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HKALE Macroeconomics

HKALE Macroeconomics. Chapter 2: Elementary Keynesian Model (I)- Two-sector. References:. CH 3, Advanced Level Macroeconomics, 5th Ed, Dr. LAM pun-lee, MacMillan Publishers (China) Limited CH 3, HKALE Macroeconomics, 2nd Ed., LEUNG man-por, Hung Fung Book Co. Ltd.

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HKALE Macroeconomics

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  1. HKALE Macroeconomics Chapter 2: Elementary Keynesian Model (I)- Two-sector

  2. References: • CH 3, Advanced Level Macroeconomics, 5th Ed, Dr. LAM pun-lee, MacMillan Publishers (China) Limited • CH 3, HKALE Macroeconomics, 2nd Ed., LEUNG man-por, Hung Fung Book Co. Ltd. • CH 3, A-L Macroeconomics, 3rd Ed., Chan & Kwok, Golden Crown

  3. Introduction • National income accounting can only provide ex-post data about national income. • The three approaches are identities as they are true for any income level.

  4. Introduction • In order to explain the level and determinants of national income during a period of time, we count on national income determination model, e.g. Keynesian Models.

  5. Business Cycle GNP Recovery Boom Recession Depression 0 Time

  6. Business Cycle • It shows the recurrent fluctuations in GNP around a secular trend

  7. HK’s Economic Performance

  8. Assumptions behind National Income Models

  9. Assumptions behind National Income Models • The level of price is constant • as Y = P×Q & P = 1, then Y = (1)×Q Y = Q • Price level tends to be rigid in downward direction • Y = National income at constant price • Potential/Full-employment national income, Yf is constant • Existence of idle resources, i.e. unemployment

  10. Equilibrium Income Determination of Keynesian's Two-sector Model (1)- A SpendthriftEconomy

  11. John Maynard Keynes

  12. Assumptions • Two sectors: households and firms • no saving, no tax and no imports • no leakage/withdrawal • Y=Yd while Yd = disposable income • consumer goods only  no investment or injection

  13. National income National expenditure Simple Circular Flow Model of a Spendthrift Economy Households C Income generated Payment for goods and service Y E Firms

  14. By Income-expenditure Approach • AD → (without S) E = C → Y (firms) ↑ ↓ Y (households) ← AS ← D for factors

  15. By Income-expenditure Approach • Equilibrium income, Ye is determined when • AS = AD • Y = E Y = E = C

  16. Equilibrium Income Determination of Keynesian's Two-sector Model (2)-A Frugal Economy

  17. Assumptions 1. Households and firms 2. Saving, S, exists • Income is either consumed or saved Y ≡ C+S • leakage, S, exists 3. Without tax, Y=Yd

  18. Assumptions 4. Consumer and producer goods • Injection (investment, I) exist 5. Investment is autonomous/exogenous 6. Saving and investment decisions made separately • S=I occurs only at equilibriumlevel of income

  19. National income National expenditure Simple Circular Flow Model of a Frugal Economy Households C S Financial markets I Income generated Payment for goods and service Y E Firms

  20. E Y-line E2 E1 45 Y 0 Y1 Y2 Income Function: Income line/45 line/Y-line • an artificial linear function on which each point showing Y = E

  21. Expenditure Function (1): Consumption Function, C • showing that planned consumption expenditure varies positively with but proportionately less than change in Yd • A linear consumption function: C = a + cYd where • a = a constant representing autonomous consumption expenditure • c = Marginal Propensity to Consume, MPC

  22. C2 C1 Y2 Y1 A Consumption Function, C E C = a + cYd a Y 0

  23. E C = a + cYd M  △C △Y a Y 0 Marginal Propensity to Consume, MPC, c • MPC = c =

  24. Properties of MPC: • the slope of the consumption function • 1＞MPC＞0 • the value of 'c' is constant for all income levels

  25. E C = a + cYd M  C a Y 0 Y Average Propensity to Consume, APC • APC =

  26. Properties of APC: • the slope of the ray from the origin • APC falls when Y rises • Since C = a + cYd Then i.e. Thus, APC＞MPC for all income levels

  27. E C = cYd ＜45 Y a = 0 Consumption Function Without ‘a” • If ‘a’ = 0, then C = cYd

  28. E C = cYd M  Y = △Y C = △C Y a = 0 Consumption Function Without ‘a” • If ‘a’ = 0, then MPC = APC =

  29. Expenditure Function (2): Investment Function, I • showing the relationship between planned investment expenditure and disposable income level, Yd

  30. E I = I* I* 0 Y Autonomous Investment Function • Autonomous investment function: I = I* where I* = a constant representing autonomous investment expenditure

  31. E I = I* + iYd I* 0 Y Induced Investment Function • Induced investment function: I = I* + iYd where i = Marginal Propensity to Invest = MPI =

  32. Properties of MPI: • the slope of the investment function • 1＞MPI＞0 • the value of ‘i' is constant for all income levels

  33. E I = I* + iYd M  I I* Y 0 Y Average Propensity to Invest, API • API =

  34. Properties of API: • the slope of the ray from the origin • API falls when Y rises • Since I = I* + iYd Then i.e. Thus, API＞MPI for all income levels

  35. E I = I* I* 0 Y MPI under Autonomous Investment Function • If I = I*, then Y will not affect I • Therefore, MPI = Slope = MPI = 0

  36. Expenditure Function (3): Aggregate Expenditure Function, E • Showing the relationship between planned aggregate expenditure and disposable income level, Yd • Aggregate expenditure function: E = C+I

  37. Aggregate Expenditure Function, E • Since C = a + cYd I = I* (autonomous function) E = C+I • Then E = (a + cYd) + (I*)  E = (a + I*) + cYd Where • (a + I*) = a constant representing the intercept on the vertical axis • ‘c’ = slope of the E function

  38. Aggregate Expenditure Function, E • Since C = a + cYd I* + iYd(induced function) E = C+I • Then E = (a + cYd) + (I* + iYd)  E = (a + I*) + (c + i)Yd Where • (a + I*) = a constant representing the intercept on the vertical axis • ‘c + i’ = slope of the E function

  39. E E = C + I C = a + cYd E2 E1 (a+I*) a I = I* I* Y 0 Y1 Y2 Aggregate Expenditure Function

  40. E E = C + I C = a + cYd E2 E1 (a+I*) I = I*+iYd a I* Y 0 Y1 Y2 Aggregate Expenditure Function

  41. Leakage Function (1): Saving Function, S • showing that planned saving varies positively with but proportionately less than change in Yd • A linear saving function: S = -a + sYd where • -a = a constant = autonomous saving • s = Marginal Propensity to save, MPS

  42. S = -a + sYd E, S S2 -a S1 0 Y Y1 Y2 A Saving Function, S

  43. MPC (c) and MPS (s)

  44. E, S S = -a + sYd M  △S Y 0 △Y -a Marginal Propensity to Saving, MPS, s • MPS = s =

  45. Properties of MPS: • the slope of the saving function • 1＞MPS＞0 • the value of ‘s' is constant for all income levels • Since Y ≡ C + S Then Hence 1 = c + s and s = 1 - c

  46. E, S S = -a + sYd M  S Y 0 -a Y Average Propensity to Save, APS • APS =

  47. Properties of APS: • the slope of the ray from the origin • APS rises when Y rises • Since S = -a + sYd Then i.e. Thus, APS＜MPS for all income levels

  48. E, S S = sYd -a = ＜45 Y 0 Saving Function Without ‘-a” • If ‘-a’ = 0, then S = sYd

  49. E, S S = sYd M  S = △S -a = Y 0 Y = △Y Saving Function Without ‘-a” • If ‘-a’ = 0, then MPS = APS =

  50. Determination of Ye by Income-expenditure Approach • Equilibrium income, Ye is determined when • AS = AD • Total Income = Total Expenditure i.e.Y = E = C + I Given C = a + cYd and I = I* Ye = Y and Yd = Y

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