PART L: THE GAMES OF NATIONAL-INCOME DETERMINATION
Topic 21: A PRESENTATION OF THE NATIONAL-INCOME ACCOUNTING SYSTEM
Reading:
LR: Chapter 18 [lightly] and Chapter 19 [background for Macro
Economics]
Chapter 20 [Important]
Concept List:
definitions of a progressive tax rate; a proportional tax rate and a regressive tax rate
types of taxes in Canada [e.g., personal income taxes, corporate income taxes and indirect taxes
on goods and services – GST, PST, import duties]
macro economic goals: economic growth, full employment [95% employment] and price
stability [price index no more than 5% annually – Bank of Canada’s goal is no greater than 3%
inflation]
potential output and output gap: gap between actual employment and full employment
real and nominal national output [GDP]; implicit price deflators and a constant dollars series of
GDP
measurement of national output [GDP]: the final goods and services approach
measurement of national output [GDP]: the factor income approach
measurement of national output [GDP]: the value added approach
definition of ‘final’ goods and services: goods and services sold to consumers, industry [on
capital account], government, the export sector and goods which become additions to physical
inventory at the end of the year
GDP has two boundaries: space and time -- all economic activities within the country/region are
included within the specified period which is usually a year
personal expenditure on goods and services [consumption] includes durables [dining room sets],
non-durables [food and clothing] and services [entertainment, rent]
automobiles purchased by consumers are classified as a consumer durable
imputed rent for owner-occupied home is included under consumer services and also in the
factor income statement under rent
gross domestic investment is the sum of new residential construction, new non-residential
construction and new machinery and equipment undertaken during the period: inventory changes
[increases and decreases] are also included under the investment category
intermediate goods and services – raw materials, energy, services purchases – are inputs which
are consumed in the production process [e.g., iron ore and coal and are transformed during the
production process into steel and resin into plastic packaging]
derivation of final goods and services in a simple three sector economy with no trade, no
government and no inventories
factor income approach includes [net domestic income at factor cost]: wages, rent, interest and
profits – where profits are presented under three categories: corporate profits before taxes, net
income of unincorporated farmers and net income of non-farm unincorporated businesses e.g.,
partnerships and sole proprietors
net domestic income at factor cost [sum of all factor income gross of any taxes] plus indirect
taxes less subsidies and plus capital consumption allowance [depreciation] theoretically equals
the sum of all final goods and services in the final goods approach to GDP
capital consumption allowance [CCA] includes depreciation taken on housing, offices and plants
and machinery and equipment in the private sector plus depreciation on capital goods in the
public sector [roads, buildings]: consumer durables are not depreciated
value added represents an industry/sector’s own contribution towards final goods [GDP]
detailed elements for the final goods statement
detailed elements for the factor income statement
net investment definition: gross investment less capital consumption allowance
interrelationships between gross investment, net investment, replacement investment and capital
consumption allowance and interpretation of negative net investment
Topic 22:
THE GAMES OF NATIONAL-INCOME DETERMINATION IN A SIMPLE
ECONOMY
Assume: Price stability in this section
Reading:
LR: Chapters 21
the determination of equilibrium national income in a simple economy without government, no
international trade and no corporate saving
the consumption function for a family, based on disposable income
the average propensity to consume [APC]
the marginal propensity to consume [MPC]
the break-even point on the consumption curve
the derived savings curve for a family: Sp = Yd - C
dissaving
the average propensity to save [APS]
the marginal propensity to save [MPS]
the sum of the two average propensities [APC + APS] equals one
the sum of the two marginal propensities [MPC + MPS] equals one
a country’s aggregate saving function: straight line approximation
linear domestic investment equation where desired investment by entrepreneurs depends upon
autonomous investment [independent of the level of Y] and induced investment [dependent on
the level of Y]
Keynesian investment function: autonomous investment only
economy’s equilibrium condition: desired investment [DI] equals desired saving [DS]
actual saving [the sum of household saving + corporate saving + government saving] always
equals actual investment – the investment which is actually recorded in the national accounts, at
all levels of Y: this is an identity
unintended increases/decreases in investment [through unwanted and unplanned inventory
adjustments]
full employment level of Y
autonomous investment shock to achieve full employment level of Y
the simple investment multiplier; the multiplier process and the multiplier formula
the multiplier is a function of leakages: principally the marginal propensity to save, the marginal
propensity to tax and the marginal propensity to import
the multiplier process causes the increase in Y to be greater than the positive/negative
autonomous shock to the economy
the multiplier is always positive and greater than one
the investment-saving presentation converted to the aggregate expenditure approach [both
approaches will generate the identical equilibrium level of Y]
Topic 23:
THE GAMES OF NATIONAL-INCOME DETERMINATION IN A FULL
ECONOMY WITH GOVERNMENT AND TRADE
Reading:
LR: Chapter 22 [Including appendix]
addition of the government sector adds: taxes, transfer payments, government expenditure and
government saving
addition of the international sector adds exports and imports [Note: Do not like the text
presentation which combines the effects of exports and imports and converts these to a net
export function. Why? The determinants of imports and exports are entirely different.
the equilibrium condition is now: Y = C + Id + G + E - M
disposable income is defined as: Yd = Y - taxes + transfer payments - corporate saving
the spending multiplier now becomes: Ks = 1/ 1-[MPCy + MPId + MPG + MPX - MPM]
when an autonomous shock occurs [i.e., when the Aggregate Expenditure Curve is shifted
vertically up or down], then the change in Y becomes the product of the spending multiplier
times the vertical shift in the Aggregate Expenditure Curve
disposable income equals consumption plus personal saving [Yd = C + Sp]
the impact of an autonomous tax shock, or a transfer payment shock, will cause the
consumption function to shift vertically by the product of the MPCYd times the amount of the
autonomous change in taxes [with a negative sign] or transfer payments [with a positive sign].
the behavioural equations for consumption, investment, government spending, exports, imports,
taxation, transfer payments and corporate saving would always be specified in a question
the consumption function will usually be defined in terms of Yd, with its slope MPCYd –
however, to solve a system of equations, it will be necessary to convert the original consumption
function to a function of Y, with its slope MPCy Note: if any other behavioural equations
e.g., imports, were initially a function of Yd, then this behavioural equation would also
require conversion to a function of Y. When the system is solved, all behavioural equations
must be established as functions of Y, and not Yd
the national-income determination problems will involve two exercises:
a. solve the original set of behaviour equations to obtain the initial equilibrium level of
Y;
b. evaluate the impact on the initial level of Y, when an autonomous shock occurs
the balanced budget multiplier theorem
the autonomous shock necessary to bring the economy for a full employment level
NOTE: The aggregate expenditure model can not satisfactorily handle inflation.
Topic 24:
AGGREGATE DEMAND AND SHORT RUN AGGREGATE SUPPLY
ANALYSIS
[Note: Long Run Aggregate Supply Curve is not
included]
Reading:
LR: Chapter 23
Concept List:
diagrams show price level on the y-axis and real national income [Y] on the x-axis
three reasons for downward slope of aggregate demand curve [AD]:
- inflation and trade
- inflation and savings impact
- inflation and interest rate impact on net investment
shifts in AD curve occur through the use of monetary policy and discretionary fiscal
policy
short run aggregate supply curve [SRAS] and its three sections: perfectly elastic, upward
sloping and vertical
assumptions behind SRAS curve:
- no change in the average unit cost of production in the economy
- no change in the labour productivity in the economy
the Keynesian/price stability part of the SRAS curve
equilibrium established under AD/SRAS curve analysis
an easy money policy, or an expansionary fiscal policy, could lead to an increase in real
output and to an increase in the price level at the same time