Ch. 3 : National Income Determination (II) (Simple Keynesian Model)
-
Upload
annice-janel-lyons -
Category
Documents
-
view
244 -
download
5
Transcript of Ch. 3 : National Income Determination (II) (Simple Keynesian Model)
![Page 1: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/1.jpg)
Ch. 3 : National Income Determination (II)
(Simple Keynesian Model)
![Page 2: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/2.jpg)
C=Ca + cYd
C
Y
![Page 3: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/3.jpg)
I=Ia
Y
I
![Page 4: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/4.jpg)
G=Ga
Y
G
![Page 5: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/5.jpg)
X=Xa
Y
X
![Page 6: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/6.jpg)
T=Ta
Y
T
![Page 7: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/7.jpg)
M=Ma + mY
Y
M
![Page 8: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/8.jpg)
AE=C+I+G+(X-M)
Y
AE
Y*
![Page 9: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/9.jpg)
Y
$
I+G+X
S+T+M
Y*
![Page 10: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/10.jpg)
Fiscal Policy
• Discretionary Fiscal Policy
• expansionary fiscal policy
• (1) increased government spending,
• (2) lower taxes, or
• (3) a combination of the two.
![Page 11: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/11.jpg)
• contrationary fiscal policy
• (1) decreased government spending,
• (2) higher taxes, or
• (3) a combination of the two.
![Page 12: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/12.jpg)
• Problems of Fiscal Policy1. Recognition Lag
2. Executive Lag
3. Response Lag
![Page 13: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/13.jpg)
Changing Government Expenditure or Taxes?
• 1. Location of Effects
• 2. Time Lag
• 3. The Reversibility of the Policy
• 4. The Public’s Reaction to Short-term Changes
![Page 14: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/14.jpg)
Built-in stabilisers
• Built-in stabilisers are those institutional arrangements that automatically increase government deficit (or decrease surplus) during slumps/recessions, and increase surplus (or decrease deficit) during booms, without the government having to make any policy decision.
![Page 15: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/15.jpg)
Examples of built-in stabilizers
• Progressive Tax System
• Welfare Scheme
• Government Purchases
• Corporate and Family Savings
![Page 16: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/16.jpg)
Some built-in stabilizers that may create disincentives:
• progressive taxation
• unemployment and welfare benefits
![Page 17: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/17.jpg)
Some built-in stabilizers that do not create disincentives:
• corporate savings
• family savings
![Page 18: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/18.jpg)
Limitations of built-in stabilizers:
• Built-in stabilisers can reduce fluctuations but cannot maintain full stability.
• built-in stabilisers may reduce the speed of recovery
![Page 19: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/19.jpg)
Balanced-Budget Multiplier
• C=Ca+cYd
• G=Ga
• I=Ia
• T=Ta
![Page 20: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/20.jpg)
• The government expenditure multiplier: Kg=1/(1-c)
• The tax multiplier : Kt=-c/(1-c)
• The balanced-budget multiplier: Kb=1/(1-c) + -c/(1-c)
=1
![Page 21: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/21.jpg)
Ga by $1 will increase income by: 1+MPC+MPC2+MPC3 ......---(1)
Ta by $1 will decrease income by: MPC+MPC2+MPC3 ......---(2)
Ga - Ta = 1
![Page 22: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/22.jpg)
Recessionary (Deflationary) Gap and Fiscal Policy
AE
YYe Yf
AE
AE’
![Page 23: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/23.jpg)
Inflationary Gap and Fiscal Policy
AE
YYf Ye
AE’
AE
![Page 24: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/24.jpg)
Paradox of Thrift
• Thriftiness, while a virtue for the individual, is disastrous for an economy.
![Page 25: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/25.jpg)
• If consumers seek to save a larger amount out of any given level of income, that attempt to save more may lead to a fall in income leaving the amount of savings unchanged or even decreased.
![Page 26: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/26.jpg)
Case 1: Investment expenditure is autonomous
Given: S = -Ca+(1-c)Y
I =Ia
![Page 27: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/27.jpg)
The Paradox of Thrift
I,S
I=Ia
S1
Y1
S2
Y2
Y
![Page 28: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/28.jpg)
Example
• S1=-20+(1-0.75)Y
• I=20
![Page 29: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/29.jpg)
• At equilibrium,
• I=S
• 20=-20+(1-0.75)Y
• 40=0.25Y
• Y=160
![Page 30: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/30.jpg)
the realized saving is:
S1=-20+(1-0.75)Y
=-20+0.25(160)
=-20+40
=20
![Page 31: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/31.jpg)
Suppose the saving function shifts upward,
S2=-10+(1-0.75)Y
I=20
![Page 32: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/32.jpg)
At equilibrium,
I=S
20=-10+(1-0.75)Y
30=0.25Y
Y=120
![Page 33: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/33.jpg)
Now the realized saving is:
S2=-10+(1-0.75)Y
=-10+0.25(120)
=-10+30
=20
![Page 34: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/34.jpg)
Case 2: Investment expenditure is an increasing function of national income
• Given: S = -Ca+(1-c)Y
• I = Ia+eY
•
![Page 35: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/35.jpg)
The Paradox of Thrift
I,S
I=Ia+eY
S1
Y1
S2
Y2
Y
![Page 36: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/36.jpg)
How the paradox can be resolved?
• If planned investment increases as a result of the increase in planned saving, then there may not be a decrease in national output.
![Page 37: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/37.jpg)
The Paradox of Thrift
I,S
I=Ia
S1
Y1
Y
![Page 38: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/38.jpg)
The Paradox of Thrift
I,S
I=Ia
S1
Y1
S2
YY2
![Page 39: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/39.jpg)
The Paradox of Thrift
I,S
I=Ia
S1
Y1
S2
Y
I=Ia’
Y2
![Page 40: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/40.jpg)
The Paradox of Thrift
I,S
I=Ia
S1
Y1
Y
![Page 41: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/41.jpg)
The Paradox of Thrift
I,S
S1
Y1
S2
Y2
Y
I=Ia+eY
![Page 42: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/42.jpg)
The Paradox of Thrift
I,S
I=Ia’+eYS1
Y1
S2
Y2
Y
I=Ia+eY
![Page 43: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/43.jpg)
Revision Exercise
• What is the 'paradox of thrift'? Explain, with the aid of diagrams, how this paradox can be resolved.
• Compare the magnitudes of the income multipliers of the simple Keynesian model under the following tax systems: lump sum income tax, proportional income tax and progressive tax.
•
![Page 44: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/44.jpg)
• What are “automatic stabilizers”? Give two examples to illustrate your answer.
• Compare the effectiveness of the proportional income tax and the progressive income tax in reducing economic instability.
![Page 45: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/45.jpg)
'Consumption depends on the level of income.'
'The level of income depends on consumption.'
With the aid of diagrams, reconcile these two statements with reference to the Keynesian model.
![Page 46: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/46.jpg)
Answer:• In the consumption curve, consumption is a
function of the level of income. As income increases, consumption will also increase. In the Keynesian model, the consumption is assumed to be: C = a + c Y where a is the intercept and c is the marginal propensity to consume.
• If the consumption curve shifts upward, the level of income will be increased because of the increase of aggregate demand in the economy. Therefore the level of income depends on consumption.
• There is no circular reasoning: it is a case of mutual determination of income and consumption. Mutual dependence is not an inconsistency.
![Page 47: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/47.jpg)
• Consider the following information about Country A:
C = 0.8Yd
I = 260
G = 400
T = 0.5Y
X = 300M = 0.2Y
![Page 48: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/48.jpg)
Find:
i. the equilibrium level of national income
ii. the income multiplier
iii. the tax multiplier
![Page 49: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/49.jpg)
Answer• a. Find the equilibrium income.• In equilibrium, Y = AE• Y = C + I + G• = 400 + 0.8(Y-T) + 50 + 32• = 482 + 0.8(Y - 40 - 0.375Y)• = 450 + 0.5Y• 0.5Y = 450• Y = 900
• In equilibrium, Y = 900
![Page 50: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/50.jpg)
b. b. Find the income multiplier.
Income multiplier = 1/(1-c-ct)
= 1/[1-0.8+(0.8)(0.375)]
= 2
The income multiplier is equal to 2.
![Page 51: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/51.jpg)
c.
Given that the existing income level is 900, and that the income multiplier is 2, the government has to increase its expenditure by 50 for full employment to be attained.
![Page 52: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/52.jpg)
Consider the following information:Labour force (L) = 600
Production function = 3L
Find:
i. the full-employment income level
ii. the no. of labour that is unemployed
![Page 53: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/53.jpg)
Suppose the government is planning to increase her expenditure in order to stimulate the economy. How much expenditure should the government increase to achieve full-employment?
![Page 54: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/54.jpg)
In a closed economy, private consumption (C), investment (I), government expenditure (G), transfer payments (TR) and tax revenue (T) are as follows:
C = 50 + 0.8Yd
I = 50
G = 100
TR = 50
T = 0.25Y
![Page 55: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/55.jpg)
a.
(i) What is the equilibrium value of Y?
(ii) What is the value of the multiplier for government expenditure?
(iii) What is the balance of the government budget?
![Page 56: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/56.jpg)
b. Assume that government expenditure is now increased by 20, from 100 to 120.
If the government wants to pursue a balanced budget, what should be the amount of transfer payments?
![Page 57: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/57.jpg)
AL Questions
![Page 58: Ch. 3 : National Income Determination (II) (Simple Keynesian Model)](https://reader035.fdocuments.net/reader035/viewer/2022062300/56649e4e5503460f94b44f4e/html5/thumbnails/58.jpg)
AL 2000/5
AD, X, M
Y
X
C+I+G+X-M
450
trade deficitM
(C+I+G+X-M)’
Y* Y**
A
B
C
D