Tutorial 2: Keynesian Theory of National Income Determination

Macroeconomics | COMC 21313

Academic Year – 2020/2021
Department of Commerce and Financial Management | University of Kelaniya

DISCUSSION QUESTIONS

1. Do you agree with the statement that Keynes derived his aggregate supply function by
using classical production function? If yes, explain the derivation of the Keynesian
aggregate supply function using appropriate diagrams.

2. Explain the concept of aggregate demand. How is the Keynesian aggregate demand
function different from the classical demand function based on the Say’s Law?

3. Explain the Keynesian consumption function and how it differs from Keynesian followers
(Keynesian economists).

4. Which of the following statements is correct? Explain with reasons.

a) Keynes assumed a constant MPC.
b) ∆𝑪/∆𝒀 varies with the increase in income in Keynes’s original consumption
function.
c) the condition that 0 < MPC < 1 holds always.

5. Suppose a consumption function is given as C = a + bY. Derive a saving function from

this consumption function.

6. Assuming a general form of two sector consumption function, prove the following.
a) 𝑆 = (1 − 𝑏)𝑌 − 𝑎
∆" ∆$
b) ∆#
+ ∆# = 1

7. What is meant by the equilibrium level of national income/ why is the equilibrium level of
income and output supposed to be stable where AD = AS?

8. What is a multiplier? Explain how an additional investment multiplies itself to contribute

to the national income. Draw a diagram to show that DY > DI when MPC > 0.

9. Suppose in a two-sector economy,

𝐶 = 100 + 0.6𝑌
𝐼 = 100
∆𝐼 = 50
Derive,
a) Savings function
b) The multiplier
c) DY through the dynamic multiplier

10. The multiplier for a two-sector economy is computed to be 4. Derive the followings.
a) The savings function
b) The investment function.
11. A two-sector economy has a total income of Rs. 150 billion and its overall MPC is worked
out be 66.67%. How much does this country need to invest to increase it total income by
100%?

12. for the given C = a + bY and I, if MPC = 0.8 and DI = 50, find the multiplier.

13. What is a transfer payment?

14. Which of the following statements are correct?

a) an expenditure is an injection into the economy and a tax is a withdrawal.
b) An equal amount of expenditure and autonomous tax will leave the equilibrium
level of national income unaffected.
c) An equal amount of transfer payment and tax reduction will have the same impact
on the national income.
d) Tax multiplier is one greater than the expenditure multiplier.
e) Expenditure multiplier is one greater than the tax multiplier.
f) The level of national income is not affected whether a tax is autonomous, or
income related because both are withdrawals from the income stream.
% '
g) 5%&'6 ∆𝐺 = [− %&']∆𝑇
% '
h) 5%&'6 ∆𝐺 > [− %&']∆𝑇
% '
i) 5%&'6 ∆𝐺 < [− %&']∆𝑇
% &'
j) %&'
+ %&' = 1

15. what is balance-budget multiplier? Prove the balanced budget multiplier is always equal to
1.

16. What is the export multiplier? Find the export multiplier from the following model.
𝐴𝐷 = 𝐶 + 𝐼 + 𝐺 + 𝑋
𝐶 = 𝑎 + 𝑏(𝑌 − 𝑇)
𝐼 = 𝐼 ̅ , 𝑇 = 𝑇C, 𝐺 = 𝐺̅ , 𝑋 = 𝑋C, 𝑀 = 0

17. How is import function different from export function? Assuming the following model,
find the foreign trade multiplier.
𝑌 = 𝐶 + 𝐼 + 𝐺 + (𝑋 − 𝑀)
𝐶 = 𝑎 + 𝑏(𝑌 − 𝑇)
𝐼 = 𝐼 ̅ , 𝑇 = 𝑇C, 𝐺 = 𝐺̅ , 𝑋 = 𝑋C, 𝑀 = 𝑀
E + 𝑚𝑌
PRACTICE QUESTIONS

1. Suppose a consumption function is given as 𝐶 = 100 + 0.8𝑌 and stock of capital is fixed
at Rs. 200. Based on this information, draw an aggregate demand function.

2. Suppose the consumption function and the investment in a two-sector economy are given
as:
𝐶 = 50 + 0.8𝑌
I=50
Find the equilibrium level of income, consumption and savings.

3. Suppose the structural equations of an economy are given as follows.

𝑌 =𝐶+𝐼
𝐶 = 100 + 0.75𝑌 and I = 100
Find the equilibrium national income and the consumption.

4. suppose the structural equations for an economy are given as follows.

𝐶 = 50 + 0.8𝑌(
𝑌( = 𝑌 − 𝑇
I = 50
G = 50
T = 50
a) Name the endogenous and exogenous variables.
b) Derive reduced form of endogenous variables.
c) Find equilibrium values for all endogenous variables.

5. Suppose the structural model of an economy is given as follows,

𝐶 = 100 + 0.8𝑌(
𝑌( = 𝑌 − 𝑇
𝐼 = 100
𝐺 = 100
𝑇 = 100
Find the following.
a) Expenditure multiplier and DY if DG = 50.
b) Tax multiplier
c) National income equilibrium, if T = 20 + 0.25Yd.
d) By how much the government should increase its expenditure (G) to increase the
national income by 500.

6. An economy is in equilibrium at Rs. 1,000 billion with an MPS of 20%. Suppose it plans
to raise the level of its income to Rs. 1,100 billion. What amount of the government
expenditure or alternatively, transfer payment would you recommend?

7. Suppose the structural model of an economy is given as follows,

𝐶 = 100 + 0.8𝑌( : 𝑌( = 𝑌 − 𝑇
𝐼 = 150, 𝐺 = 50 𝑎𝑛𝑑 𝑇 = 20 + 0.25𝑌

Find the following.

a) Equilibrium level of income, consumption and savings.
b) Change in equilibrium income if G increases to 100 and I decreases to 100.
8. You are given the following information of a hypothetical economy as follows.
C = 100 + b(Y – 50 – tY)
I = 50, G = 50, X = 10, M = 5 + 0.1Y, MPC = 0.8 and t = 0.25
a) Specify the endogenous and exogenous variables.
b) Find the reduced form of the equilibrium equation.
c) find the equilibrium level of income and imports.

9. Suppose that an economy is in equilibrium at,

Y = C + I + G + GT + (X – M)
Where, C = 50 + b(Y – 50 – tY + GT)
I = 100, G = 50, GT = 25, X = 10, M = 5 + 0.1Y, b = 0.8 and t = 0.25
a) Find the national income at the equilibrium.
b) Find the foreign trade multiplier.
c) How much additional government expenditure will be required to increase the
equilibrium level of national income by Rs. 50?
d) At the equilibrium, does the economy have trade deficit or trade surplus and by
how much?

10. Suppose, C = 50 + 0.6(Y – T), I = 35, X = 30, G = 25, T = 20 and M = 8 + 0.1Y

a) Find the equilibrium level of income.
b) Determine by how much either increase or decrease the government expenditure
(G) to increase the equilibrium income by 16.
c) Trade balance at the equilibrium level of income with DG = DT.

11. Suppose in an economy,

Consumption function : C = 150 + 0.75Y
Investment Spending : I = 100
Government Spending : G = 115
Tax : Tx = 20 + 0.20Y
Transfer Payment : GT = 40
Exports : X = 35
Imports : M = 15 + 0.1Y
Where, Y and Yd are income and disposable income, respectively. All figures are in rupees.
a) Equilibrium level of national income
b) Consumption at the equilibrium income.
c) Net export (X – M) at the equilibrium income.
d) By how much the equilibrium income changes if investment increases by Rs. 50.
e) The increase in the government spending required to ensure that the economy
reaches the full employment level of income of Rs. 1, 200.