Keynesian Model of Income

Determination
Module 4 (Chapters 5-8, Vanita Agarwal)
B.Chatterjee
School of Commerce
NMIMS
 US Subprime Crisis Exported to India
We have been making references to the 2007-08 subprime crisis quite a few number of times in the
course so far. While the prime lending refers to the loans offered to the most creditworthy
customers, subprime lending refers to the loans given to the borrowers who do not have good
credit history and may have unstable or low incomes. Banks generally give loans to such subprime
customers at a higher interest rate. However, the US interest rates were quite low during 2001 to
2005, and, in the eagerness to sell homes and to offer credit, loans were granted to many subprime
US borrowers. Since real estate prices were high, banks and customers used the very homes they
were buying as collateral against the loans. These subprime loan assets were sold by banks to
government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac. The GSEs in turn
repackaged these loans as mortgage-backed securities (MBS) with a much higher credit rating.
Foreign investors readily bought these MBS.
Over time, however, housing bubble burst, real estate prices started going down and interest rates
went up. By the third quarter of 2007, it had become clear that subprime borrowers were defaulting
on loan payments. As home prices has also come down, now loans could not be recovered through
foreclosures. The ultimate buyers of MBS got wind of it and started selling MBS in the US stock
market. Panic gripped the market and stock prices plunged. Lehman Brothers, a leading financial
firm, went bankrupt in September 2008. Many existing investment projects were wound up and
prospective ones shelved which resulted in a recession in the US. To recover financial losses in the
US, investors started liquidating overseas portfolio investments including those in India. Therefore,
stock prices plummeted in India as well. As investors took funds out of India, increased demand for
US dollar resulted in depreciation of rupee. India’s export dwindled because of the recession in the
US and Europe. Thus falling exports and falling stock prices dimmed the business confidence in
India, and production and investments fell. The recession has been passed on to India. The result-
the GDP growth dropped to 4.93 percent in 2008-09.
Business Cycle
• In general, a business cycle describes changes in the demand-side of
the economy as measured by GDP

• Short run fluctuations in the economy

— what causes short run fluctuations
— What can we develop a framework to explain them
— what policy levers should they use?
GDP Growth Rate: India
Business Cycle

Post 2008
Business Cycles
Expansion Recession Expansion

Total Output
growth
trend

Trough
• Short run Business Cycles and Long Run Growth.
• This course provides an analytical framework to understand short run
Business Cycles
 Keynes versus Classics
Classical Economists
• Economy is at full employment.
• Price adjustment mechanism.
• Laissez-Faire economy
As price adjustment is a long-run process, the U.S. economy didn’t recover on its own
without government intervention
Keynes
• Demand determined economy. The
output produced in an economy is
dependent on the level of demand.
• Excess capacity exists
• Output adjustment mechanism.
Prices fail to adjust in short run. So
output has to adjust.
• Government Intervention required
How should we go about understanding
Business Cycle?
• We will use the Keynesian Model of Income Determination
• We will start with a simple model and first determine the equilibrium
output.
• Then we will see how output may fluctuate around that equilibrium
output. This will explain why we see boom and recession.
• Use this model to show the effect of government policy.
Aggregate Demand and Equilibrium Output
Components of Aggregate Demand
Consumption Demand/Expenditure (C)
Investment Demand/Expenditure (I)
Government Demand/Expenditure (G)
External Sector demand/Expenditure (X-M)
Aggregate Demand=C+I+G+(X-M)

Aggregate Supply is the GDP, which is measured, as we have seen as

C+I+G+(X-M).
Then what is the difference? Where may the discrepancy come from
between AD and AS?
Treatment of Inventories in GDP
GDP= Consumption Expenditure (C)+ Investment Expenditure (I)+ Government
Expenditure (G) + Net Exports (X-M)

Investment Expenditures: Planned Investment Expenditure (Gross fixed capital)

+ Unplanned Investment Expenditure (Change in Stocks)

Planned Investment Expenditure: new physical assets (machines, factory etc.) +

inventory maintained by businesses

Unplanned Expenditure: Changes in inventory/stock

(accumulation/decumulation to existing inventory/stock level)
23-01-2019 to be used only for lecture purpose at NMIMS SOC 10
• Difference lies in the unplanned expenditure-changes in inventory/stock
(accumulation/decumulation to existing inventory/stock level)

• Actual Expenses: Total production (adding the expenses is just one way
to calculate it). So this Aggregate Supply/GDP.

• Planned Expenses: Total Sales. Here also you add the expenses. What
you don’t add is the changes in inventory level (addition to inventory due
to unsold stock, or fall in inventory due to sales more than expected).
This is Aggregate Demand.
• Actual Expenses (Aggregate Supply)=Planned Expenses (Aggregate
Demand)+ Unplanned Expenses
Equilibrium Output

Concept of the equilibrium:

The economy is in equilibrium when Actual Aggregate
Expenditure (Aggregate Income/GDP)=Planned Expenditure

Actual Expenditure  Income(Y/GDP)Planned Expenditure

C+Ip+Iu+G C+Ip+G
(Aggregate Supply) (Aggregate Demand)
The economy is at equilibrium when there are no unplanned
expenditures (investments), that is when
Iu=0 (meaning no change in inventory level)
The Keynesian Model of Income Determination in
a Two Sector Economy
Assumptions-
1. Prices are fixed
2. Only two sectors- Consumption and Investment
3. No government
4. Closed Economy
5. Consumption depends only on income
6. Investment expenditure is autonomous

Aggregate Demand (AD) in this two sector economy

AD=C+I
where C=aggregate demand for consumer goods
I= aggregate demand for investment goods
Aggregate Demand in a two sector economy
AD=C+I
The Consumption function:
Consumption is not constant, but increases with income  the relationship between
consumption and income is described by the consumption function
Consumption expenditure(C) is a function of disposable income(Yd)
C=C(Yd).
Disposable income= GDP(Y)-Taxes (T) +Transfers (R). Since we assume no government, T and R
both are zero. Hence Yd=Y.
This consumption function is represented in a linear form as:
C  C  cY C 0 0  c 1

The intercept is the level of consumption when income is zero  this is greater than zero
since there is a subsistence level of consumption
The slope is known as the marginal propensity to consume (MPC)  the increase in
consumption per unit increase in income
The Consumption Function
C

C  C  cY

Y
Marginal and Average
C
propensity to consume
Average Propensity to Consume (APC) is
defined as the ratio of consumption to C  C  cY
income for different levels of income.
APC=C/Y
Marginal Propensity to consume (MPC) is
defined as the change in consumption due
to change in income. C
Thus MPC  C Y

Y
Thus the APC for the consumption
C
function C  C  cY is Y  c
and MPC is “c”
 C=156068.5+0.51Y
Consumption Function
3500000

3000000

Consumption (C)
2500000

2000000

1500000

1000000

500000

0
0 200000 400000 600000 800000 1000000 1200000 1400000 1600000 1800000
GDP/Income (Y)
 The Aggregate Demand
AD=C+I
Assumption: Investment is autonomous/fixed. Therefore I  I .

C  C  cY

Therefore

AD  C  cY  I  A  cY
The Aggregate Demand
AD
AD  A  cY

C  C  cY

Y
The Equilibrium Income
The Equilibrium Income
(Actual Expenditure)
Planned Expenditure/AD 450/AS(AD=Y)

AD  A  cY
(Planned Expenditure)

Y* Y/Actual Expenditure/GDP/AS

Equilibrium GDP
Adjustments to the
Equilibrium
To consider why this is an equilibrium,
consider the adjustments: Planned (Actual Expenditure)
Expenditure 450/AS(AD=Y)
Planned Expenditure (AD)> Actual
Expenditure (AS/GDP) /AD
Iu<0 and inventory stock is falling AD  A  cY
(unplanned inventory decumulation)
(Planned Expenditure)
Induces firms to increase production
Planned Expenditure<Actual Expenditure
(AS/GDP)
Iu>0 and inventory stock is rising
Induces firms to decrease production
A
Only when Planned Expenditure=Actual
Expenditure (AS/GDP ), there is no
tendency for change to occur.
Iu=0 and inventory stock remains
unchanged
Y1 Y* Y2 Y/Actual
No change in production level Expenditure
/GDP/AS
The Algebra
Determination of Equilibrium income
Equilibrium: AD=AS
AD  C  I
AD  A  c.Y
AS  Y
Y  A  cY
Y  cY  A
A
Y  Y *
1 c
The Leakage-Injection Approach
Savings (S) is a leakage
Now if these Savings are Invested (I), then we say leakages are injected.
If all leakages are injected, then S=I. In that case, can we say that the
economy is in equilibrium?

Disposable Income (which is GDP here or AS), Y=C+S

Aggregate demand=C+I

We know, the economy is in equilibrium when AD=AS

Therefore, C+I=C+S or S=I
 The savings function S

S Y C
C  C  cY
S  C  sY
S  Y  C  cY  C  (1  c)Y  C  sY

Average Propensity to Save (APS)

S C
 s
Y Y

Marginal Propensity to Save (MPS) Y

S
s C
Y
 Planned Expenditure/AD (Actual Expenditure)
450/AS(AD=Y)
AD<AS
AD  A  cY
(Planned Expenditure)

AD>AS implies S<I A AD>AS

Y* Y/Actual Expenditure/GDP/AS

AD<AS implies S>I S

S  C  sY

S>I

S<I
I

C Y* Y
Numericals
Suppose that the consumption function is given as C=50+0.6Y and the
investment is I=80. Find
a) The equilibrium level of Income
b) Equilibrium level of consumption
c) Equilibrium level of saving
Numericals
Suppose the economy is characterized by the consumption function
C  C  cY
Let C  150 , c=0.8 and Investment, I=200
a) Derive the savings function
b) Find the equilibrium level of output using the saving-leakage
approach.
The Keynesian Model of Income Determination in a three sector
economy: Introduction of the Government Sector (Chapter 7: Vanita
Agarwal)

• Government Expenditures (G): includes goods purchased by the

central, state and local governments and also the payments made to
the government employees

• Transfers (R): those government payments which do not involve any

direct services by the recipient. For example welfare benefits,
unemployment insurance, etc.

• Taxes (T): include taxes on property, income and goods. Taxes can be
categorized into two categories- direct and indirect. Example income
tax (direct), sales, excise tax (indirect)
Equilibrium Income: AD-AS approach
Assume autonomous government spending, lump sum tax and
Transfers
The economy is characterized as follows:
C  C  cYd
II
T T
RR
Disposable Income (Yd): Yd  Y  T  R
GG
The Consumption Function C

Disposable Income (Yd): Yd  Y  T  R

C  C  cT  cR  cY

Consumption Function:
C  C  cYd
 C  c(Y  T  R )
C  cT  cR
 C  cT  cR  cY

Y
The Aggregate Demand

AD
AD  A  cY

AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
I G C  C  cT  cR  cY
AD  A  c.Y
C  cT  cR

Y
Equilibrium Income: AD-AS approach
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G  (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AS  Y
Y  A  cY
Y  cY  A
A A  C  I  G  cT  cR
Y Y *
1 c
To consider why this is an equilibrium,
consider the adjustments: Planned (Actual Expenditure)
Expenditure 450/AS(AD=Y)
Planned Expenditure (AD)> Actual
Expenditure (AS/GDP) /AD
Iu<0 and inventory stock is falling AD  A  cY
(unplanned inventory decumulation)
(Planned Expenditure)
Induces firms to increase production
Planned Expenditure<Actual Expenditure
(AS/GDP)
Iu>0 and inventory stock is rising
Induces firms to decrease production
Only when Planned Expenditure=Actual A
Expenditure (AS/GDP ), there is no (C  I  G  cT  cR )
tendency for change to occur.
Iu=0 and inventory stock remains
unchanged
Y1 Y* Y2 Y/Actual
No change in production level Expenditure
/GDP/AS
Equilibrium Income: Injection-Leakage approach
Savings (S) and Taxes (T) are leakages

Now if these Savings are Invested (I) and Taxes are used for government
spending (G) and Transfers (R), then we say leakages are injected.
If all leakages are injected, then S+T=I+G+R. In that case, can we say the
economy is in equilibrium?

Disposable Income (Yd): Yd=Y-T+R. Y=Yd+T-R. We know that Y is Aggregate

Supply/GDP
Yd=C+S. Therefore, Y=C+S+T-R

Aggregate demand=C+I+G

We know, the economy is in equilibrium when AD=AS

Therefore, C+I+G=C+S+T-R or S+T=I+G+R
The savings function
S
C  C  cYd  C  c(Y  T  R )
 (C  cT  cR )  cY S  C  (1  c)(R  T )  (1  c)Y

S  Yd  C
S  (Y  T  R )  (C  cT  cR )  cY
 C  T  cT  R  cR  Y  cY
 C  (1  c)T  (1  c) R  (1  c)Y
 C  (1  c)( R  T )  (1  c)Y
Average Propensity to Save (APS)

S C  (1  c)(R  T ) Y
  (1  c)
Y Y  C  (1  c)(R  T )
Marginal Propensity to Save (MPS)

S
 (1  c)
Y
 Equilibrium Income: Injection-Leakage approach
Planned Expenditure/AD (Actual Expenditure)
450/AS(AD=Y)
S T  I G  R AD<AS AD>AS implies S+T<I+G+R
AD  A  cY
(Planned Expenditure)
S  C  (1  c)(R  T )  (1  c)Y
II A AD>AS

T T
Y* Y/Actual Expenditure/GDP/AS
RR
GG S
S  T  C  (1  c)( R  T )  T  (1  c)Y
S  T  C  (1  c)( R  T )  (1  c)Y  T
AD<AS implies S+T>I+G+R
I G R  I G  R S+T>I+G+R
S+T<I+G+R I G  R

 C  (1  c)( R  T )  T Y* Y
Numerical Example
In an economy, C=50+0.80Yd, I=100 crores, government expenditure is
at 50 crores whereas T=20 crores.

a) Find the equilibrium level of income in the three sector economy.

b) Find the equilibrium level of consumption and savings at the
equilibrium level of income
c) Depict the injection-leakage equality at the equilibrium level.
Equilibrium Income: AD-AS approach
Incorporating Proportional income tax

The economy is characterized as follows:

C  C  cYd
II
T  T  tY Disposable Income: Yd  Y  T  R  Y  T  tY  R
RR
GG Consumption Function:

C  C  cYd  C  c(Y  T  tY  R )
 C  cT  cR  cY  ctY
 C  cT  cR  c(1  t )Y
The Aggregate Demand

AD  A  c(1  t )Y
AD
AD  C  I  G
 C  cYd  I  G 
 C  c(Y  T  R )  I  G  C  c(Y  T  tY  R )  I  G
 (C  I  G  cT  cR )  cY  ctY  A  cY  ctY
AD  A  c(1  t )Y
I G C  C  cT  cR  c(1  t )Y

C  cT  cR

Y
 Equilibrium Income: AD-AS approach
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  tY  R )  I  G  (C  I  G  cT  cR )  cY  ctY  A  c(1  t )Y
AD  A  c(1  t )Y
AS  Y
Y  A  c(1  t )Y
Y  c(1  t )Y  A
A
Y Y *
1  c(1  t ) A  C  I  G  cT  cR
To consider why this is an equilibrium,
consider the adjustments: Planned (Actual Expenditure)
Expenditure 450/AS(AD=Y)
Planned Expenditure (AD)> Actual
Expenditure (AS/GDP) /AD
Iu<0 and inventory stock is falling
(unplanned inventory decumulation) AD  A  c(1  t )Y
(Planned Expenditure)
Induces firms to increase production
Planned Expenditure<Actual Expenditure
(AS/GDP)
Iu>0 and inventory stock is rising
Induces firms to decrease production
Only when Planned Expenditure=Actual A
Expenditure (AS/GDP ), there is no (C  I  G  cT  cR )
tendency for change to occur.
Iu=0 and inventory stock remains
unchanged
Y1 Y* Y2 Y/Actual
No change in production level Expenditure
/GDP/AS
Multiplier Accelerator Synergy in NREGA
• What is NREGA?

• Do you think NREGA would increase the GDP of India? How?

• Which factor would the effect of the multiplier depend on?

• The value of the multiplier is expected to be low or high in case of

NREGA?

• How does the concept of accelerator work in case of NREGA?

Multiplier Concepts (Chapter 6 and 7: Vanita
Agarwal)
Policy Question

If government spending increases by Rs 100 crore, then by how much

does the equilibrium level of income rise?
OR
If the government wants to increase the equilibrium income by Rs 200
crore, then by how much it has to increase its spending?
Multiplier Process: Change in government
spending (Government spending multiplier)
Round Increase in Increase in Increase in Total (Cumulative)
Demand/Spending Production Income Increase in Income
this round This round This round

1 G G G G

2 cG cG cG G  cG  (1  c)G

3 c 2 G c 2 G c 2 G G  cG  c 2 G  (1  c  c 2 )G
4 c 3 G c 3 G c 3 G G  cG  c 2 G  c 3 G  (1  c  c 2  c 3 )G
--- --- --- --- ---
--- --- --- --- 1
G
1 c
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
AD 450/AS(AD=Y)
 (C  I  G  cT  cR )  cY  A  cY AD1

AD  A  c.Y AD  A  cY

As G rises, A rises which shifts the AD curve upward to AD1.

The multiplier process starts working, which increases the

GDP/Y from Y1 to Y2.
A

Y1 Y2 Y

Equilibrium GDP
Deriving the multiplier for changes in G
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AD  AS
Y  (C  I  G  cT  cR )  cY
(1  c)Y  (C  I  G  cT  cR )
(1  c)Y  (C  I  G  cT  cR )
C  I  T  R  0
(1  c)Y  G
1
Y  G
1 c
Deriving the multiplier for changes in I (Investment Multiplier)
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AD  AS
Y  (C  I  G  cT  cR )  cY
(1  c)Y  (C  I  G  cT  cR )
(1  c)Y  (C  I  G  cT  cR )
C  G  T  R  0
(1  c)Y  I
1
Y  I
1 c
Deriving the multiplier for changes in R (Transfer Payment Multiplier)
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AD  AS
Y  (C  I  G  cT  cR )  cY
(1  c)Y  (C  I  G  cT  cR )
(1  c)Y  (C  I  G  cT  cR )
C  G  I  T  0
(1  c)Y  cR
c
Y  R
1 c
If any of the autonomous components of A changes, Y/GDP would
change in the multiplier process.
Multiplier: case study
Lump sum tax multiplier
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AD  AS
Y  (C  I  G  cT  cR )  cY
(1  c)Y  (C  I  G  cT  cR )
(1  c)Y  (C  I  G  cT  cR )
C  G  I  R  0
(1  c)Y  cT
c
Y  T
1 c
Tax Cut Vs Government Spending
• A tax cut will generally stimulate aggregate demand more rapidly

• Multiplier effect of tax cut on GDP is lesser than government

spending.

• A tax cut will be easier to reverse once the economy has recovered.

• Compared to an increase in government spending, a tax cut is less

likely to increase structural unemployment and reduce the
productivity of resources
Assume there is an increase in government spending. However, this
spending is exactly financed by increase in taxation. Would there be any
increase in GDP?
AD  C  I  G
 C  cYd  I  G  C  c(Y  T  R )  I  G
 (C  I  G  cT  cR )  cY  A  cY
AD  A  c.Y
AD  AS
Y  (C  I  G  cT  cR )  cY
(1  c)Y  (C  I  G  cT  cR )
This is called Balanced Budget
(1  c)Y  (C  I  G  cT  cR ) Multiplier
C  I  R  0
(1  c)Y  G  cT
G  T
(1  c)Y  G  cG
1 c
Y  G
1 c
Y  G
Limitations of the multiplier
• Existence of leakages form the income stream
• The availability of consumer goods
• There may exist time lags
• The full employment ceiling
Paradox of Thrift
By savings wealth is created which makes an
individual richer S
Keynes argued, what is true for an individual
may not be applicable to an economy. S2
Why? S1
- If the entire economy becomes thrifty, I
there will be decrease in total
Y2 Y1
consumption. Y
- This would cause a decrease in aggregate
demand
- GDP/National Income will decrease
The Keynesian Model of Income Determination in a Four sector
economy: Introduction of the Foreign Sector (Chapter 8: Vanita Agarwal)
The volume of exports depend on the following factors:
• The prices of the exports in the domestic economy relative to prices
in other economies
• The income level of other countries
• Taste, preferences, customs and traditions in other economies
• The tariff and trade policies between the domestic economy and the
other countries
• The domestic economy’s level of imports
• Exchange rate policies
The Keynesian Model of Income Determination in a Four sector
economy: Introduction of the Foreign Sector (Chapter 8: Vanita Agarwal)
The volume of imports depend on the following factors:
• The prices of imports relative to domestic prices
• The income level of the domestic country
• Taste, preferences, for imports as compared to the domestic goods
• The tariff and trade policies between the domestic economy and the
other countries
• Exchange rate policies
Simplifying Assumption
• Exports of an economy is autonomous

• Imports are determined by the income level of the domestic economy

Equilibrium Income: AD-AS approach
The economy is characterized as follows:
C  C  cYd
II
T T
RR
GG
Disposable Income (Yd): Yd  Y  T  R
XX
M  M  mY
 Equilibrium Income: AD-AS approach
AD  C  I  G  X  M
 C  cYd  I  G  X  M  mY  C  c(Y  T  R )  I  G  X  M  mY  (C  I  G  X  M  cT  cR )  cY  mY  A  cY  mY
AD  A  c.Y  mY
AS  Y
Y  A  cY  mY
Y  cY  mY  A
A
Y Y *
1 c  m

A  C  I  G  X  M  cT  cR
To consider why this is an equilibrium,
consider the adjustments: Planned (Actual Expenditure)
Expenditure 450/AS(AD=Y)
Planned Expenditure (AD)> Actual
Expenditure (AS/GDP) /AD
Iu<0 and inventory stock is falling AD  A  (c  m)Y
(unplanned inventory decumulation) (Planned Expenditure
Induces firms to increase production
Planned Expenditure<Actual Expenditure
(AS/GDP)
Iu>0 and inventory stock is rising
Induces firms to decrease production A
Only when Planned Expenditure=Actual (C  I  G  X  M  cT  cR )
Expenditure (AS/GDP ), there is no
tendency for change to occur.
Iu=0 and inventory stock remains
unchanged
Y1 Y* Y2 Y/Actual
No change in production level Expenditure
/GDP/AS
Equilibrium Income: Injection-Leakage approach
Savings (S) , Taxes (T) and Imports are leakages

Now if these Savings are Invested (I) and Taxes are used for government
spending (G) and Transfers (R) and Imports are funded by Exports (X), then
we say leakages are injected.
If all leakages are injected, then S+T+M=I+G+R+X. In that case, can we say
the economy is in equilibrium?

Disposable Income (Yd): Yd=Y-T+R. Y=Yd+T-R. We know that Y is Aggregate

Supply/GDP
Yd=C+S. Therefore, Y=C+S+T-R

Aggregate demand=C+I+G+X-M

We know, the economy is in equilibrium when AD=AS

Therefore, C+I+G+X-M=C+S+T-R or S+T+M=I+G+R+X
 Equilibrium Income: Injection-Leakage approach
Planned Expenditure/AD (Actual Expenditure)
450/AS(AD=Y)
S T  M  I G  R  X AD<AS AD>AS implies S+T+M<I+G+R+X
AD  A  (c  m)Y
S  C  (1  c)(R  T )  (1  c)Y (Planned Expenditure)
II
A AD>AS
T T
RR Y* Y/Actual Expenditure/GDP/AS

GG
S
M  M  mY S  T  M  C  (1  c)(R  T )  T  M  (1  c  m)Y
S T  M AD<AS implies S+T+M>I+G+R+X
 C  (1  c)( R  T )  (1  c)Y  T  M  mY S+T+M<I+G+R+X S+T+M>I+G+R+X

 C  (1  c)( R  T )  T  M  (1  c  m)Y I G  R  X

 C  (1  c)(R  T )  T  M Y* Y

I G R X  I G  R  X
Government Spending Multiplier with foreign sector
AD  C  I  G  X  M
 C  cYd  I  G  C  c(Y  T  R )  I  G  X  M  mY
 (C  I  G  X  M  cT  cR )  cY  mY  A  cY  mY
AD  A  c.Y  mY
AD  AS
Y  (C  I  G  X  M  cT  cR )  cY  mY
(1  c  m)Y  (C  I  G  X  M  cT  cR )
(1  c  m)Y  (C  I  G  X  M  cT  cR )
C  I  T  R  X  M  0
(1  c  m)Y  G
1
Y  G
1 c  m
Autonomous Investment Multiplier with foreign sector
AD  C  I  G  X  M
 C  cYd  I  G  C  c(Y  T  R )  I  G  X  M  mY
 (C  I  G  X  M  cT  cR )  cY  mY  A  cY  mY
AD  A  c.Y  mY
AD  AS
Y  (C  I  G  X  M  cT  cR )  cY  mY
(1  c  m)Y  (C  I  G  X  M  cT  cR )
(1  c  m)Y  (C  I  G  X  M  cT  cR )
C  G  T  R  X  M  0
(1  c  m)Y  I
1
Y  I
1 c  m
Transfer Payment Multiplier with foreign sector
AD  C  I  G  X  M
 C  cYd  I  G  C  c(Y  T  R )  I  G  X  M  mY
 (C  I  G  X  M  cT  cR )  cY  mY  A  cY  mY
AD  A  c.Y  mY
AD  AS
Y  (C  I  G  X  M  cT  cR )  cY  mY
(1  c  m)Y  (C  I  G  X  M  cT  cR )
(1  c  m)Y  (C  I  G  X  M  cT  cR )
C  G  T  I  X  M  0
(1  c  m)Y  cR
c
Y  R
1 c  m
Lumpsum Tax Multiplier with foreign sector
AD  C  I  G  X  M
 C  cYd  I  G  C  c(Y  T  R )  I  G  X  M  mY
 (C  I  G  X  M  cT  cR )  cY  mY  A  cY  mY
AD  A  c.Y  mY
AD  AS
Y  (C  I  G  X  M  cT  cR )  cY  mY
(1  c  m)Y  (C  I  G  X  M  cT  cR )
(1  c  m)Y  (C  I  G  X  M  cT  cR )
C  G  R  I  X  M  0
(1  c  m)Y  cT
c
Y  T
1 c  m
 Foreign Trade Multiplier
AD  C  I  G  X  M
 C  cYd  I  G  X  M  mY  C  c(Y  T  R )  I  G  X  M  mY  (C  I  G  X  M  cT  cR )  cY  mY
AS  Y
Y  (C  I  G  X  M  cT  cR )  cY  mY
Y  cY  mY  (C  I  G  X  M  cT  cR )
(1  c  m)Y  C  I  G  X  M  cT  cR
(1  c  m)Y  C  I  G  X  M  cT  cR
C  I  G  M  T  R  0
1
Y  X
1 c  m
Applicability of the multiplier to less
developed countries
• There should exist only involuntary unemployment and no other form
of unemployment
• It should mainly be an industrial economy
• There should exist excess capacity in the consumer goods industry
• There should exist an elastic supply of capital