Presentation on theme: "DETERMINATION OF NATIONAL INCOME in the Keynesian Model"— Presentation transcript:
1DETERMINATION OF NATIONAL INCOME in the Keynesian Model At Equilibrium national income:withdrawals equal injectionsincome equals expenditure5
2A simplified circular flow of income model J = I + G + XIncomesCdfigW = S + T + M
3Consumption Determinants of consumption Disposable income wealth, interest rates, taxation policy, consumer indebtedness, future expectations
4Consumption Function C’ C An increase in wealth, and improvement in expectations, will shift the consumption function upward.CConsumptionSpendingB′C2An increase in income from Y1 to Y2, leads to an increase in consumption from C1 to C2. Hence the economy moves from point B on the consumption function to point B′.A′BC1A45oY1Y2Income
5Investment Investment Interest rate net rate of profit capital stocks business taxestechnological innovationsfuture expectationsAssumptions:interest rates are fixed,hence investment is given at some level
6Investment Spending Investment Spending Interest rate I r 50 I 50 (billions $)Interest rateIr50I50Investment Demand (billions $)Income
7Graphical Analysis AE = C + I + G + Xn C + I C G Income Aggregate Expenditures(Spending)CGI45oY*Income
8The MultiplierThe view that a change in autonomous expenditures (e.g. investment) leads to an even larger change in aggregate income.The multiplier is the number by which the initial change in spending is multiplied to obtain the total amplified increase in income.The size of the multiplier increases with the marginal propensity to consume (MPC).
9The Multiplier Principle ExpenditurestageAdditional income (dollars)Additional consumption (dollars)Marginal propensity to consumeRound 11,000,000750,0003/4Round 2750,000562,500Round 3562,500421,875Round 4421,875316,406Round 5316,406237,305All others949,219711,914Total4,000,0003,000,000For simplicity (here) it is assumed that all additions to income are either spent domestically or saved.The multiplier concept is fundamentally based upon the proportion of additional income that households choose to spend on consumption: the marginal propensity to consume (here assumed to be 75% = 3/4).
10Means a Larger Multiplier A Higher MPCMeans a Larger MultiplierSize of multiplierMPC.910.0.85.0.754.0.6188.8.131.52.331.5As the MPC increases more and more money of every injection is spent (and so received as payment and then spent again, received as payment and spent again, etc.).
11the formula: the simple multiplier 1 / (1 – mpc) or 1/mps The multiplier:the formula: the simple multiplier1 / (1 – mpc) or 1/mpsthe full multiplier:1 / mpw (mpw=mps+mrt+mpm)6
12Withdrawals net saving: the saving function net taxes: tax functions the mps: marginal propensity to savedeterminants of savingnet taxes: tax functionsthe mrt: marginal rate of taxationimports: import functionsthe mpm: marginal propensity to importeffect of imports on Cdthe withdrawals functionMPS+MRT+MPM = MPW: marginal propensity to withdraw3
13The MultiplierIn evaluating the importance of the multiplier, one should remember:taxes and spending on imports will dampen the size of the multiplier;it takes time for the multiplier to work; and,the amplified effect on real output will be valid only when the additional spending brings idle resources into production without price changes.
14DETERMINATION OF NATIONAL INCOME Relationship between the 45° line diagram and the AD and AS diagram7
15Showing the multiplier effect on the 45o line and AD/AS diagrams Price LevelASAD1OOutputSpendingAE1OfigYYe1