National Income
National Income Determination
Introduction
• A key objective of Macroeconomics is to explain GDP growth and its fluctuations • Therefore, need to understand the forces that determine GDP (“National Income”)
• John Maynard Keynes in his “General Theory of Employment, Interest and Money” (1936) developed a model of income determination • Known as Keynesian Theory of Income Determination
• Aggregate spending / demand determines the level of aggregate output
Concepts and Functions
Actual vs. Planned Expenditure
• Actual expenditures are expenditures actually incurred by the economic entities in the economy • Planned expenditures are expenditures intended to undertake by the economic entities • Macroeconomic equilibrium (as proposed by Keynes) occurs when the actual Aggregate Demand (expenditure) equals the planned Aggregate Demand (expenditure) • i.e., the planned (intended) AD should equal the actual level of output, which is the equilibrium level of output
Components of Aggregate Demand Two-sector Model
AD = C + I
Consumption Function (C)
• A functional statement of the relationship between disposable income (Y) and consumption expenditure (C)
C = f(Yd)
• Consumption is a positive linear function of income
C = a + bYd
Note: In a two-sector model Y = Yd. (Why?)
a is a positive constant, (a>0) showing the level of consumption at zero level of income, also known as autonomous consumption b represents the slope of the consumption function 0 excess demand (ED) If AD < Output => excess supply (ES)
Equilibrium Output
Desired AD > output spending
E
AD < output
AD = C + I
45o
Output, Income
Planned Investment = Planned Savings
Saving, Investment S = -a + (1-b)Y
-a
E
I
Income (Y)
Planned investment < planned saving i.e. households planned consumption is less than firms’ investment plans; firms build up stocks and/or reduce output
Planned investment > planned saving i.e. households planned consumption is
Introduction
• A key objective of Macroeconomics is to explain GDP growth and its fluctuations • Therefore, need to understand the forces that determine GDP (“National Income”)
• John Maynard Keynes in his “General Theory of Employment, Interest and Money” (1936) developed a model of income determination • Known as Keynesian Theory of Income Determination
• Aggregate spending / demand determines the level of aggregate output
Concepts and Functions
Actual vs. Planned Expenditure
• Actual expenditures are expenditures actually incurred by the economic entities in the economy • Planned expenditures are expenditures intended to undertake by the economic entities • Macroeconomic equilibrium (as proposed by Keynes) occurs when the actual Aggregate Demand (expenditure) equals the planned Aggregate Demand (expenditure) • i.e., the planned (intended) AD should equal the actual level of output, which is the equilibrium level of output
Components of Aggregate Demand Two-sector Model
AD = C + I
Consumption Function (C)
• A functional statement of the relationship between disposable income (Y) and consumption expenditure (C)
C = f(Yd)
• Consumption is a positive linear function of income
C = a + bYd
Note: In a two-sector model Y = Yd. (Why?)
a is a positive constant, (a>0) showing the level of consumption at zero level of income, also known as autonomous consumption b represents the slope of the consumption function 0 excess demand (ED) If AD < Output => excess supply (ES)
Equilibrium Output
Desired AD > output spending
E
AD < output
AD = C + I
45o
Output, Income
Planned Investment = Planned Savings
Saving, Investment S = -a + (1-b)Y
-a
E
I
Income (Y)
Planned investment < planned saving i.e. households planned consumption is less than firms’ investment plans; firms build up stocks and/or reduce output
Planned investment > planned saving i.e. households planned consumption is
References: 1. Chapters 6, 7, and 8, ‘Macroeconomics Theory and Policy’, by D.N. Dwivedi. 2. Chapter 9,‘Principles of Macroeconomics’, by William Boyes and Michael Melvin. 3. Chapter 3, ‘Macroeconomic Policy Environment’ by Shymal Roy. Thank You