National income determination

Equilibrium in a Simple Economy

Simple economy: Two Sector, Closed Economy System

Two Sectors: Consumption (+Savings) and Investments

Equilibrium in a Simple Economy

Simple Economy: Overall Production (AS) = Aggregate

Demand (AD) for the final goods and services Equilibrium Condition: AS = AD Equilibrium = economic stability

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

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+I Z = Aggregate Demand C = Consumption Expenditures I = Investment Expenditures

Equilibrium in a Simple Economy

Equilibrium Condition: AS = AD

Y=Z
C+S=C+I

S=I

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

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

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

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 additional income used in additional consumption; additional consumption per unit increase in the level of national income

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

Simple Theory of National Income Determination

Y=C+I

Investment (I)
Independently determined from the level of national income

I = I0

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

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

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

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

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)

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)

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

Simple Theory of National Income Determination

Conditions for Disequilibrium

Y<Z
C+S<C+I

S<I
Excess aggregate demand -> inflationary pressure

Simple Theory of National Income Determination

Conditions for Disequilibrium

Y>Z
C+S>C+I

S>I
Lack of Demand