Lecture 3 - National Income Determination

8/12/2019 Lecture 3 - National Income Determination

http://slidepdf.com/reader/full/lecture-3-national-income-determination 1/21

National income determination



Equilibrium in a Simple Economy

Simple economy: Two Sector, Closed Economy System

Two Sectors: Consumption (+Savings) and Investments




Simple Economy: Overall Production (AS) = AggregateDemand (AD) for the final goods and services

Equilibrium Condition: AS = AD

Equilibrium = economic stability





AS Total income generated by owners of factor inputs

used in the production of final goods and services for a

particular period of timed

Y = C + S

Y: Total Income

C: Consumption

S: Savings





AD measure of the sum of various forms of demand for

final goods and services

Z = C + IZ = Aggregate Demand

C = Consumption Expenditures

I = Investment Expenditures





Y = Z

C + S = C + I

S = I




S = I

Savings

Part of national income for nonconsumption

Outflow: not used to purchase the final goods and services

produced within the year




S = I

To offset the outflow, an equal amount of inflow or injection

into the system must be undertaken to maintain the

equilibrium in the economy

Investments

A form of deman that purchases the final goods and services not

consumed by households



Simple Theory of National Income

Determination

Y = C + I

Consumption (C)

Influenced positively by the level of national income (NI),

increase in NI, increase in C

Increase in C < increase in NI – may devote the increase in NI

to savings




Determination

Y = C + I

Consumption (C)

Consumption Function

Relationship describing the factors that influence the level of

consumption expenditures in the economy

C = C0 + cY

C0: autonomous consumption

cY: income-led consumption

c: marginal propensity to consume (mpc) –

proportion of the additionalincome used in additional consumption; additional consumption per

unit increase in the level of national income




Determination

Z = S + I

Savings

Savings Function

Complement of the consumption function

S = -C0 + sY

-Co: autonomous savings

sY: level of savings that is influenced by the level of income

s: marginal propensity to save – influence of a unit change in NI




Determination

Y = C + I

Investment (I)

Independently determined from the level of national income

I = I0




Determination

Y = C + I

Y = C0 + cY + I0

Y – Co – cY = Io

-Co + (1 –

c)Y = I0 -Co + sY = Io

* Equilibrium condition in the economy is attained




Determination

sY = Co + Io

Y = 1/s (Co + Io)

Y = 1/(1-c)*(Co + Io)

• Equilibrium level of NI is the reciprocal of mps

• Reciprocal of mps – multiplier – a number that

measures the change in national income due to changes

in autonomous expenditures




Determination

sY = Co + Io

Y = 1/s (Co + Io)

Y = 1/(1-c)*(Co + Io)

• Equilibrium level of NI is the reciprocal of mps

• Reciprocal of mps – multiplier – a number that

measures the change in national income due to changes

in autonomous expenditures




Determination

Concept of Multiplier Multiplier effect: the effect of the changes in autonomous

expenditures on national income

Cumulative effect of an initial expenditure on subsequent

expenditures and income Multiplier: a number that measures the increase in national

income due to an increase in autonomous expenditures




Determination

Equilibrium National Income with No Change in Investment

Y = Z

Y = Co + cY + Io

Y –

cY = Co + Io Y (1 – c) = Co + Io

Y1 = 1/ (1-c) * (Co + Io)




Determination

Equilibrium National Income with Change in Investment

Y = Z

Y = Co + cY + Io +I

Y –

cY = Co + Io +

I Y (1 – c) = Co + Io +I

Y2 = 1/ (1-c) * (Co + Io +I)




Determination

Change in National Income Due to a Change in Investment

Y = Y2 – Y1

Y = [1/ (1-c) * (Co + Io +I)] – [1/ (1-c) * (Co + Io)]

Y = 1/ (1

–

c) *

I Y/I = 1/ (1 – c) multiplier




Determination

Conditions for Disequilibrium

Y < Z

C + S < C + I

S < I Excess aggregate demand -> inflationary pressure




Determination

Conditions for Disequilibrium

Y > Z

C + S > C + I

S > I Lack of Demand

Documents

Lecture 3 - National Income Determination