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Chapter 3 Determination of Equilibrium National Income Lecturer: Pn. Siti Hajar Binti Md.Jani Power Point by ; Pn.Azizah Isa. UiTM Kelantan 1 BUSINESS CYCLE Aggregate Econ. Activity (% in real GDP) Boom/Inflation Potential Growth Path Actual Growth Path Trough/Depression/Slump/ Unemployment years Lecturer: Pn. Azizah Isa 2 NATIONAL INCOME EQUILIBRIUM Keynes argued that “an economy could reach equilibrium but not necessarily at the full employment.” Lecturer: Pn. Azizah Isa 3 Equilibrium and Full-employment Equilibrium will occur when there is no tendency for an economy to change. It refers to a situation when all consumers and firms have no incentive to change their behaviour. Full employment equilibrium is the situation of equilibrium in an economy at the best efficient and full utilization of resources. “An economy can be at the equilibrium but not always to be at full-employment.” Lecturer: Pn. Azizah Isa 4 Two approaches: To Determine National Income Equilibrium: 1. Total Approach. 2. Injection-Leakage Approach. Lecturer: Pn. Azizah Isa 5 i) Total Approach: Equilibrium may occur when planned aggregate expenditure is equivalent to planned output. (AD = AS) (aggregate demand = aggregate supply). Lecturer: Pn. Azizah Isa 6 i) Leakage-Injection Approach: Equilibrium also can be determined when: INJECTION = LEAKAGE Injections are additional spending from: investments (I), government purchases (G) and exports (X). Leakages are withdrawals from: savings (S), tax payment (T) and imports (M). So, at equilibrium, (I+G+X = S+T+M) (INJECTION = LEAKAGE) Lecturer: Pn. Azizah Isa 7 DETERMINATION OF EQUILIBRIUM NATIONAL INCOME Keynesian model is drawn based on the relationship between income and expenditure: Y = C + I + G + (X – M) where, C = f (Yd) , C is a function of Real Disposable Income (income after tax), where, Yd = Y – t . Lecturer: Pn. Azizah Isa 8 Components of Aggregate Expenditure: 1. CONSUMPTION, C = f (Yd) 2. INVESTMENT, I = f (i, Y) 3. GOVERNMENT EXPENDITURE, G 4. NET EXPORT (X – M) Lecturer: Pn. Azizah Isa 9 1. Consumption and Saving Disposable Income is used for Consumption spending and Saving. Yd = C + S and, C = f (Yd), S = f (Yd) Both C and S is a function of income,Y and having a positive relationships. ( Y rises, C and S also will rise). Lecturer: Pn. Azizah Isa 10 Given that; Consumption function: C = a + bYd and Saving function: S = – a + (1 – b) Yd There is (two)2 components of Consumption spending by households: C1, Autonomous Consumption = a C2, Induced Consumption = bYd Where, b is the Marginal Propensity to Consume (MPC). Lecturer: Pn. Azizah Isa 11 Autonomous Consumption, a and Induced Consumption, bY C2 = a is a fixed amount irrespective of the income earned, is the part of consumption which does not vary with the level of income (Y increases but “a” is constant). C2 = bY is an amount that depends on the disposable income, is the amount of consumption spending by households that is induced by disposable income (Y increases, C2 increases). Lecturer: Pn. Azizah Isa 12 CONSUMPTION, C Consumption function, C = f (Yd) C C = a + bYd a real output, Y The slope of consumption function is given by: b = C/ Y = Marginal Propensity to Consume (MPC) and the value 0 < b < 1 (positive but less than). Lecturer: Pn. Azizah Isa 13 Autonomous Consumption, C C1 = a C = a + b Yd is the vertical intercept of the a consumption function, 0 real output, Y at a (in the diagram). It is the amount of consumption that would occur even if the household earned nothing, Y=0. when Y= 0 (no income earned), C = a. (basic consumption for living). Lecturer: Pn. Azizah Isa 14 Consumption and Saving schedule Y C S 0 60 -60 100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140 With no income earned, Y = 0 , autonomous C = a = 60 and dissaving = - a = - 60. While Y = C + S , if Y = 0 , then C = - S. Lecturer: Pn. Azizah Isa 15 How is the increase in income will increase consumption? Consumption is induced by the value of b (that is = MPC), since, C = a + bY Lecturer: Pn. Azizah Isa 16 FOR EXAMPLE: Given that C = a + bY, therefore, if b = 0.6 , how large is the increase in consumption if there is an increase in income? Since C = a + 0.6Y, thus C will increase by 0.6Y , (given a = fixed or autonomous consumption) , so, C will increase by 60% out of total income, Y. Meaning that, for any increase in income, 40% can be saved and 60% will be spend on consumption. Lecturer: Pn. Azizah Isa 17 For example: a change in income from RM1000 to RM1500 with the MPC = 0.6, C = bY = 0.6 (500) = 300. Therefore, consumption will increase by RM300. Lecturer: Pn. Azizah Isa 18 Consumption and Saving schedule Y C S 0 60 -60 100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140 In a 2-sector economy, C = a + bY . Since C = a + 0.6Y, and a = 60 thus C = 60 + 0.6Y. At income 200, C = 60 + 0.6(200) = 60 + 120 = 180 and Y = C + S so , S = Y – C = 200 -180 = 20. Lecturer: Pn. Azizah Isa 19 Changes in consumption when income change. consumption Y=C C=a+bY C 400 Y 45° Note: b= C Y = 400 500 income 1000 1500 Lecturer: Pn. Azizah Isa 20 Changes in consumption when income change. Y=C consumption C=a+bY C 400 Y e Note: b= C Y a 45° income 1000 = 400 500 1500 Lecturer: Pn. Azizah Isa 21 SAVINGS Some part of income earned is saved. two components of savings: autonomous dissaving, S1 = – a induced saving, S2 = (1 – b)Y where, (1 – b) = Marginal Propensity to Save. = S/Y = slope of saving function. Lecturer: Pn. Azizah Isa 22 Dissaving and induced saving. Autonomous dissaving, (- a), is the amount that households draw out from their wealth to consume when no income earned. Induced saving, (1 –b)Y, is the amount of saving that is induced by earnings of disposable income. Lecturer: Pn. Azizah Isa 23 Saving Function, S Saving S = – a + (1– b)Yd 0 Yd (real output) –a (1 – b) is the slope of saving function = ΔS/ΔY Lecturer: Pn. Azizah Isa 24 Consumption & Saving Function, C,S Y = AD Y = C + S, When S = 0, Y = C at the breakeven, Y=C C = a + bYd e point, e. S = – a + (1– b)Yd a 45º Yd (real output) 0 –a Lecturer: Pn. Azizah Isa 25 Note that: MPC + MPS =1, thus MPS = (1 – MPC). If MPC = b and MPS = (1 – b), Then, b + (1 – b) = 1 Lecturer: Pn. Azizah Isa 26 APC, APS The fraction of income that is used for consumption is the: Average Propensity to Consume (APC): APC = C Y And, the fraction of income that is used for saving is the: Average Propensity to Save (APS): APS = S Y and, at any level of income, APC + APS = 1 Lecturer: Pn. Azizah Isa 27 MPC, MPS, APC, APS CONSUMPTION, C C = a + bYd 1200 800 a 0 1000 1600 Lecturer: Pn. Azizah Isa INCOME,Y 28 MPC CONSUMPTION, C C = a + bYd 1200 ∆C MPC = ∆C = 400 800 ∆Y a 0 ∆Y 1000 600 is the slope of the consumption function. 1600 Lecturer: Pn. Azizah Isa INCOME,Y 29 MPC, APC CONSUMPTION, C C = a + bYd 1200 ∆C 800 MPC = ∆C = 400 TC a 0 ∆Y 600 APC = TC = 1200 TY 1600 ∆Y 1000 TY 1600 Lecturer: Pn. Azizah Isa INCOME,Y 30 MPC, APC CONSUMPTION, C C = a + bYd 1200 MPC = ∆C = 400 ∆Y 600 APC = TC = 1200 TY 1600 TC 800 TC a 0 1000 TY 1600 Lecturer: Pn. Azizah Isa INCOME,Y 31 MPS, APS MPS = (1 – b) = ΔS/ΔY Saving is the slope of saving function. S = – a + (1– b)Yd ΔS 0 ΔY Yd (real output) –a Lecturer: Pn. Azizah Isa 32 MPS, APS while, APS = TS/TY Saving S = – a + (1– b)Yd ΔS TS TS ΔY 0 Yd (real output) –a TY Lecturer: Pn. Azizah Isa 33 MPS, APS while, APS = TS/TY Saving S = – a + (1– b)Yd TS TS 0 Yd (real output) –a TY Lecturer: Pn. Azizah Isa 34 APC, APS changes with income; MPC, MPS are constant. APC falls and APS will rise as income increases. - because as income increases, households consumption will rise but with a smaller percentage compared to the increase in income, while saving will rise with a larger percentage instead. While MPC and MPS is assume constant as long as the slopes of the consumption and saving curves are constant or assume to be straight lines. Lecturer: Pn. Azizah Isa 35 EXAMPLE 1 Y 0 100 200 300 400 500 C 60 120 180 240 300 360 S -60 -20 20 60 100 140 APC 1.2 0.9 0.8 0.75 0.72 APS -0.2 0.1 0.2 0.25 0.28 MPC 0.6 0.6 0.6 0.6 0.6 MPS 0.4 0.4 0.4 0.4 0.4 As income increases, APC falls but APS rises. Meanwhile, MPC and MPS are constant. Lecturer: Pn. Azizah Isa 36 Other determinants of Consumption: Wealth The richer the higher is the consumption. Interest rates Large items were bought on loans that pay interest. Expectation of future prices Price is expected to increase in future, more consumption now (may involve in hoarding). Lecturer: Pn. Azizah Isa 37 Consumption in Islam (according to M. Fahim Khan, 1922) A Muslim has to be rational in their spending. The rationality of consumption in Islam is: to spend wisely and moderately: to consume only enough goods for healthy living. Excessive indulgence in luxurious living is discouraged: Israf (extravagant or overspending on goods excessively are wasteful and prodigal. Lecturer: Pn. Azizah Isa 38 to follow the hierarchy of needs: Dharuriyat, Hajiyat, Kamaliat and not to consume the Tarafiat goods. to consume only permissible goods (halal) but not prohibited goods (haram). part of his expenditure is also spend for fisabilillah (spending for the betterment of Islamic livings) part of his income is also saved for future expenditure. Conclusion: spending by Muslim consumers is to achieve the satisfaction in this world and also to earn reward in the hereafter. Lecturer: Pn. Azizah Isa 39 BREAK-EVEN INCOME is a situation when all the income is just nice for consumption purposes while no saving at all. thus, Y = C and S = 0. C,S e AS=AD S>0 C = a + bY S = - a + (1 – b)Y S<0 45º Y S=0 Lecturer: Pn. Azizah Isa 40 QUESTION TO PONDER: look out in the manual 1. Use the given data to answer the following questions. (All figures are in RM million) INCOME(Y) CONSMPTN (C) 0 140 200 260 400 600 SAVING(S) 20 500 800 1000 a) Fill up the blank with appropriate values. QUESTION TO PONDER: ANSWER 1. Use the given data to answer the following questions. (All figures are in RM million) INCOME(Y) CONSMPTN (C) SAVING(S) 0 140 200 260 140 60 400 120 + 260 = 380 20 600 500 100 800 120 + 500 = 620 180 1000 120 + 620 = 740 260 a) Fill up the blank with appropriate values. Y = 200 and C = 120 , S = 80 b) What are the values of MPC and MPS? c) Write down the consumption function and saving function. d) What is the amount of break-even income? Lecturer: Pn. Azizah Isa 43 b) What are the values of MPC and MPS? MPC = C = 260 - 140 = 0.6 Y 200 – 0 MPS = 1 – MPC = 1 – 0.6 = 0.4 Lecturer: Pn. Azizah Isa 44 c) Write down the consumption function and saving function. C = 140 + 0.6Y S = - 140 + 0.4Y Lecturer: Pn. Azizah Isa 45 d) What is the amount of break-even income? is a point at e, when S = 0, so Y = C. S = - 140 + 0.4Y Since S = 0, 0 = -140 + 0.4Y 140 = 0.4Y C,S Y = 140/0.4 = 350 e 45º C= 140 + 0.6Y S = -140 + 0.4Y Y S=0 Lecturer: Pn. Azizah Isa 46 Additional Question: Use the given data to answer the following questions. (All figures are in RM million) INCOME(Y) CONSMPTN (C) SAVING(S) 0 140 200 260 140 60 400 380 20 600 500 100 800 620 180 1000 740 260 Calculate the APC and APS at each level of income. ANSWER: INCOME (Y) CONSMPTN (C) SAVING (S) APC APS 0 140 - - 200 260 140 60 1.3 - 0.3 400 380 20 0.95 0.05 600 500 100 0.83 0.17 800 620 180 0.78 0.23 1000 740 260 0.74 0.26 The values for APC and APS at each level of income. 2. INVESTMENT Definition: Investment is defined as the spending or purchase of plants, machineries, buildings and inventories by firms for the purpose of producing goods and services. Lecturer: Pn. Azizah Isa 49 2 types of INVESTMENT - Keynes two(2) types of investment spending: i) Autonomous Investment what firms may had intended to plan or desired or has been fixed and does not depend on income. ii) Induced Investment actual investment expenditures used to produce newly produced goods, and depends on the level of: I = f ( i, e, Y, t…) Lecturer: Pn. Azizah Isa 50 Investment depends on the level of: I = f ( i, e, Y, t ….) interest rate, future expected profitability, income, technology, capacity and business taxes. Lecturer: Pn. Azizah Isa 51 1. Autonomous Investment As assume by Keynes; - is a fixed investment that does not change with the change in income, but ; there will be a shift in the autonomous horizontal function, up or down when there’re other factors that affect it. Lecturer: Pn. Azizah Isa 52 1. Autonomous Investment Function refers as a fixed investment that does not change with the change in income. Investment I1 Autonomous Investment I0 Real Income Diagram: Autonomous Investment A shift in autonomous investment upward to I1 may cause by an increase in expected profit or a fall in interest rate but does not depend on real income. Example; the government planned spending to provide public goods. Lecturer: Pn. Azizah Isa 53 2. Induced Investment Function real interest rate (i) i2 i1 e I = f(i, ) I = f(i) refers to an investment that changes with the interest rate, income or expected profitability etc. I’ I’’ Investment Diagram: Induced Investment Induced investment has a negative relationship with real rate of interest. If future profit is expected to increase, at any given level of real interest rate the investment function will increase and shift the curve to the right. Lecturer: Pn. Azizah Isa 54 2. Induced Investment Function investment I = f(Y) is the actual investment that is induced by changes in income. Income Diagram: Induced Investment Induced investment has a positive relationship with aggregate income. Example is capital investment by the purchase of new plants and equipments. Lecturer: Pn. Azizah Isa 55 Investment From Islamic Perspective Investment is permissible in Islam but extravagant and maximizing profit in doing any business activities is not allowed. Muslims are not allowed to freeze their wealth. Islam encourages Muslim to produce goods and to attain profit but also to give the emphasis on the welfare benefits to the society. This means, Muslim entrepreneurs were not allowed to maintain maximum profit but only satisfactory profit or responsibility profit, which includes their responsibility to Allah and the responsibility for the benefits of the society. Lecturer: Pn. Azizah Isa 56 Investment From Islamic Perspective According to Siddiqui (1979), a relevant profit returns for a Muslim in production is a “satisfactory profit” earning, whereby it lies between the maximum profit that could be allowed by the Islamic principles and the minimum limit that could cover the cost. Meaning that, it is the profit that gives satisfaction to the investor in terms of the well beings and money returns that could afford to maintain his business and future business expansion, for the long term benefit of the consumers, society and government. Lecturer: Pn. Azizah Isa 57 Investment From Islamic Perspective Underlying constraints in business activities in Islam involves: i. Avoid the monopoly profit making. Any control of output and prices are strictly not allowed. ii. Producing only the permissible (halal) goods but not the forbidden (haram) goods. iii. Avoid transactions which involve the gharar and gambling activities. iv. Does not involve in any misused of powers, injustice, suppress others and manipulation – must emphasis on the welfare of the society. Lecturer: Pn. Azizah Isa 58 Investment From Islamic Perspective v. Production of goods must follow the hierarchy of needs: Dharuriyat Hajiyat and Kamaliat goods but not the Tarafiat (Tassiniyat)(haram) goods. vi. Does not involves interest payment or any riba activities, both the riba al-nasiah (the addition to the capital) and the riba al-fadhal (an addition to the exchange of goods or other objects which is of the same nature – e.g. padi, wheat and money). Instead to avoid riba, Muslims are encouraged to have alternatives profit sharing in terms of mudharabah (sharing profit) or musyarakah (joint-venture). Lecturer: Pn. Azizah Isa 59 Factors that influence Investment in Islam are: Income II. Expected returns III. Viability of the projects. IV. Facilities available or provided by the government. V. The respond of market demand. VI. Availability of fund. I. Lecturer: Pn. Azizah Isa 60 Investment and Saving Investment is an injection: could increase aggregate expenditure (AD) and boost up economic growth (income). Investment spending will multiply through the multiplier effect to increase income. Saving is a leakage: could lower aggregate expenditure (AD) and income. Saving becomes an outflow of money (leakage) from an economy. It becomes a stock of money that is not spent. At equilibrium, Saving will be equal to Investment, (S=I) Lecturer: Pn. Azizah Isa 61 Equilibrium in 2 sector economy Y=AD C,S,I e2 Y= C+I C+I C = a + bYd e1 S = – a + (1– b)Yd a 0 –a I 45º Y1 Y2 S=I Yd (real output) In 2 sector econ; equilibrium; Y = C + I Lecturer: Pn. Azizah Isa 62 Equilibrium in 2 sector economy Y=AD C,I e2 C+I equilibrium; Y = C + I (in 2 sector economy) 0 45º Y2 Lecturer: Pn. Azizah Isa Yd (real output) 63 Equilibrium in 2 sector economy C,S,I e2 S = – a + (1– b)Yd I 0 Y2 S=I Yd (real output) In 2 sector econ; equilibrium; S = I Lecturer: Pn. Azizah Isa 64 QUESTION TO PONDER 1e) If investment is RM150 millions, calculate the equilibrium income and sketch a diagram to show this. I = 150 C = 140 + 0.6Y Lecturer: Pn. Azizah Isa 65 ANSWER: At equilibrium (in 2 sector economy); (Using Total Approach): Y=C+I Y = 140 + 0.6Y + 150 Y – 0.6Y = 290 0.4Y = 290 Y = 290/0.4 Y = 725 Lecturer: Pn. Azizah Isa 66 ANSWER: C,I Y = AD C+I e 45º Ye = 725 Y Example: Question to Ponder 2. Refer to this diagram to answer the following questions. S,I S = -300 + 0.25Yd I2 400 Look out: in the manual I1 0 Y0 Y1 3500 Income (RM million) -300 o o o o o Find the break-even income at Y0 Find the equilibrium income when investment (I1 ) is at RM400 million. How much is the new investment (I2) to achieve equilibrium income of RM3500 million? If equilibrium income is RM3500 million, how much is the amount of saving and consumption? At income level of RM3500 million, calculate the APS and APC. 3. GOVERNMENT EXPENDITURE Government Expenditure G1 G0 G will be autonomously fixed according to Government Budget Policy for each year. Real Income Diagram: Autonomous Government Expenditure Equilibrium in 3 sector Y=AD economy e3 C + I +G AD C+I C e2 e1 S+T I+G 0 I 45º Y1 Y2 Y3 S+T = I+G Yd Equilibrium in 3 sector Y=AD economy e3 C + I +G AD S+T I+G 0 S+T = I+G 45º Y1 Y2 Y3 Yd 4. NET EXPORT (X – M) Export is an injection and could increase the national income through the foreign trade multiplier, but import is a leakage. Thus, net export (X-M), means the real foreign sector minus the total import of goods and services into the economy. Lecturer: Pn. Azizah Isa 72 NATIONAL INCOME EQUILIBRIUM in 4 sector Y=E Expenditure (RM) Y1=C+I+G+(X-M) e1 Yfe=C+I+G+(X-M) Y0 = C+I+G+(X-M) ef e0 45° Ye0 Yfe Ye1 Real Output (National Income) KEYNESIAN EQUILIBRIUM NATIONAL INCOME Keynesian assume that equilibrium output can be reached not necessarily at the full-employment. - the equilibrium can be less or more than the full-employment equilibrium, causing the economy with the inflationary or deflationary-gap. Lecturer: Pn. Azizah Isa 74 Inflationary & Deflationary Gaps Y=E Expenditure (RM) Y1=C+I+G+(X-M) Inflationary Gap Deflationary Gap Inflationary gap: Yfe < Ye. Deflationary gap: Yfe > Ye e0 45° e1 Yfe=C+I+G+(X-M) Y0 = C+I+G+(X-M) ef -GDP Gap Ye0 Yfe +GDP Gap Ye1 Real Output (National Income) NATIONAL INCOME EQUILIBRIUM with inflation Y=E Expenditure (RM) Y1=C+I+G+(X-M) Inflationary Gap e1 Yfe=C+I+G+(X-M) ef Inflationary gap: Yfe < Ye1 45° Yfe Ye1 Real Output (National Income) NATIONAL INCOME EQUILIBRIUM with unemployment Y=E Expenditure (RM) Yfe=C+I+G+(X-M) Deflationary Gap Deflationary gap: Yfe > Ye0 ef Y0 = C+I+G+(X-M) e0 45° Ye0 Yfe Real Output (National Income) NATIONAL INCOME EQUILIBRIUM Y=E Expenditure (RM) Y1=C+I+G2+(X-M) e1 Spending multiplier , ef Yfe– Y0 Thus , Y = m G Y0 = C+I+G0+(X-M) G m =Y = G G1 – G0 e0 45° Yfe=C+I+G1+(X-M) Y Y0 Yfe +GDP Gap Y1 Real Output (National Income) MULTIPLIERS Any Injection will multiply positively, while any Leakage will multiply negatively. Lecturer: Pn. Azizah Isa 79 MULTIPLIERS Spending Multipliers, m: i) Investment Multiplier = mI = 1/MPS = 1/(1 – MPC) Therefore, Y = 1/MPS x I = mI x I Y = mI I Lecturer: Pn. Azizah Isa 80 Example: Investment Multiplier Given, I = RM10 million and MPC = 0.75 Therefore, in the manual Y = 1/MPS x I = 1/0.25 X 10 mil. = 4 X 10 mil. = 40 mil. Thus, New Y = Y + 40 mil. If the initial income, Y= 2000, then New Y = 2000 + 40 = 2040 mil. Lecturer: Pn. Azizah Isa 81 MULTIPLIERS ii) GOVERNMENT SPENDING MULTIPLIER Y 1 = G MPS (assume an economy without tax, Yd =Y) Therefore, Y = 1/MPS X G Thus, national income increases by the amount of Y as Government increases spending. That is, new Y2 = Y1 + Y Lecturer: Pn. Azizah Isa 82 iii) Government Multiplier with tax = = 1 MPSt 1 1 – b(1 – t) = 1 (1 – b) + bt Look at example 7 and exercise 3 and 4 in the manual. Lecturer: Pn. Azizah Isa 83 iv) Simple Tax Multiplier, if tax, T = a Tax Multiplier, mT = 1 – Spending Multiplier = 1 – 1/MPS = – MPC/MPS –b = (1 – b) And, Y = mT T T = Y mT Lecturer: Pn. Azizah Isa 84 Example: Assume that, to achieve full-employment equilibrium, the GDP has to be increased by RM 5 billion and MPS is 0.5. Calculate the tax cut required to achieve this full-employment. tax multiplier, mT = 1 – (1/MPS) = – MPC/MPS = 1 – (1/0.5) = 1–2 = –1 tax cut, T = Y (-1) = - 5/(-1) =-5 By reducing the tax RM5 billion, GDP then will increase by RM 5Lecturer: billion. Pn. Azizah Isa 85 v) If tax, T = a + tY Tax Multiplier = -b 1 – b(1 – t) = -b (1 – b) + bt Now, C = a + b(1-t)Y Look at example 7 and 8 in the manual. Lecturer: Pn. Azizah Isa 86 The effect of a change in Income Tax A tax reduction may caused to an increase in consumption and thus effect towards a higher income. Assume, T = a + tY And the slope of AD is now b(1 – t). AD AD1 = Ct = a + b(1 – t)Yd a tax cut may increase income AD0 = C = a + bYd Y = Y0 Y1 Y Lecturer: Pn. Azizah Isa –b . T 1 – b(1 – t) 87 vi) OPEN ECONOMY MULTIPLIER 1 = (MPS + MPT + MPM) Lecturer: Pn. Azizah Isa 88 Accelerator Principle state that: “a change in Consumption would lead to a greater change in Investment.” i.e. a small change in DD (consumption on output) would lead to a great change in Investment. ∆C great ∆I Lecturer: Pn. Azizah Isa 89 Relationship between multiplier and accelerator: The effect with multiplier is that: I greater Y by the multiplier, k ∆Y=k∆I The effect with accelerator is that: greater I C ∆I=a∆C Lecturer: Pn. Azizah Isa by the accelerator, a 90 This means that; with the multiplier, m and the accelerator, a working together; I Y AD Lecturer: Pn. Azizah Isa C I 91 ACCELARATOR – J.M. CLARK it was then incorporated into Keynesian theory. - ‘cos it was closely related to multiplier effect. C I Y (an increase in C would lead to the increase in Investment and Aggregate Demand and thus towards an increase in Income.) Lecturer: Pn. Azizah Isa 92 THANK YOU FOR LEND ME YOUR EARS. That’s all for today. Lecturer: Pn. Azizah Isa 93 3. Balanced Budget Policy When government expenditure is just equivalent to the tax revenue collection. A balanced budget is also used to increase real output and economic growth. Any increase in government expenditure (which is equal to the amount of tax collection) will increase the real output by the same amount. Its multiplier is equivalent to one (1). Y = 1 . G Thus, the resulting increase in the equilibrium Y is exactly equal to the increase in G or T itself. ∆Y = ∆G = −∆T It can be conclude that, although the government does not spend more than what it collects in tax revenue, she still can stimulate the economy, since the spending multiplier effect is larger than the tax multiplier effect.94 Lecturer: Pn. Azizah Isa