NATIONAL INCOME EQUILIBRIUM What is National Income Equilibrium

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NATIONAL INCOME EQUILIBRIUM What is National Income Equilibrium Powered By Docstoc
					NATIONAL INCOME EQUILIBRIUM



What is National Income Equilibrium?

Is a situation where there is no tendancy for the NI to change.According
to Keynes, it will achived when;

The Total Value of Expenditure made by all sector in economy
                          =
          The Total Value of Output Produced

Why it is important to study the NI Level?
 - Because the Equilibrium level will affect the employment in the
    economy.
 - Also related to the rate of unemployment in the economy.
 - If the level of NI is it means there is a lots of goods and
    services produced in the economy and reflects that a great amount
    of resources are being employed in the economy.
2 Approaches to determine National Income Equilibrium

   1. Aggregate Demand and Aggregate Supply Approach
      (AD=AS)

Aggregate Demand or aggregate expenditure is the total demand for good and
services in the economy.       consumption
                                investment
                                government sector
                                foreign sector (net exports)

Aggregate Supply or aggregate output is the total quantity of goods and services
produced in an economy in any given period of time

Equilibrium NI:
                              AD= AS


   2.    Leakage – Injection Approach

Leakage is a withdrawal from the income- expenditure stream. Leakage include
Savings, taxes and imports.

Injection is additional spending to the income-expenditure stream.Injections
include investment, government expenditure and exports.

Equilibrium NI:
                              LEAKAGE = INJECTION
CONSUMPTION AND SAVINGS

Consumption Theory

Consumption refers to the purchase of goods and services by individuals or
households which are produced by firms.

Income = Consumption + Savings

      Y= C+S


Average Propensity to Consume (APC)

  -        Is the relationship between the total income and total consumption.

  -        Is the ratio of total consumption to total income

  APC = Total Consumption

           Total Income

           = C
             Y


Marginal Propensity To Consume (MPC)

  -        Is the relationship between a change in total Consumption and change

           in total income

  -        Is the ratio of change in total Consumption to change in total income.

      MPC = Change in Total Consumption
                Change in Total Income

           =              C
                          Y
Consumption Function
  - Refers to the relationship between the consumption level and the income
     level.

       C = a + bYd                      where,
                                        C      = consumption expenditure
                                        a      = autonomous consumption (does not
                                        depend on the income level)- the part of
                                        consumption when the consumer income
                                        level is 0
                                        b        = marginal propensity to consume
                                                (MPC)
                                        Yd = Disposable Income


Savings Theory              a) Autonomous savings
                            Refers to that part of savings doest not depend on the
                         income level and occurs when there is autonomous
                         consumption.         Is the expenditure incurred by the
                         consumer if there is no income

                                  b) Induced savings
                                     Is part of the income and it depends on the
                                        savings.
                                     income,       savings

Average Propensity to Save (APS)

   -      Is the relationship between the total income and total savings

   -      Is the ratio of total savings to total income

         APS = Total Saving
               Total Income
            = S
                Yd
Marginal Propensity To Save (MPS)

   -       Is the relationship between a change in total savings and change

           in total income

   -       Is the ratio of change in total savings to change in total income.

       MPC =      Change in Total Saving
                  Change in Total Income

            =            S
                         Yd




Savings Function
   - Refers to the relationship between savings and the income level.

        S = - a + ( 1- b )Yd            where,
                                        S     = Savings
                                        -a    = autonomous savings (does not
                                        depend on the income level
                                        1-b     = marginal propensity to save
                                               (MPS) because MPC + MPS = 1
                                        Yd = Disposable Income


Relationship between Consumption and Saving

APC + APS = 1
MPC + MPS = 1
Breakeven

Breakeven income is the level at which households consume all their income.So,
savings is = 0.

At the breakeven point,

   i) Y= C                ii) S= 0           iii) APC= 1        iv) APS= 0



Non Income Determinants
Factor that can change the consumption besides income:

1.Distribution of Wealth
- Assuming that individuals have identical needs, taste and incomes but unequal
wealth.
- Wealthy individuals will spend more on consumption than individuals who are
less wealthy

2. Price and Wage Levels
- affect an individuals propensity to consume.
- Price level    Propensity to Consume
- Wage level Propensity to Consume

3. Changes in Consumer Taste and Fashion
- If people have a buy now and pay later, they are likely to have a higher level of
consumption than they are anxious to avoid getting in debt
- also based from taste and the latest fashion

4. Change in expectations
- example: the expectations of war in the future will increase current purchasing of
goods , especially nessecity good.
5. Rate of interest
- Other things being equal, real consumption is inversely related to the rate of
interest.
- Rational consumer will save more if the rate of interest is high.
- EX : If the rate of interest on fixed deposit increase from 3.5 % to 10 %,
consumer will save more, and reducing their consumption of goods and services.

6. Consumer credit
- An increase in credit limits (credit cards) can attract consumers to borrow and
spend more
- Usage of credit cards can attract consumers to use it for their purchases and this
increase consumption.

7. The invention of new goods
- The invention of new goods coming into the market to replace the old
commodities. Ex : Colour TV replacing black and white. TV.
- The level of consumption expected to rise

Factor that can change the savings
1.The size of disposable income
- Income increase, saving will increase in a greater amount.
- MPS and APS will increase as Y increase

2. The distribution of income
- High income earners save more than low income earners.
- MPS and APS will increase when income increase.
- MPS and APS For higher income earners will increase more than lower income
earners.

3. Interest rate
- Sometimes people saving are influenced by the rate of interest. High interest rate
will encourage individuals to save.
4. Availability of financial Institutions
- The more banks and finance companies that exist, the more opportunity
individuals to save.

5. Government policies
- Government fiscal policy will affect savings. If the government operates
progressive taxes and welfare payments to low income earners, savings will
decline
- because low income earners have a low MPS.


Investment Theory
   - Refers to the spending on purchases and accumulation of capital goods such
      as buildings, equipment, and additions to inventories.

   - 2 types of investment            i) Autonomous investment

                                      ii) Induced investment

   i) Autonomous Investment
   - Is fixed and independent of income.
   - The amount of investment can be influenced by other factor such as interest
      rate, repayment rates, business expectation and technology developments.
   ii) Induced Investment
   - Depends on the National Income.
   - When NI Induced investment will




Factors Influencing Investment

1.Rate Of Interest
- Interest the financial cost that firm must pay to borrow the money capital required
to purchase the real capital

 Ex: Company ALIRAN needs to borrow money from Maybank to buy machinery
for its company. Company ALIRAN must pay an interest rate of 8 % for the
amount of money it borrowed.

- If the rate of interest is        the cost of borrowings more expensive
investment from a firm will

2. Rate Of Return
- Any business or firm will wants a higher return for its investment.
- If the cost of investment > rate of return = not profitable (discourage investors)
3. Government Policies
- To attract investors both domestic foreign
- Government gives some tax exemptions or reductions on investments.
- Ex : In Malaysia, the government reduces corporate tax to encourage foreign
direct investment.

4. Technological changes
- Technological changes can improve the quality of the product

                           Cost of the production

                Rate of return on the investment

               Encourage more investors to invest

   - Ex : Malaysia can produce electronic goods at a lower cost and sell at a
     cheaper price with modern technology.


5. Expectation of the future

- If the firm is confident or optimistic about the future profitability of new existing
products, they will be more interested to invest.
DETERMINATION OF EQUILIBRIUM

Study about How Equilibrium is determined in 2 sector, 3 sector and 4 sector
economies.

A) 2 Sector       Households             B) 3 Sector      Households
                       Firms                               Firms
                                                   Government

C) 4 Sector      Households
                      Firms
                 Government

                    Foreign Sector




Equilibrium in a 2 Sector Economy

   - Equilibrium occurs when AD= AS
Aggregate Demand – Aggregat Supply Approach

   - Sum of all household consumption ( C ) and investment from the firm (I)

                                    AS =Y
                                   AD = C + I

                  So, equilibrium , AS= AD
                                     Y= C+I


   1) Mathematical Equation
      i)   Autonomous Consumption = 100
      ii)  MPC = 0.7
      iii) Autonomous Investment = 500

      So, consumption function, C= 100 + 0.7 Yd
      Y=C+I
        = 100 + 0.7 Y + 500
Y- 0.7Y = 600
0.3Y = 600
      Y = 2000 ( EQUILIBRIUM INCOME)

   1) Graphical Analysis
   - Transfer into graphic form
Leakage- Injection Approach
     Savings from household + Firms = Leakages
     Investment by the firms = Injections

     Equilibrium occurs when,

     Injection = Leakage
     I= S

  1) Mathematical Equation
     i)   Autonomous Consumption = 100
     ii)  MPC = 0.7
     iii) Autonomous Investment = 500

Consumption Function :          C = 100 + 0.7 Y
So, the Saving Function is      S= -100 + 0.3 Y
Equilibrium
                         S= I
             -100 + 0.3 Y = 500
             0.3 Y       = 600
                   Y     = 2000 ( EQUILIBRIUM INCOME)
Graphical Analysis
Equilibrium in a 3 Sector Economy

  - Equilibrium occurs when AD= AS




Aggregate Demand – Aggregat Supply Approach

  - Sum of all household consumption ( C ) and investment from the firm (I)

                                   AS =Y
                                AD = C + I + G

                  So, equilibrium , AS= AD
                                     Y= C+I + G




  - There are 2 types of Tax in 3 sector economy
    a) Autonomous Taxes
  - Refer to taxes that are independent of income.
  - Do not relate to income.
  - If the income increase or decrease, autonomous taxes remain constant.
  b) Induced Taxes
- Refer to taxes that depend on income.
- Induces Taxes changes as income changes
- If the income increase, induced taxes will increase.


1) Mathematical Equation
   Equilibrium using autonomous tax

     i)     C = 200 + 0.75 Yd (Yd is disposable income)
     ii)    I = 100
     iii)   G= 50
     iv)    T = 100

   Taxes have an effect on the consumption. So, the Equilibrium Income is

                      Y = C + I+ G
                       = 200 + 0.75 Yd + 100 + 50
                       = 350 + 0.75 ( Y- T)
                       = 350 + 0.75 ( Y- 100)
                       = 350 + 0.75 Y – 75
            Y- 0.75 Y = 275
              0.25 Y =275
                  Y = 1100 ( EQUILIBRIUM INCOME)

   Equilibrium using induced tax

   i)       C = 200 + 0.75 Yd (Yd is disposable income)
   ii)      I = 100
   iii)     G= 50
   iv)      T = 0.2Y
                      Y = C + I+ G
                       = 200 + 0.75 Yd + 100 + 50
                       = 350 + 0.75 ( Y- T)
                       = 350 + 0.75 ( Y- 0.2Y)
                       = 350 + 0.75( 0.8 Y)
                       = 350 + 0.6 Y
            Y- 0.6 Y   = 350
              0.4 Y  = 350
                  Y = 875 ( EQUILIBRIUM INCOME)


   2) Graphical Analysis
   - Transfer into graphic form
   - Equilibrium using autonomous tax




Equilibrium using induced tax

      Leakage- Injection Approach
      Savings and taxes from household + Firms = Leakages
      Investment by the firms and Government = Injections

                                Equilibrium occurs when,

                                  Injection = Leakage
                                    I+ G     =S+T
   1) Mathematical Equation
      Equilibrium using autonomous tax

   i)     C = 200 + 0.75 Yd (Yd is disposable income)
   ii)    I = 100
   iii)   G = 50
   iv)    T = 100

          Consumption Function :        C = 200 + 0.75 Yd
          So, the Saving Function is    S= -200 + 0.25 Yd
          Equilibrium Income is

                         I+G = S+T
                      100 + 50 = - 200 + 0.25 Yd + 100
                            150 = -100 + 0.25 ( Y- T)
                            150 = -100 + 0.25 ( Y- 100)
                            150 = -125 + 0.25 Y
                       0.25 Y = 275
                           Y = 1100 ( EQUILIBRIUM INCOME)

Equilibrium using induced tax

             C = 200 + 0.75 Yd (Yd is disposable income)
              I = 100
             G = 50
             T = 0.2 Y

          Equilibrium Income is
                        I+ G = S+T
                      100 + 50 = - 200 + 0.25 Yd + 0.2 Y
                             150 = -200 + 0.25 ( Y- 0.2 Y) + 0.2Y
                             150 = -200 + 0.25 ( 0.8 Y)+ 0.2 Y
                             150 = -200 + 0.4 Y
                          0.4 Y = 350
                            Y = 875 ( EQUILIBRIUM INCOME)
   1) Graphical Analysis
      Equilibrium using autonomous tax




Equilibrium using induced tax
Multiplier Concept

   - The multiplier is the ratio of the change in income to the change in
     Aggregate Demand (AD).

Formula Multiplier (M) =      Change in income (      Y)

                        Change in Aggregat Demand (         AD)


   - The size of the multiplier depends upon the size of the marginal propensity
     to consume.
   - MPC the size of the multiplier

   - M     =     1
                 1- MPC


Investment Multiplier
   - Investment multiplier refers to the ratio of the change in the equilibrium
      income to a change in investment.

Mi =        Change in income (    Y)                   or        MI   =      1
Government Expenditure Multiplier                                         1- MPC
         Change in Investment (    I)


   - Government expenditure multiplier refers to the ratio of the change in the
     equilibrium income to a change in government expenditure assuming there
     is no change in taxes.

Mg   =          Change in income (      Y)                  or        MI    =      1
                                                                                1- MPC
         Change in Government Expenditure (      G)
Tax Multiplier

   - Tax multiplier refers to the ratio of the change in equilibrium income to a
     changes in taxes assuming there is no change in government expenditure.

M t=     Change in income (    Y)
                                                          M   t =   -MPC
                                                  Or
                                                                    MPS
       Change in Aggregat Demand (     AD)

				
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