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Chapter 3

Chapter 3. Determination of Equilibrium National Income. BUSINESS CYCLE. Aggregate Econ. Activity. (%  in real GDP). Boom/Inflation. Potential Growth Path. Actual Growth Path. Trough/Depression/Slump/Unemployment. years. NATIONAL INCOME EQUILIBRIUM.

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Chapter 3

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  1. Chapter 3 Determination of Equilibrium National Income Lecturer: Pn. Siti Hajar Binti Md.Jani Power Point by ; Pn.Azizah Isa. UiTM Kelantan

  2. BUSINESS CYCLE Aggregate Econ. Activity (%  in real GDP) Boom/Inflation Potential Growth Path Actual Growth Path Trough/Depression/Slump/Unemployment years Lecturer: Pn. Azizah Isa

  3. NATIONAL INCOME EQUILIBRIUM • Keynes argued that“an economy could reach equilibrium but not necessarily at the full employment.” Lecturer: Pn. Azizah Isa

  4. Equilibrium and Full-employment Equilibrium will occur when there is no tendency for an economy to change. It refers to a situation when all consumers and firms have no incentive to change their behaviour. Full employment equilibrium is the situation of equilibrium in an economy at the best efficient and full utilization of resources. “An economy can be at the equilibrium but not always to be at full-employment.” Lecturer: Pn. Azizah Isa

  5. Two approaches: • To Determine National Income Equilibrium: • Total Approach. • Injection-Leakage Approach. Lecturer: Pn. Azizah Isa

  6. i)Total Approach: • Equilibrium may occur when planned aggregate expenditure is equivalent to planned output. (AD = AS) (aggregate demand = aggregate supply). Lecturer: Pn. Azizah Isa

  7. i)Leakage-Injection Approach: • Equilibrium also can be determined when: INJECTION = LEAKAGE • Injectionsare additional spending from: investments (I), government purchases (G) and exports (X). • Leakages are withdrawals from: savings (S), tax payment (T) and imports (M). • So, at equilibrium, (I+G+X = S+T+M) (INJECTION = LEAKAGE) Lecturer: Pn. Azizah Isa

  8. DETERMINATION OF EQUILIBRIUM NATIONAL INCOME • Keynesian model is drawn based on the relationship between income and expenditure: Y = C + I + G + (X – M) where, C = f (Yd) , C is a function of Real Disposable Income (income after tax), where, Yd = Y – t . Lecturer: Pn. Azizah Isa

  9. Components of Aggregate Expenditure: • CONSUMPTION, C = f (Yd) • INVESTMENT, I = f (i, Y) • GOVERNMENT EXPENDITURE, G • NET EXPORT (X – M) Lecturer: Pn. Azizah Isa

  10. 1. Consumption and Saving Disposable Income is used for Consumption spending and Saving. Yd = C + S and, C = f (Yd), S = f (Yd) Both C and S is a function of income,Y and having a positive relationships. ( Y rises, C and S also will rise). Lecturer: Pn. Azizah Isa

  11. Given that;Consumption function:C = a + bYdand Saving function:S = – a + (1 – b) Yd There is (two)2 components of Consumption spending by households: C1, Autonomous Consumption = a C2, Induced Consumption = bYd Where, bis theMarginal Propensity to Consume (MPC). Lecturer: Pn. Azizah Isa

  12. Autonomous Consumption, aand Induced Consumption, bY C2= ais a fixed amount irrespective of the income earned, • is the part of consumption which does not vary with the level of income (Yincreases but “a” is constant). C2=bYis an amount that depends on the disposable income, • is the amount of consumption spending by households that is induced by disposable income (Y increases, C2 increases). Lecturer: Pn. Azizah Isa

  13. CONSUMPTION, C • Consumption function, C = f (Yd) C C = a + bYd a real output, Y The slope of consumption function is given by: b = C/ Y = Marginal Propensity to Consume (MPC) and the value 0 < b < 1 (positive but less than). Lecturer: Pn. Azizah Isa

  14. Autonomous Consumption,C1 = a C C = a + b Yd a 0 real output, Y • is the vertical intercept of the consumption function, at a (in the diagram). • It is the amount of consumption that would occur even if the householdearned nothing, Y=0. • when Y= 0 (no income earned), C = a. (basic consumption for living). Lecturer: Pn. Azizah Isa

  15. Consumption and Saving schedule With no income earned, Y = 0 , autonomous C = a = 60 and dissaving = - a = - 60. While Y = C + S , if Y = 0 , then C = - S. Lecturer: Pn. Azizah Isa

  16. How is theincrease in incomewill increase consumption? Consumption is induced by the value of b (that is = MPC), since, C = a + bY Lecturer: Pn. Azizah Isa

  17. FOR EXAMPLE: Given that C = a + bY, therefore, if b = 0.6 , how large is the increase in consumption if there is an increase in income? Since C = a + 0.6Y, thus C will increase by 0.6Y , (given a = fixed or autonomous consumption) , so, C will increase by 60% out of total income, Y. Meaning that, for any increase in income, 40% can be saved and 60% will be spend on consumption. Lecturer: Pn. Azizah Isa

  18. For example: • a change in income from RM1000 to RM1500 with the MPC = 0.6,  C = b  Y = 0.6 (500) = 300. • Therefore, consumption will increase by RM300. Lecturer: Pn. Azizah Isa

  19. Consumption and Saving schedule In a 2-sector economy, C = a + bY . Since C = a + 0.6Y, and a = 60 thus C = 60 + 0.6Y. At income 200, C = 60 + 0.6(200) = 60 + 120 = 180 and Y = C + S so , S = Y – C = 200 -180 = 20. Lecturer: Pn. Azizah Isa

  20. Changes in consumption when income change. consumption Y = C C = a + b Y 400  C Note: b =  C = 400  Y  Y 500 45° income 1000 1500 Lecturer: Pn. Azizah Isa

  21. Changes in consumption when income change. Y = C consumption C = a + b Y 400  C Note: b =  C = 400  Y e  Y a 45° 500 income 1000 1500 Lecturer: Pn. Azizah Isa

  22. SAVINGS • Some part of income earned is saved. • two components of savings: • autonomous dissaving, S1 = – a • induced saving, S2 = (1 – b)Y where, (1 – b) = Marginal Propensity to Save. = S/Y = slope of saving function. Lecturer: Pn. Azizah Isa

  23. Dissaving and induced saving. Autonomous dissaving, (- a), is the amount that households draw out from their wealth to consumewhen no income earned. Induced saving, (1 –b)Y, is the amount of saving that is induced by earnings of disposable income. Lecturer: Pn. Azizah Isa

  24. Saving Function, S Saving S = – a + (1– b)Yd 0 Yd (real output) –a (1 – b)is the slope of saving function =ΔS/ΔY Lecturer: Pn. Azizah Isa

  25. Consumption & Saving Function, C,S Y = AD Y = C + S, When S = 0, Y = C at the breakeven, point, e. Y = C C = a + bYd e S = – a + (1– b)Yd a 45º Yd (real output) 0 – a Lecturer: Pn. Azizah Isa

  26. Note that: MPC + MPS =1, thus MPS = (1 – MPC). If MPC = b and MPS = (1 – b), Then, b + (1 – b) = 1 Lecturer: Pn. Azizah Isa

  27. APC, APS The fraction of income that is used for consumption is the: Average Propensity to Consume (APC): APC = C Y And, the fraction of income that is used for saving is the: Average Propensity to Save (APS): APS = S Y and, at any level of income, APC + APS = 1 Lecturer: Pn. Azizah Isa

  28. MPC, MPS, APC, APS CONSUMPTION, C C = a + bYd 1200 800 a INCOME,Y 0 1000 1600 Lecturer: Pn. Azizah Isa

  29. MPC CONSUMPTION, C C = a + bYd 1200 ∆C 800 MPC = ∆C = 400 ∆Y 600 is the slope of the consumption function. ∆Y a INCOME,Y 0 1000 1600 Lecturer: Pn. Azizah Isa

  30. MPC, APC CONSUMPTION, C C = a + bYd 1200 ∆C 800 MPC = ∆C = 400 ∆Y 600 APC = TC = 1200 TY 1600 TC ∆Y a INCOME,Y 0 1000 1600 TY Lecturer: Pn. Azizah Isa

  31. MPC, APC CONSUMPTION, C C = a + bYd 1200 MPC = ∆C = 400 ∆Y 600 APC = TC = 1200 TY 1600 800 TC TC a INCOME,Y 0 1000 1600 TY Lecturer: Pn. Azizah Isa

  32. MPS, APS MPS =(1 – b) = ΔS/ΔY is the slope of saving function. Saving S = – a + (1– b)Yd ΔS ΔY 0 Yd (real output) –a Lecturer: Pn. Azizah Isa

  33. MPS, APS while,APS =TS/TY Saving S = – a + (1– b)Yd ΔS TS TS ΔY 0 Yd (real output) –a TY Lecturer: Pn. Azizah Isa

  34. MPS, APS while,APS =TS/TY Saving S = – a + (1– b)Yd TS TS 0 Yd (real output) –a TY Lecturer: Pn. Azizah Isa

  35. APC, APS changes with income; MPC, MPS are constant. APC falls and APS will rise as income increases. - because as income increases, households consumption will rise but with a smaller percentage compared to the increase in income, while saving will rise with a larger percentage instead. While MPC and MPS is assume constant as long as the slopes of the consumption and saving curves are constant or assume to be straight lines. Lecturer: Pn. Azizah Isa

  36. EXAMPLE 1 As income increases, APC falls but APS rises. Meanwhile, MPC and MPS are constant. Lecturer: Pn. Azizah Isa

  37. Other determinants of Consumption: • Wealth The richer the higher is the consumption. • Interest rates Large items were bought on loans that pay interest. • Expectation of future prices Price is expected to increase in future, more consumption now (may involve in hoarding). Lecturer: Pn. Azizah Isa

  38. Consumption in Islam (according to M. Fahim Khan, 1922) A Muslim has to be rational in their spending. The rationality of consumption in Islam is: • to spend wisely and moderately: • to consume only enough goods for healthy living. • Excessive indulgence in luxurious living is discouraged: Israf(extravagant or overspending on goods excessively are wasteful and prodigal. Lecturer: Pn. Azizah Isa

  39. to follow the hierarchy of needs:Dharuriyat, Hajiyat, Kamaliat and not to consume the Tarafiat goods. • to consume only permissible goods (halal) but not prohibited goods (haram). • part of his expenditure is also spend for fi-sabilillah (spending for the betterment of Islamic livings) • part of his income is also saved for future expenditure. Conclusion: spending by Muslim consumers is to achieve the satisfaction in this world and also to earn reward in the hereafter. Lecturer: Pn. Azizah Isa

  40. BREAK-EVEN INCOME • is a situation when all the income is just nice for consumption purposes while no saving at all. thus, Y = C and S = 0. C,S AS=AD S > 0 C = a + bY e S = - a + (1 – b)Y S < 0 45º Y S = 0 Lecturer: Pn. Azizah Isa

  41. QUESTION TO PONDER: look outin the manual 1. Use the given data to answer the following questions. (All figures are in RM million) a) Fill up the blank with appropriate values.

  42. QUESTION TO PONDER: ANSWER 1. Use the given data to answer the following questions. (All figures are in RM million) • Fill up the blank with appropriate values. • Y = 200 and C = 120 , S = 80

  43. What are the values of MPC and MPS? • Write down the consumption function and saving function. • What is the amount of break-even income? Lecturer: Pn. Azizah Isa

  44. What are the values of MPC and MPS? MPC =C = 260 - 140 = 0.6 Y 200 – 0 MPS = 1 – MPC = 1 – 0.6 = 0.4 Lecturer: Pn. Azizah Isa

  45. c) Write down the consumption function and saving function. C = 140 + 0.6Y S = - 140 + 0.4Y Lecturer: Pn. Azizah Isa

  46. What is the amount of break-even income? • is a point at e, when S = 0, so Y = C. S = - 140 + 0.4Y Since S = 0, 0 = -140 + 0.4Y 140 = 0.4Y Y = 140/0.4 = 350 C,S C= 140 + 0.6Y e S = -140 + 0.4Y 45º Y S = 0 Lecturer: Pn. Azizah Isa

  47. Additional Question: Use the given data to answer the following questions. (All figures are in RM million) Calculate the APC and APS at each level of income.

  48. ANSWER: The values for APC and APS at each level of income.

  49. 2. INVESTMENT Definition: Investment is defined as the spending or purchase of plants, machineries, buildings and inventories by firms for the purpose of producing goods and services. Lecturer: Pn. Azizah Isa

  50. 2 types of INVESTMENT - Keynes two(2) types of investment spending: i) Autonomous Investment • what firms may had intended to plan or desired or has been fixed and does not depend on income. ii)Induced Investment • actual investment expenditures used to produce newly produced goods, and depends onthe level of: I = f ( i, e, Y, t…) Lecturer: Pn. Azizah Isa

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