Chapter 4:

NATIONAL INCOME DETERMINATION :

KEYNESIAN MODEL

CHAPTER
11
 INTRODUCTION

• It is important to learn about and understand the

determination of national income equilibrium because the
equilibrium level will affect the level of employment in the
economy and it is also used to identify the rate of
unemployment that occur in the economy.
• An increase in the production of goods and services in the
economy is the result of a high equilibrium level of national
income.
• This indicates that an excessive amount of resources are
being employed in the economy.
 APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM

Aggregate
Supply = Leakages =
Aggregate Injections
Demand Approach
Approach
 APPROACHES IN DETERMINING NATIONAL
INCOME EQUILIBRIUM (cont.)

A leakage is an income
Injection is an income received by all sectors in
that can be raised within the economy which is not
the circular flow. distributed within the
Injections include circular flow. Leakages
investments, government include savings, taxes and
expenditures and imports. A leakage will
exports. reduce our national
income.
 COMPONENTS OF
LEAKAGES/WITHDRAWALS
• S+T+M

• S=SAVING
• T=TAX
• M=IMPORT
• DISPOSABLE INCOME = (Yd)

• =S+T+M
 FORMULA –NATIONAL INCOME
EQUILIBRIUM
SECTOR AD-AS LEAKAGES-INJECTION
TWO-SECTOR Y=C+I S=I
THREE-SECTOR Y=C+I+G S+T=I+G
FOUR-SECTOR Y=C+I+G+X-M (NX) S+T+M=I+G+X
 AUTONOMOUS AND INDUCED
CONSUMPTION

• Consumption can be defined as spending by all households

in the economy on goods and services produced within the
economy. Consumption is the main component of aggregate
expenditure.
• The most important factors which influences consumption is
disposable income.
Yd = Y + Transfer payment - Taxes
Yd = Y - T
• Two sector only, we assume Y= yd
• 3&4 sector, Yd= Y-tax
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Concepts of Conception
 MPC+ MPS=1
APC+APS=1
• MPC
• =THE CHANGES OF C/THE CHANGES Yd
• MPC=475-400/450-350=0.75
• Yd=350,450, 550
• C= 400, 475,550
• APC=400/350=
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)
Consumption Function
• Consumption function shows the amount of households spending
on goods and services at different levels of disposable income.
• According to Keynes, there are two types of consumption, namely
autonomous consumption and induced consumption.
• The general form of the consumption function equation is:

C= a + bYd
where,
C = total consumption
a = autonomous consumption which is independent of the Y d
b = marginal propensity to consume (MPC) or slope of consumption function
Yd = disposable income
 AUTONOMOUS CONSUMPTION
• C= a + bYd
• When Yd=0
• C= a + b(0)
• C=a
AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Factors Influencing Consumption

• Income level
• Expectation
• Wealth
• The price level
• Interest rate
• Stock of durable goods
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Saving Theory
 Autonomous saving or dissaving is the part of savings not
related to income it occurs when there is autonomous
consumption.
 Autonomous consumption is the expenditure incurred by
the consumer if there is no income.
 Saving is considered as part of income received by
households that is not used consumption or expenditure.
 Important Formula

•Yd= C+S (CLOSED

ECONOMY-TWO SECTOR
ECONOMY)
• C=Yd-S
• S=Yd-C
INCOME YD C S= (YD-C)
100 175 -75
200 250 -50
300 325 -25
400 400 0
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Concepts of Saving
 FORMULA MPS, MPC, APS, APC

• MPC+MPS=1
• MPS=1-MPC
• MPC=1-MPS

• APC+APS=1
• APC=1-APS
• APS=1-APC
 AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Saving Function

• S = -a + (1 - b)Yd
where,
• -a = autonomous saving
• b = marginal propensity to consume (MPC)
• Thus, (1 - b) = 1 - MPC = MPS

Break-even Income
• Break-even point refers to the point at which consumption is equal
to national income.
• At this point, saving is equal to zero.
 S = -a + (1 - b)Yd
S=-80+0.2(800)

MPC=1-0.2=0.8

C=80+0.8(400)
MPS=1-0.8=0.2
yd C=yd-s S
200 240 -40
400 400 0
600 560 40
800 720 80
 EXERCISE
YD C S APC APS MPC MPS
350 400 -50 1.14 -0.14 0.75 0.25
450 475 -25 1.05 -0.05 0.75 0.25
550 550 0 1 0 0.75 0.25
650 625 25 0.96 0.04 0.75 0.25
750 700 50 0.93 0.07 0.75 0.25
850 775 75 0.91 0.09 0.75 0.25
950 850 100 0.89 0.11 0.75 0.25
 DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER

• The expenditure multiplier can be defined as the ratio of

the change in income to the change in aggregate demand.
This aggregate demand can be referred to investments,
government spending, taxes and balance budget and
import.
• The size of the expenditure multiplier which depends on
household marginal decisions to spend, is called the
marginal propensity to consume (MPC) or marginal
propensity to save (MPS).
 DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

• The multiplier shows that an initial change in aggregate

demand can have a much greater impact on the equilibrium
level of national income. The expenditure multiplier denoted
by K can be measured by:

• Since the size of K depends on MPC and MPS, therefore K can

be measured using the following formula:
 DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

• The tax multiplier is a ratio of a decrease in national income

to an initial increase in tax. It shows that any increase in tax
will have a negative influence on aggregate income and the
overall economy.
• The tax multiplier can be measured as:

• Thus, it can be expressed as: