this level of income, there is no available and useful resource of the economy that is wasted.
•full employment means the full utilization of all available labor and capital resources so that the economy is able to produce at the limits of its potential gross national product.
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NATIONAL INCOME EQUILIBRIUM with inflation
Real Output (National Income)
ExpenditureY1=C+I+G+(X-M)
Y=E
45°
Yfe=C+I+G+(X-M)
Yfe Ye1
Inflationary Gape1
ef
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NATIONAL INCOME EQUILIBRIUM with unemployment
Real Output (National Income)
Expenditure
Y0 = C+I+G+(X-M)
Y=E
45°
Yfe=C+I+G+(X-M)
Ye0 Yfe
Deflationary Gape0
ef
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MULTIPLIERSAny Injection will multiply positively, whileany Leakage will multiply negatively.