The Contemporary World

6: Determination of National Income

 (1) Total Spending = C + I + G (I) (C+I)
 
0 80 (80) 40 120
Total Spending - consists of spending on consumption
good and services, and spending on capital or 100 160 (60) 40 200
investment goods. 200 240 (40) 40 280
 
C - Households 300 320 (20) 40 360
I - Business 400 400 0 40 440
G - Government 500 480 20 40 520
 
Equilibrium 600 560 40 40 600
 The equilibrium between spending and income. 700 640 60 40 680
 The equal between income and planned
800 720 80 40 760
spending (or aggregate demand)
 If the economy is at equilibrium, then all the 900 800 100 40 840
participants in the economy (producers and  
consumers) will be satisfied. Investment - from the business. does not depend on the
 This will be maintained until it is disturbed by income of the market. autonomous spending
new inflows or outflows. Consumption - dependent on the income earned
 
Income Determination Models Savings - income not spent.
  savings = income - consumption
Simplest Macroeconomic Model - Only Household and (5) S = Y - C
Firms  
  Marginal Propensity to Consume
1. Government is absent. Income is determined  Refers to the change in the level of
only by Consumption (C) and Investment (I). consumption.
(2) Y = C + I (two sector model)  
  (6) MPC = Change in C / Change in Y
2. Firms retain none of their profits. = (480-400) / (500-400)
3. There is no foreign trade. The economy in this = 80/100 = 0.8
case is called a closed economy.  
  Marginal Propensity to Save
Consumption Function  Saving is complementary to consumption
 The relationship of consumption to income  MPS is a necessary corollary to the MPC
 Consumer od household spending depends on  Saving behavior of the people in the market
the income level of consumers (7) MPS = Change in S / Change in Y
 When people have more income, they tend to = (20-0) / (500-400)
spend more; when they have less income, they = 20/100 = 0.2
tend to spend less.  
(3) C = b + cY (8) MPC + MPS = 1
(4) C = 8- + .80Y = .80 + .20 = 1
   
B - consumption  
C - marginal propensity to consume Equilibrium in the Simple Model
Y - income Given: Initial consumption at zero disposable income (b)
 Even if income is zero, there is consumption. = 80
  Marginal propensity to consume (c ) = .80
Schedule of Income and Total Spending (in billion pesos) Investment (I) = 40
Income Consumption Savings Planned Total C = b + cY (Consumption Function)
(Y) (C ) (S) Investment Spending Y=C+I
Y = (b + cY) + I
 6: Determination of National Income
Y - cY = b + I
1Y - cY = b + I
Y (1-c) = b + I
Y = (b + I / 1-c)= (80 + 40/1 - .80) = 120/.20 = 600
 
S=I
S - manifestation of outflow
Outflow = Inflow
40 = 40
 
Outflow - that part of income that goes out of the
circular flow. (Saving, Tax, Import)
Inflow - injection of income originating from outside the
circular flow. (Investment, Govt. Spending, Export)
 
Spending can be calculated using the consumption
function formula:
Consumption Function = C = b + cY
C - consumption
B - Initial consumption at zero disposable income'
CY - Marginal Propensity to Consume
Given: b = 80, c = .80, Y = 600
C = 80 + .80 (600)
C = 80 + 480
C = 560
 
The Multiplier
The 3-sector model
Y=C+I+G
Y = b +cY + I + G
 
M = 1 / 1-c
M = 1 / 1- .80
M = 1 / .20
M = 5 (size of the multiplier)