Determination of Equilibrium National Income

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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 = bY
= 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
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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
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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
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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
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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
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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
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