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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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national income, aggregate demand, International economics, Monetary policy, Balance of Payments, interest rates, price level, interest rate, government expenditure, Fiscal Policy

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posted: | 3/18/2010 |

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