Transcript Document

DETERMINATION OF
NATIONAL INCOME in the
Keynesian Model
At Equilibrium national income:
– withdrawals equal injections
– income equals expenditure
A simplified circular flow of income model
J=I+G+X
Cd
Incomes
fig
W=S+T+M
Consumption
• Determinants of consumption
– Disposable income
– wealth, interest rates, taxation policy,
consumer indebtedness, future expectations
Consumption Function
C’
C
Consumption
Spending
C2
An increase in wealth, and
improvement in
expectations, will shift the
consumption function
upward.
B′
A′
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′.
B
C1
A
45o
Y1
Y2 Income
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
Investment Spending
Investment
Spending
Interest
rate
(billions $)
r
I
50
I
50
Investment
Demand
(billions $)
Income
Graphical Analysis
AE = C + I + G + Xn
C+I
Aggregate
Expenditures
(Spending)
C
G
I
45o
Y*
Income
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).
The Multiplier Principle
Expenditure
stage
Additional income
Additional consumption
Marginal propensity
to consume
(dollars)
(dollars)
Round 1
Round 2
Round 3
Round 4
Round 5
All others
1,000,000
750,000
562,500
421,875
316,406
949,219
750,000
562,500
3/4
3/4
421,875
316,406
237,305
711,914
3/4
3/4
3/4
3/4
Total
4,000,000
3,000,000
3/4
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).
A Higher MPC
Means a Larger Multiplier
MPC
.9
.8
.75
.66
.5
.33
Size of
multiplier
10.0
5.0
4.0
3.0
2.0
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.).
• The multiplier:
• the formula: the simple multiplier
1 / (1 – mpc) or 1/mps
• the full multiplier:
1 / mpw
(mpw=mps+mrt+mpm)
• Withdrawals
– net saving: the saving function
• 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
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.
DETERMINATION OF
NATIONAL INCOME
• Relationship between the 45° line diagram
and the AD and AS diagram
Showing the multiplier effect on the 45o line and AD/AS diagrams
Price Level
AS
AD1
O
Output
Spending
AE1
O
fig
Ye
Y
Price Level
AS
AD1
O
Output
AE2
Spending
AE1
O
fig
Ye
Ye2
Y
Price Level
AS
AD2
AD1
O
AD3
Output
AE2
Spending
AE1
O
fig
Ye
Ye2
Y
Short-run Macroeconomic
Equilibrium
Simple Keynesian Analysis of Unemployment and
Inflation
ending
The recessionary gap
AE
O
Ye
figY
F
Y
Spending
The recessionary gap
AE
a
b
recessionary gap
O
Ye
figY
F
Y
Spending
The inflationary gap
AE
e
Inflationary gap
O
f
Yfig
F
Ye
Y
Spending
The recessionary gap
AE
a
b
recessionary gap
S
c
d
O
Ye
figY
F
I
Y