Lecture 3 - National Income Determination
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Transcript of 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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 2/21
Equilibrium in a Simple Economy
Simple economy: Two Sector, Closed Economy System
Two Sectors: Consumption (+Savings) and Investments
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 3/21
Equilibrium in a Simple Economy
Simple Economy: Overall Production (AS) = AggregateDemand (AD) for the final goods and services
Equilibrium Condition: AS = AD
Equilibrium = economic stability
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 4/21
Equilibrium in a Simple Economy
Equilibrium Condition: AS = AD
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 5/21
Equilibrium in a Simple Economy
Equilibrium Condition: AS = AD
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 6/21
Equilibrium in a Simple Economy
Equilibrium Condition: AS = AD
Y = Z
C + S = C + I
S = I
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 7/21
Equilibrium in a Simple Economy
S = I
Savings
Part of national income for nonconsumption
Outflow: not used to purchase the final goods and services
produced within the year
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 8/21
Equilibrium in a Simple Economy
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 9/21
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 10/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 11/21
Simple Theory 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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 12/21
Simple Theory of National Income
Determination
Y = C + I
Investment (I)
Independently determined from the level of national income
I = I0
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 13/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 14/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 15/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 16/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 17/21
Simple Theory of National Income
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)
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 18/21
Simple Theory of National Income
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)
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 19/21
Simple Theory of National Income
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
8/12/2019 Lecture 3 - National Income Determination
http://slidepdf.com/reader/full/lecture-3-national-income-determination 20/21
Simple Theory of National Income
Determination
Conditions for Disequilibrium
Y < Z
C + S < C + I
S < I Excess aggregate demand -> inflationary pressure