In a … 8o. In the economy, as one man's expenditure is another man's income, the total expenditure of the economy must be equivalent to the total income. The process of determination of equilibrium level of national income will become clear if we use simple algebra. The increase in investment would result in the equal increase of income, which is described as follows: When the income of individuals increases to Rs. The aggregate demand and aggregate supply intersect each other at point E, which is termed as equilibrium point. The theory of multiplier is based on an assumption that goods and services are abundant and there would be no scarcity of them in economy. Keynes believed that there are two major factors that determine the national income of a country. d. Contains no profit that is undistributed or savings by the organization. Overview Of Keynesian Income And Expenditure Model Economics Essay Introduction: Keynesian economic theory has been named after a British, John Maynard Keynes (1883 – 1946). In this method, the equilibrium point is achieved when the following condition is satisfied: As, C + S = Y, therefore, the equilibrium condition of national income determination would become: At equilibrium point, the consumption is equal to: Substituting the value of C in the national income equilibrium condition, we get: For the determination of national income with the help of income-expenditure approach, let us assume that the consumption function is C = 200 + 0.50Y and I = 150. Figure-6 demonstrates the shift in national income due to shift in equilibrium point and AD schedule: In Figure-6, C + I schedule represents the initial AD schedule. In addition, it is also assumed that the consumer tastes and preferences and income distribution remains constant. (BS) Developed by Therithal info, Chennai. Since Y = AD, equation ( 1) can be written as . Similarly, beneath point E, the AD and AS schedules represent that the aggregate demand is more than aggregate supply. For example, in Table-1, when the income or aggregate supply is Rs. So, the formula for calculating multiplier with the help of MPS is as follows: Therefore, multiplier can also be termed as the reciprocal of MPS. By substituting the value of consumption in the equation of AD, we get: Let us prepare an AD schedule by assuming that the investment is Rs. The correlation between income and expenditure is represented by an angle of 45°, as shown in Figure-2: According to Keynes theory of national income determination, the aggregate income is always equal to consumption and savings. AD schedule is prepared by adding the schedule of C and I. Aggregate effective demand refers to the aggregate expenditure of an economy in a specific time frame. They are consumption expenditure (C), investment expenditure (I), government expenditure (G) and net expenditure on trade or net exports that is, exports minus imports, (X-M). The preceding equation of ΔY determines the relationship between ΔY and ΔI. In the Keynesian model of income and output determination, market equilibrium is a state I which aggregate expenditure and aggregate income/output are equal. In the SKM the condition for equilibrium can be expressed as: Y = E – (1) Total income depends on total employment which depends on effective demand which in turn depends on consumption expenditure and investment expenditure. As a result, businesses would have a pile of unsold stocks. The schedule curve after point E represents that the AS is greater than AD (AS > AD). 700. The Keynesian AS curve is drawn based on an assumption that total income is equal to total expenditure. The households are the owners of factors of production and provide factor services to businesses to earn their livelihood in the form of wages, rents, interest, and profits. The increase in national income can be calculated as follows: The national income increases due to increase in the investment. It then shows how to solve for multipliers. The central proposition of the simple Keynesian model (the SKM) is that national output (income) reaches its equilibrium value when output is equal to aggregate demand. Y = AD = C+ I + G + (X-M) or Y = C+ I + G + (X-M) Keynes gives all attention to the ADF. On the other hand, the four-sector model contains households, businesses, government, and foreign sector.Let us discuss these three types of models of income determination given by Keynes. Determination of National Income in Two-Sector Economy: The determination of level of national income in the two-sector economy is based on an assumption that two-sector economy is an economy where there is no intervention of the government and foreign trade. Aggregate supply is the total of commodities supplied in the economy. Consequently, suppliers would spend Rs. Share Your Word File According to Keynes, there can be different sources of national income, such as government, foreign trade, individuals, businesses and trusts. However if there is a situation of scarcity in the economy, then the consumption expenditure would automatically be reduced, irrespective of the rate of MPC. Suppose investment increases, which leads to a movement in the investment schedule from I to I + ΔI, showing an upward shift. However, shifts in consumption schedule are very rare as it is an income function, whereas investment schedule can fluctuate because of autonomous factors, such as risks and individual perceptions. 150, which is more than the aggregate supply. The formula used for aggregate income determination: Aggregate Income = Consumption(C) + Saving (S). On the contrary, if consumption expenditure keeps on increasing, it would result in inflation, while there would be no increase in the real income. This implies that the national income in the two-sector economy is Rs. This is because in case of full employment there is no scope of producing additional goods and services and generating additional real income. This produces an additional income for suppliers of consumer goods and services that is’ equal to Δy3 = Rs. The multiplier can be of two types on the basis of its application. Therefore, the numerical value of AS schedule is one. According to Keynes, there can be different sources of national income, such as government, foreign trade, individuals, businesses and trusts. Keynes's theory of the determination of equilibrium real GDP, employment, and prices focuses on the relationship between aggregate income and expenditure. In other words, the total income earned is fully spent on different types of goods and services. The investment schedule is shifting due to the autonomous investment in some venture. Enjoy the videos and music you love, upload original content, and share it all with friends, family, and the world on YouTube. Keynes used 'aggregate demand and aggregate supply approach' to explain his simple theory of income determination. For example suppose Mr. A earns Rs. In a two-sector economy, a shift in AD schedule occurs due to a shift in consumption or investment schedule or in both, simultaneously. The value of multiplier depends upon the rate of MPC. 100 then the aggregate demand is Rs. Keynesian economics is called the Keynesian revolution. Let us determine the relationship between change in national income (ΔY) and change in investment (ΔI) by understanding the concept of multiplier given below. Keynesian consumption function has been depicted by CC’ curve in Fig. Its main tools are government spending on infrastructure, unemployment benefits, and education. In a logical sense, there is a time gap between an increase in income with the corresponding increase in autonomous investment. The central problem in macro economics is the determination of income and employment of a nation as a whole. Mr. B buys a second hand car with that amount from Mr. C. Further, Mr. C deposits the money in a foreign bank. A Keynesian equilibrium is maintained until an external force disrupts the pattern of expenditure or output. Investment depends upon the marginal efficiency of capital and the rate of interest. Equation Description (1) Y =Z Output equals aggregate demand, an equilibrium condition The Keynesian cross model of under-employment equilibrium is explained in Figure 2 where income and employment are taken on the horizontal axis and consumption and investment on the vertical axis. For example, in the two-sector economy, the government is not involved in activities, such as taxation, expenditure, and consumption. The two types of multiplier are explained in the following points: Refers to a multiplier in which it is assumed that the change in investment and income are simultaneous. The exogenous variables are those fixed, given conditions that comprise the environment in which the system works. When the entrepreneurs find that their receipts are less than their costs, they will stop offering employment to new workers. Answer: B. front 33. b. AS can be defined as total value of goods and services produced and supplied at a particular point of time. In such a case, the saving function can be determined as follows: Therefore, in the present case, the saving function would be: At equilibrium point I = S, therefore, the national income equilibrium would be: The national income level at equilibrium point is same in both the cases, income-expenditure approach and saving-investment approach. Therefore, the shift in AD schedule is because of the shifts in investment schedule. 6.1 in which along the X-axis national income is measured and along the Y-axis the amount of consumption is measured. There is no time lag between change in investment with respect to change in income. 200 billion of income level, aggregate supply and aggregate demand are equal. Income Determination The term 'aggregate' is used to describe any quantity that is a grand total for the whole economy. Figure-3 represents the graphical representation of national income determination in the two-sector economy: In Figure-3, while drawing AS schedule it is assumed that the total income and total expenditure are equal. With the shift in AD schedule, the equilibrium point reaches to E2 and level of national income reaches to Y2. The total expenditure of an economy can be divided in to four categories of spending. NOTE: Since the back of the pages are printed in reverse order (last page is printed first), keep the pages in the same order as they were after Step 1. As already mentioned, the point of intersection between the two curves shows the maximum possible employment. An Expanded Model and Equilibrium Eq.No. In other words, the profit earned by an organization is completely distributed in the form of dividends among shareholders. The calculation of ΔY is shown as follows: ΔY = 100 + 100 * (0.8) + 100 * (0.8)2 + 100 * (0.8)3……. 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