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Keynesian Theory of Income Determination : two-sector model using AE=AS Approach This courseware is designed for revision purposes after finishing the above topic. 13 power point presentations 1 excel worksheet for interactive construction 10 multiple choice questions (4 options) It includes the following areas:

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Keynesian Theory of Income Determination : two-sector model using AE = AS Approach Coursework(Sec1-39-11) by s.w. Leung

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Assumptions in NI Models a single concept of NI (Y) a constant level of potential income (Yf) existence of unemployment constant price level i.e. Y=Q since P=1

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Two-sector model --- Keynesian Circular flow diagram E(AE) : Aggregate expenditure Y(NI) : National income Next section

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Circular flow diagram Two sectors : Household & Firm Household Firm Financial market C E Y S I National Income National Expenditure C : consumption S : saving I : investment Y : Income generated E : Payments for goods & services

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E = C + I E (AE) : Aggregate expenditure In a two-sector economy, firms (F) produce consumption goods (C) and investment goods (I), that means expenditure (E) in the economy is on either C or I ; and we get an income- generated function.

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Y(NI) : National income On the other hand, income (Y) received by households (H) is either consumed (C) or saved (S). To complete the flow of income and expenditure, E = Y, we get the equilibrium income (Ye).

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A graphical approach (AE = AS) to income determination E function and Y-line component of AE simple algebra of income determination construction

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E function and Y-line E function E = C + I E Y 0 E(AE) : Demand side Y(AS) : Supply side E = Y E Y Y-line(45 0 ) 0 Construct a Y-line (45 0 ) : shows all the points where E equals Y E = Y = Q (re: assumption P=1) (E) expenditure in the economy equals (Y) income generated by producing (Q) output

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Component of AE Consumption function : Cf Cf = C + cY a function of Yd (in a two-sector model Y = Yd) C : intercept on E-axis (amount consumed when income is zero) c : slope of Cf (c is the marginal propensity to consume) Investment function : I I : an autonomous function (doesn’t vary with Y) Aggregate expenditure function (E or AE) E = C + I a function of Y

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Simple algebra of income determination Given : C = 80 + 0.6Y I = 40 Find Ye Solution : E = C + I E = 80 + 0.6Y + 40 = 120 + 0.6Y In equilibrium E = Y(Ye) Y = 120 + 0.6Y 0.4Y = 120 Y = 300 and C = 80 + 0.6(300) = 260

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construction Let’s take C = 80 + 0.6Y and I = 40 to find Ye graphically An excel worksheet (sheet 1) will be used to illustrate.

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Multiple Choice Exercise MCdemo25.htm demo1.wmf MCdemo25.htm demo1.wmf You come to the END !!!

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