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# 1

Aggregate Demand in an economy with leakages in the income-expenditure stream
Suppose an increase in autonomous spending (say, increase in investment) by 100 units raises
national income (Y) by 100 units, ∆Y = 100. As per simple Keynesian model national
output/income will increase in an amplified manner because of income multiplier. However,
we should know what the additional factors we will take into account while analyzing the
income multiplier effect.
We know that Y = C + S + T + M ; where S, T and M are leakages.
Given these leakages, we want to know how much of this increase in income will be spent on
domestically produced goods and services. We have already learnt that the amount of money
spent on domestically produced goods and services is the income left after tax payment,
spending on imported products and savings.
Given that: ∆Y = 100 (1)
b = 0.8, t = 0.2 and m = 0.1
Extra Taxes paid (∆T) = t ∆Y = 0.2 × 100 = 20 (2)
∆Y
D
= ∆Y - t∆Y = (1 - t)∆Y [where Y
D
= Disposable Income]
= (1 – 0.2) × 100
 ∆Y
D
= 80 (3)
Now, additional spending on imports (∆M) = m ∆Y
D
= m (1 - t)∆Y
= 0.1 × 80
 ∆M = 8 (4)
Net ∆Y
D
(i.e., Y
D
left after spending on imports) = ∆Y
D
– m ∆Y
D

= (1 - m) ∆Y
D

= (1 - m) (1 - t) ∆Y
= (1 – 0.1) × 80
 Net ∆Y
D
= 72 (5)
Now, additional spending on domestically produced goods and services (∆C) = b × Net Y
D

= b (1 - m) (1 - t) ∆Y
= 0.8 × 72
 ∆C = 57.6 (6)
2

Extra Savings (∆S) = (1- b) × Net Y
D

= (1 – 0.8) × 72
 ∆S = 14.4 (7)
Note that, (6) + (7) = (5) => ∆C + ∆S = Net ∆Y
D

(6) + (7) + (4) = (3) => ∆C + ∆S + ∆M = ∆Y
D

(6) + (7) + (2) + (4) = (1) => ∆C + ∆S + ∆T + ∆M = ∆Y
So, with the three leakages (savings, taxes and imports), consumption spending on
domestically produced goods and services will increase by 57.6 units when income increases
by 100 units. But if there were no leakages in the income-expenditure stream then with the
same amount of increase in income, consumption spending on domestically produced goods
and services would increase by b∆Y = 0.8 × 100 = 80 units. This shows that with leakages
consumption spending on domestically produced goods and services is lower than that without
leakages. Also note that, more the number of leakages, the lower is the consumption spending
on domestically produced goods and services. That means,
∆C (with S, T and M leakages) < ∆C (with S and T leakages) < ∆C (with S leakage)
Moreover, consumption spending on domestically produced goods and services also depends
on the propensity to save, propensity to import and the proportional tax rate.
From the above analysis we found that an initial increase in income will have lesser
impact on aggregate consumption spending on domestically produced goods and services when
there are leakages in the income-expenditure stream.