DPB2023

MACROECONOMICS

CHAPTER 3:
DETERMINANT OF NATIONAL
INCOME EQUILIBRIUM
Arrow Process
Chapter Review
Why use graphics from PowerPointing.com?
•Investment
multiplier
• Two – sector C+I • Government
• Consumption (MPC & APC)
• Three – sector C+I+G spending
• Four – sector C+I+G+X-M • Savings (MPS & APS)
• Taxes
• Balanced
budget
• Import

EQUILIBRIUM IN UNDERSTANDING MARGINAL &

CIRCULAR FLOW OF APPROACH MULTIPLIER
ECONOMICS AVERAGE
INCOME AND EFFECTS
VARIABLES PROPENSITIES
DIAGRAM

• Consumption mathematical • AD = AS table &

• Savings function • Leakage = Injection mathematical
methods
• Investment types & • Sketch/draw the diagram
• Government spending factors
 What is national income equilibrium?

 Is a situation where the equilibrium achieved from

countries total expenditure for goods and services is
equal to total supply in the economy
 as an equation:
AS = AD

Aggregate Aggregate
demand supply (AS)
(AD)
 What is national income equilibrium?
 National income equilibrium will calculate in:
 two sector economy
 three sector economy
Circular
 four sector economy flow of
income
 What is circular flow of income?

• A diagram shows the flow of products from

firms to households and the flow of
resources from households to firm
• There are three circular flow of income

Two sector Three sector Four sector

economy economy economy
Circular Flow of Income
Two sector economy
 Circular Flow of Income
Two sector economy

 Consists of households and firm Household

will
 How it works? supplying
all these
resources
Own the to firms
resources of:

Household
Physical flow
 Circular Flow of Income
Two sector economy

• Now from firms, how it works?

Rent

Buy the resources

from household Wages
for production

Firms
Sell/supply the
goods and services
Profit to household
Interest
 Circular Flow of Income
Two sector economy

Supplying
resources to firms

Buy the resources

from households
Monetary Produce the goods
flow
and services to Physical flow
households
Household
Buy the goods and Firms
services from firms
 Household will
supplying all
resources to firms

Buy and pay the

resources from
household for
production

Sell/supply the goods Firms

Household and services to
household

Buy the goods and

services from firms
 Try yourself!

Firms
Household
Circular Flow of Income
Three sector economy
 Circular Flow of Income
Three sector economy
• Consists of:

Firms
Household
Government
 Circular Flow of Income
Three sector economy
• How it works:

Pay the taxes to

government

Pay the taxes to

government
Government

Government’s revenue
 Circular Flow of Income
Three sector economy
• How it works:
Buy the resources
from household
(pension, wage)

Buy the goods and

services from firms
(public investment;
Government subsidies)

Government expenditure
 Household will supplying all
resources to firms

Buy and pay the resources

from household for production

Government
Transfer
expenditure
payment

Taxes Taxes Firms

Government
Household
Sell/supply the goods and
services to household

Buy the goods and

services from firms
 Household will supplying all
resources to firms
Try yourself!
Buy and pay the resources
from household for production

Government
Transfer
expenditure
payment

Taxes Taxes Firms

Government
Household
Sell/supply the goods and
services to household

Buy the goods and

services from firms
Circular Flow of Income
Three sector economy
Circular Flow of Income
Four sector economy
 Circular Flow of Income
Four sector economy
• Consists of:

Government Firms

Household

Foreign sector
 Export
Export

Foreign sector

Import Import

Transfer Government
payment expenditure

Firms
Household
Taxes Government Taxes
 Try yourself!
Export
Export

Foreign sector

Import Import

Transfer Government
payment expenditure

Firms
Household
Taxes Government Taxes
VARIABLES OF ECONOMIC
SECTOR

Consumption (C )
Savings (S)
Investment (I)
Government spending (G)
Consumption
This concept can be explain by Consumption
“Marginal propensities to Depend on income
functions
consume (MPC)” Yd C
C=a+bY
Yd C

Is an injection
Consumption A person will increase
component in consumption as their
the economy income increases

Consumer will spend

only a part of the Average propensities to
increase in income and consume (APC)
save the rest
Savings
 This concept can be explain by Dependent on income
“Marginal propensities to save Yd S
(MPS)”
Yd S

Saving functions
S = - a + (1-b) Y
Savings

Average propensities to
save (APS)
Is a leakage Is a part of household
component in the income that not spend
economy
 Marginal Propensity to Consume
 We can know how much the consumption by
calculate the MPC
 The change in consumption resulting from a given
change in real disposable income
 Mathematically:
C
MPC 
Yd
 Marginal Propensity to Save

 Households do a saving with extra dollar that they do

not spend
 Therefore, we can know how much they spend by
using the MPS
 MPS is the change in saving resulting change in real
disposable income
S
 Mathematically: MPS 
Yd
 Consumption Function

• The relationship between savings and the level of

income
• Formula:
C = a + bY
C = consumption expenditure
a = autonomous consumption
b = marginal propensity to consume (MPC)
Yd = disposable income
MPC + MPS = 1
 Savings function

• The relationship between savings and the level of

income
• Savings function can be written as:

S  a  (1  b)Yd
S = savings
-a = autonomous savings
1-b = marginal propensity to save (MPS)
Yd = disposable income
 Average Propensity to Consume
 A ratio of total consumption to real disposable
income
C
APC 
Yd

APC + APS = 1
 Average Propensity to Save
• Is the ratio of savings to real disposable income

S
APS 
Yd
The most volatile
Is the important
component in AD
component in AD

Investment

Two types: Is an injection

1. Autonomous investment component in
2. Induced investment the economy
Does not depends on For welfare
national income motives. Not for
making profits.

The curve is : Autonomous

Perfectly Inelastic Investment
Essential to Examples:
development Construction of
purposes road, bridges,
school, charitable
Not affected by a rise in houses by
wages of workers or raw government
materials
 Autonomous Investment
The curve
Investment
Perfectly
Inelastic
curve
I

National
Income
 Is response to a
changes in national It is done for
income profits motives by
private sector

The curve is : Induced

positive Investment

Examples: the
Essential for a nation to investors invest in
maintain its stability and the company for
economic prosperity gain margin profit
 Induced Investment
The curve
Investment
Positive
I relationship

Y I
National
Income
Interest rate (r) Rate of return
(r.r)

Is the financial cost

that firms have to pay • Is the value of return
when borrowing capital Factors of from investment
to purchase assets Investment • The firms get profit
from its investment
r I • Is to improve a quality
• Is to attract
of productionr.r
investorsand
both domestic
product by
andnew
I
Technological Government
foreign
innovation and
change policies
• Example: inventions
reduce
• May taxes
attract businesses to
invest
Is a second largest It is an injection
component of AD component in three
sector

Government
expenditure

Considered as an
Example: defense and autonomous
war expenditure ----
does not depends on
national income
 Taxes Economic goal

Taxes is the
revenue for
government. Factors of The changes in
The more revenue, government plan
more expenditure
Government also make a change
expenditure in government
expenditure
The political pattern.
stability would
determine the
success of Political
government stability
expenditure
THE APPROACH/METHOD

AS = AD
INJECTION = LEAKAGE
 Calculate National Income Equilibrium

 There are TWO methods:

Method

Aggregate Injection - Leakage

approach approach
 Calculate National Income Equilibrium

Aggregate Approach

Two sector Three sector Four sector

AS = AD AS = AD
AS = AD
Y=
Y = C+I Y = C+I+G C+I+G+X-M
 Calculate National Income Equilibrium

Injection= Leakage Approach

Two sector Three sector Four sector

I=L I=L
I=L
I+G+X =
I=S I+G = S+T S+T+M
 AS = AD Curve
AD (C,I)
Y=AE
Aggregate expenditure (in RM)

E0 C+I

C=100+0.7Yd
600
Consumption
100 function
45º

0 2000 Y
Y* Output (in RM)
 Injection = Leakage Curve
S,I
S=-100+0.3Yd
500 Investment

0 Y
2000* Savings
-50
function
-100

Income (in RM)

 Tabular analysis
Aggregate Consumption (C) Savings (S) Investment (I) Aggregate
Supply Demand (C+I)
0 100 -100 500 600
1000 800 200 500 1400
1500 1150 350 500 1650
2000* 1500 500 500 2000*
2500 1850 650 500 2350
3000 2200 800 500 2700
THE TWO SECTOR
EQUILIBRIUM

AS = AD
INJECTION = LEAKAGE
 Algebra Analysis
• Given are the following information:
– Autonomous consumption = 100
– MPC = 0.7
– Autonomous Investment = 500
Consumption function, C=100+0.7Yd (in two sector, Yd=Y since no tax)

AS = AD Injection = Leakage
Y = C+I I=S
Savings function can be derived from
= 100+0.7Y+500 consumption function
Y-0.7Y = 600 S = -100+0.3Yd
0.3Y = 600
S =I
Y = 600/0.3
-100+0.3Y = 500
Y = 2000 0.3Y = 600
Y = 2000
 AS = AD Curve
AD (C,I)
Y=AE
Aggregate expenditure (in RM)

E0 C+I

C=100+0.7Yd
600
Consumption
100 function
45º

0 2000 Y
Y* Output (in RM)
 Injection = Leakage Curve
S,I
S=-100+0.3Yd
500 Investment

0 Y
2000* Savings
-50
function
-100

Income (in RM)

 Tabular analysis
Aggregate Consumption (C) Savings (S) Investment (I) Aggregate
Supply Demand (C+I)
0 100 -100 500 600
1000 800 200 500 1400
1500 1150 350 500 1650
2000* 1500 500 500 2000*
2500 1850 650 500 2350
3000 2200 800 500 2700
THE THREE SECTOR
EQUILIBRIUM

AS = AD
INJECTION = LEAKAGE
 Equilibrium in Three-sector

• Equilibrium achieved when:

AS = AD INJECTION = LEAKAGE
Y = C+I+G I+G=S+T

• Determination of equilibrium in three-sector is more

complex, which is about two types of tax:
– Autonomous tax
– Induced tax
 Autonomous tax
If income
increase /
Tax that are For
decrease,
independen example:
tax remain
t on income RM 100
constant
Autono
mous
tax
 If income
change,
induced
Taxes that depend For example: tax =
Induced tax
tax also 0.6Y
on income

changes

Induced tax
 Algebra Analysis (Autonomous Tax)
• Given are the following information:
C = 200+0.75Yd
I = 100 AS = AD
Y = C+I+G
G = 50 = 200 + 0.75Yd + 100 + 50
T = 100 = 350 + 0.75Yd
= 350 + 0.75 (Y-T)
= 350 + 0.75 (Y – 100)
= 350 + 0.75Y – 75
= 275 + 0.75Y
Y – 0.75Y = 275
0.25Y = 275
Y = 275/0.25
Y = 1100*
 Algebra Analysis (Autonomous Tax)
• Given are the following information:
C = 200+0.75Yd Savings function can be
derived from consumption
I = 100
INJECTION = LEAKAGE function: S=-200+0.25Yd
G = 50 I + G = S + T
T = 100 100 + 50 = - 200+ 0.25Yd+100
150 = -100 + 0.25(Y-T)
150 = -100 + 0.25 (Y-100)
150 = -100 + 0.25Y-25
150 = 125 + 0.25Y
150+125 = 0.25Y
275 = 0.25Y
275/0.25 = Y
1100 = Y
 Algebra Analysis (Induced Tax)
• Given are the following information:
C = 200+0.75Yd AS = AD
I = 100 Y = C+I+G
= 200 + 0.75Yd + 100 + 50
G = 50 = 350 + 0.75Yd
T = 0.2Y = 350 + 0.75 (Y-T)
= 350 + 0.75 (Y – 0.2Y)
= 350 + 0.75 (0.8Y)
= 350 + 0.6Y
Y – 0.6Y = 350
0.4Y = 350
Y = 350/0.4
Y = 875*
 Algebra Analysis (Induced Tax)
• Given are the following information:
C = 200+0.75Yd Savings function can be
I = 100 INJECTION = LEAKAGE derived from consumption
function: S=-200+0.25Yd
G = 50 I + G = S + T
100 + 50 = - 200+ 0.25Yd+0.2Y
T = 0.2Y 150 = -200 + 0.25(Y-T)+0.2Y
150 = -200 + 0.25 (Y-0.2Y)+0.2Y
150 = -200 + 0.25 (0.8Y) +0.2Y
150 = -200 + 0.2Y + 0.2Y
150 = -200 + 0.4Y
150+200 = 0.4Y
350 = 0.4Y
350/0.4 = Y
875 = Y
AS = AD with
autonomous tax Consumption
AD (C,I,G) function
before tax
Aggregate expenditure (in RM)

Y=AE
E0 C+I+G
C=200+0.75Yd
C = 125+0.75Yd
350 Consumption
200 function after
tax
125 45º
Y
1100
0
Y*

Output (in RM)

 Injection = Leakage Savings
with autonomous tax function
before tax
S,I
S=-200+0.25Yd
S+T = -225+0.25Y
150 I+G
Savings
function after
tax
0 Y
-50 2000*
-200
-225

Income (in RM)

 AS = AD with
induced tax Consumption
function
Aggregate expenditure (in RM) AD (C,I,G) before tax
Y=AE
E0 C+I+G
C=200+0.75Yd
C = 200+0.6Y
350
Consumption
200 function after
45º tax
875 Y
0
Y*

Output (in RM)

 Injection = Leakage Savings
with autonomous tax function
before tax
S=-200+0.25Yd
S,I
S+T = -200+0.2Y
150 I+G
Savings
function after
tax
0 Y
-50 875*
-200

Income (in RM)

THE FOUR SECTOR
EQUILIBRIUM

AS = AD
INJECTION = LEAKAGE
 Algebra Analysis

• Given the following information:

C = 200+0.75Yd ANSWER:

I = 100 AS = AD
G = 50 Y = C+I+G+X-M
Y = 200+0.75(Y-T)+100+50+(100-50)
T = 100 Y = 400+0.75(Y-100)
Y = 400+0.75Y-75
X = 100 Y = 325+0.75Y
M = 50 Y-0.75Y = 325
0.25Y = 325
Y = 325/0.25
Y = 1300*
 AS = AD
Aggregate expenditure (in RM) AD (C,I,G,X-M)

Y=AE
E0 C+I+G+X-M

C=200+0.75Yd
600

Consumption
100 function
45º
Y
1300
0
Y*

Output (in RM)

 Algebra Analysis

• Given the following information:

C = 200+0.75Yd
I = 100 ANSWER:

G = 50 INJECTION = LEAKAGE
I+G+X = S+T+M
T = 100 100+50+100 = -200+0.25(Y-100)+100+50
250 = -75+0.25Y
X = 100 250+75 = 0.25Y
M = 50 325 =Y
1300 =Y
 Injection = Leakage S+T+M

250 I+G+X

0 Y
-50 1300*

-75

Income (in RM)

 MULTIPLIER EFFECTS

INVESTMENT MULTIPLIER
GOVERNMENT EXPENDITURE MULTIPLIER
TAX MULTIPLIER
BALANCED BUDGET MULTIPLIER
 What is Multiplier?

• The multiplier effect refers to the increase in national

income (Y) arising from any new injection of
spending (C), investment (I) or government spending
(G)
 What is Multiplier?

• The multiplier effect refers to the increase in national

income (Y) arising from any new injection of
spending
• Examples of such situations include:
– When the government funds building of a new
highway
– When there is an increase in exports abroad
– When there is a reduction in interest rates or tax
rates
– When there is increase in an investment
 Multiplier
• The size of multiplier depends on the size of MPC
• Therefore, the higher the MPC, the higher the size of
multiplier
• The lower the value of MPC, the lower the size of
multiplier
• Formula of multiplier is written as below:
• K
 Formula
Multiplier Formula by change in Multiplier formula:
national income K=

Investment = K * ∆I

Government expenditure ∆Y = K* ∆G 1
1 − 𝑀𝑃𝐶
Tax ∆Y = K* ∆T
− MPC
=1
MPS
Balanced Budget ∆Y = K* ∆T − MPC
∆Y = K* ∆G Tax = =1
MPS
1
Govt =
1 − 𝑀𝑃𝐶

Import ∆Y = K* ∆M
 Question
• Now government increases its spending by RM10
million. If the marginal propensity to consume is 0.8,
how much now change in national income?