1. DETERMINATION OF NATIONAL INCOME in the Keynesian Model
At Equilibrium national income:
withdrawals equal injections
income equals expenditure 5

2. A simplified circular flow of income model
J = I + G + X
Incomes Cd
fig
W = S + T + M

3. Consumption Determinants of consumption Disposable income
wealth, interest rates, taxation policy, consumer indebtedness, future expectations

4. Consumption Function C’ C
An increase in wealth, and improvement in expectations, will shift the consumption function upward. C
Consumption
Spending B′ C2
An 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′ B C1 A
45o Y1 Y2
Income

5. Investment Investment Interest rate net rate of profit capital stocks
business taxes
technological innovations
future expectations
Assumptions:
interest rates are fixed,
hence investment is given at some level

6. Investment Spending Investment Spending Interest rate I r 50 I 50
(billions $)
Interest rate I r 50 I 50
Investment Demand (billions $)
Income

7. Graphical Analysis AE = C + I + G + Xn C + I C G Income Aggregate
Expenditures
(Spending) C G I
45o Y*
Income

8. The Multiplier
The 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).

9. The Multiplier Principle
Expenditure
stage
Additional income (dollars)
Additional consumption (dollars)
Marginal propensity to consume
Round 1
1,000,000
750,000
3/4
Round 2
750,000
562,500
Round 3
562,500
421,875
Round 4
421,875
316,406
Round 5
316,406
237,305
All others
949,219
711,914
Total
4,000,000
3,000,000
For 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).

10. Means a Larger Multiplier
A Higher MPC
Means a Larger Multiplier
Size of multiplier
MPC .9
10.0 .8
5.0
.75
4.0
.66
3.0 .5
2.0
.33
1.5
As 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.).

11. the formula: the simple multiplier 1 / (1 – mpc) or 1/mps
The multiplier:
the formula: the simple multiplier
1 / (1 – mpc) or 1/mps
the full multiplier:
1 / mpw (mpw=mps+mrt+mpm) 6

12. Withdrawals net saving: the saving function net taxes: tax functions
the mps: marginal propensity to save
determinants of saving
net taxes: tax functions
the mrt: marginal rate of taxation
imports: import functions
the mpm: marginal propensity to import
effect of imports on Cd
the withdrawals function
MPS+MRT+MPM = MPW: marginal propensity to withdraw 3

13. The Multiplier
In 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.

14. DETERMINATION OF NATIONAL INCOME
Relationship between the 45° line diagram and the AD and AS diagram 7

15. Showing the multiplier effect on the 45o line and AD/AS diagrams
Price Level AS
AD1 O
Output
Spending
AE1 O
fig Y
Ye1

16. Price Level AS
AD1 O
Output
AE2
Spending
AE1 O
fig Y
Ye1
Ye2

17. AD2
Price Level
AD3 AS
AD1 O
Output
AE2
Spending
AE1 O
fig Y
Ye1
Ye2

18. Short-run Macroeconomic Equilibrium
Simple Keynesian Analysis of Unemployment and Inflation

19. The recessionary gap
Spending AE O
fig Ye YF Y

20. The recessionary gap
Spending AE a
recessionary gap b O
fig Ye YF Y

21. The inflationary gap
Spending AE e
Inflationary gap f O Ye
fig YF Y

22. The recessionary gap AE S I Spending Y a b recessionary gap c d O Ye
fig Ye YF Y