Determination of National Income Equilibrium

CHAPTER
3
DETERMINATION OF NATIONAL INCOME EQUILIBRIUM

LEARNING OUTCOMES

At the end of this chapter, students should be able to:

i) Differentiate between two approaches in determine of national income

equilibrium.
ii) Define and explain autonomous and induced consumptions from conventional
perspective.
iii) Explain Islamic consumption theory according to Fahim Khan.
iv) Discuss autonomous and induced investment from conventional perspective.
v) Calculate national income equilibrium for two, three and four sector economies.
vi) Define and calculate the multiplier.
vii) Illustrate inflationary and deflationary gap.

SHORT NOTES

3.1 Two approaches in determine of national income equilibrium.

 Equilibrium – when aggregate supply (aggregate output) is equal to or in balance with
aggregate demand (aggregate expenditure/spending).

 Aggregate Demand – Aggregate Supply Approach is achieved when total

expenditure equal to total quantity of goods and services produced in the economy.

 Leakages – Injections Approach is achieved when leakages equal injections. Leakage

is withdrawal from the income-expenditure stream while Injections is additional
spending to the income-expenditure stream

AD = AS Leakage & injection

Sector economy
Approach Approach

2 sector Y=C+I I=S

3 sector Y=C+I+G I+G=S+T

4 sector Y = C + I + G + (X -M) I+G+X=S+T+M

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 Determination of National Income Equilibrium

3.2 Concepts from conventional perspective.

 Autonomous consumption is the amount of consumption that not related to income but
influence by non-income factor such as wealth and interest rate.

 Induced consumption is the amount of consumption that related to income. Any

change in disposable income leads to change in consumption.

 Autonomous Investment is fixed and not affected by income but influenced by other
factors such as rate of interest and rate of return.

 Induced Investment is the value of investment directly related to income. Induced

investment will increase as income increase.

 Multiplier is defined as the ratio of the change in income to the changes in Aggregate
Demand. Multiplier use to determine how many times the change in national income
happen due to change in Aggregate Demand.

K = 1
(1 – MPC)

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 Determination of National Income Equilibrium

MULTIPLE CHOICES

1. An equilibrium equation for an open economy is

A. Y=C+I+G+T+X
B. S–T+X=I+G-M
C. Y = C + I + G + (X – M)
D. S+I+M=T–X-G

2. Given the Consumption function is C = 300 + 0.7Y, the amount of income at breakeven
is

A. RM 300
B. RM 600
C. RM 1200
D. RM 1000

3. Given the saving function in two-sector economy is S = -200 + 0.4Yd. Calculate the
value of multiplier in this economy.

A. 1.67
B. 0.4
C. 0.6
D. 2.5

4. Leakage in a closed economy include

A. investment.
B. import.
C. savings.
D. consumption.

5. If the income is zero, consumption

A. is equal to zero.
B. is less than zero.
C. is greater than zero.
D. can be less or greater than zero.

6. Given the consumption function in a two-sector economy is C = 150 + 0.5Y. Calculate

the value of breakeven income.

A. 0
B. 150
C. 250
D. 300

7. The savings function is stated as S = -200 + 0.4Y. Calculate the value of multiplier in
this economy.

A. 2.5
B. 1.67
C. 0.4
D. 0.6

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 Determination of National Income Equilibrium

MATCH THE CONCEPT WITH THE CORRECT DEFINITION.

Proportion of income which is use for

Consumption consumption at various level of disposable
income.

Saving The rate of change in savings when there are

changes in disposable income.

Dissaving/Autonomous The situation where national income (Ye) is

exceeded full employment income (Yfe). This
saving
situation will lead to inflation.

Marginal propensity to Proportion of income which is use for savings at

Consume (MPC) various level of disposable income.

The situation where national income (Ye) is not

Marginal propensity to
at full employment income (Yfe). This means the
Save (MPS) resources are not fully utilized.

Average propensity to Part of income received by household but did not

Consume (APC) use for consumption.

Average propensity to Spending on goods and services by all

Save (APS) household in the economy.

The situation of money spends more than

income received. Excess spending will be paid
Inflationary gap by using savings account, credit card or loan.
This spending is not related to income received.

The rate of change in consumption when there is

Deflationary gap changes in disposable income.

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 Determination of National Income Equilibrium

TRUE AND FALSE QUESTION.

Circle the correct answer. T represents TRUE and F represents FALSE.

National income equilibrium can be calculated by T

using two approaches; AS = AD approach and
leakage = injection approach F

Aggregate demand for four sector economy T

consists of consumption, investment,
government expenditure and net export. F

Government expenditure and export is a leakage T

because money will flow out of the economy.
F

The problem of deflationary gap will occur when T

national income more than national income at full
employment. F

T
Autonomous consumption is consumption that
independent of income.
F

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 Determination of National Income Equilibrium

STRUCTURED QUESTION

QUESTION 1

Answer to following questions based on the table below.

National Income (Y) Consumption (C) Saving (S)

(RM million) (RM million) (RM million)
0 50
1000 300
2000 650
3000 2000
4000 2650
5000 1700

a) Compute the above table.

b) Define autonomous consumption. Determine the value of autonomous consumption

and Marginal Propensity to Consume (MPC).

c) Derive the consumption function and saving function.

d) Calculate the value of break-even income.

e) Calculate:
i) Average Propensity to Consume (APC) and Average Propensity to Save (APS)
when income (Y) is RM2000 million.

ii) Average Propensity to Consume (APC) and Average Propensity to Save (APS)
when income (Y) is RM5000 million.

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 Determination of National Income Equilibrium

QUESTION 2

The following table contains data of a two-sector economy.

Consumption Savings (S) National Income Investment (I) Aggregate Demand

(C) (RM Million) (RM Million) (Y) (RM Million) (RM Million) (AD) (RM Million)
8000 400 650
650 9650 650
10000 10900 650
11000 1150 650
12000 1400 650

a) Complete the above table.

b) Calculate the value of Marginal Propensity to Consume, Marginal Propensity to Save,

Autonomous Consumption and Autonomous Savings. Derive the consumption function
and savings function.

c) What is the equilibrium level of national income? Give your reason.

d) Calculate the value of Average Propensity to Consume (APC) and Average Propensity
to Save (APS) at the equilibrium level of income.

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 Determination of National Income Equilibrium

QUESTION 3

The table shows the data on national income and consumption of a country. Assuming a
country has a closed economy.

National Average Average

Consumption (C) Saving (S)
income (Y) Propensity to Propensity to
(RM million) (RM million)
(RM million) Consume (APC) Save (APS)
1500 800
2000 1200
2500 1600
3000 2000
3500 2400

a) Complete the table.

b) Find the value of marginal propensity to consume (MPC) and marginal propensity to
save (MPS).

c) Calculate the value of autonomous consumption and autonomous saving.

d) Derive consumption function and saving function.

e) Assuming that investment is equal to RM600 million, calculate the national income
equilibrium for the country.

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 Determination of National Income Equilibrium

QUESTION 4

Assuming a country has a closed economy. Answer the following questions. (All figures are
in RM million).

National Income (Y) Consumption (C) Saving (S) Investment (I)

(RM) (RM) (RM) (RM)
0 250
1000 250
2000 250
3000 250
4000 250
5000 250
6000 250
7000 250

a) Complete the above table; given the consumption function C = 500 + 0.6Yd.

b) Calculate the equilibrium national income for this country by using Aggregate Demand –
Aggregate Supply approach.

c) Derive saving function. Determine the value of Autonomous Consumption, Autonomous

Saving, Marginal Propensity to Consume (MPC) and Marginal Propensity to Save
(MPS).

d) Calculate breakeven income for this country.

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 Determination of National Income Equilibrium

QUESTION 5

Given the following information about two sector economy. (All values are in RM million)

Consumption function (C) = 400 + 0.7Y

a) State the value of autonomous consumption and autonomous saving.

b) Determine the value of Marginal Propensity to Consume (MPC) and Marginal

Propensity to Save (MPS).

c) Derive saving function from consumption function.

d) Calculate the value of Average Propensity to consume (APC) and Average Propensity
to Save (APS) when national income (Y) is RM4000 million.

e) Calculate the value of break-even income.

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 Determination of National Income Equilibrium

QUESTION 6

Answer the following questions based on the diagram given below. All figures are in RM
million.

Aggregate demand

Y = AD

C+I

C = 300 + 0.5Y

Y0 6000 National income

a) Calculate the value of A, B and Y0.

b) Calculate new value of Y0 when the autonomous consumption increases to RM500

million.

c) Referring to a), calculate the value of Average Propensity to Consume and Average
Propensity to Save at national income level, RM6000 million.

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 Determination of National Income Equilibrium

QUESTION 7

The graph below shows the equilibrium level of national income for a two-sector economy.
All values are in RM million.

Withdrawal & injection

250 I

0
2000 4000 National Income

-250

a) Calculate the value of Marginal Propensity to Consume (MPC) and Marginal Propensity
to Save (MPS).

b) Derive the consumption function and saving function.

c) Calculate the value of consumption and savings at income RM4000 million.

d) Calculate the Average Propensity to Consume (APC) and Average Propensity to Save
(APS) at income RM2000 million and RM4000 million.

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 Determination of National Income Equilibrium

QUESTION 8

Given the following information about an economy. (All values are in RM million)

Consumption function (C) = 150 + 0.65Yd

Tax (T) = 100

a) State the value of autonomous consumption and autonomous saving.

b) Determine the value of Marginal Propensity to Consume (MPC) and Marginal

Propensity to Save (MPS).

c) Derive the following:

i) saving function before tax

ii) saving function after tax

iii) consumption function after tax.

d) Calculate the value of Average Propensity to consume (APC) and Average Propensity
to Save (APS) when national income (Y) is RM10000 million.

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 Determination of National Income Equilibrium

QUESTION 9

Based on the following information, answer the questions below. (All figures are in RM
million)

Consumption function C = 500 + 0.7Yd

Investment I = 200
Government expenditure G = 300
Tax T = 50

a) Derive consumption function after tax.

b) Calculate national income equilibrium for above economy.

c) Find the new equilibrium income if investment increases to RM 350 million.

d) Based on (b), Calculate the new equilibrium income if government expenditure

decreases by RM 100 million.

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 Determination of National Income Equilibrium

QUESTION 10

Answer the following based on the information given. Given Saving function is S = -500 +
0.5Yd and Tax (T) is RM100. All data are in RM million.
S/I/G
S

800 I+G

400 I

Y1 Y2 Y3 National Income
(Y)

a) State the values of autonomous consumption and autonomous saving.

b) Calculate the break-even income at Y1.

c) Calculate the national income equilibrium, Y2.

d) Calculate the national income equilibrium, Y3.

e) Calculate the value of consumption and saving after tax at equilibrium income, Y3.

f) Calculate the Average Propensity to Consume (APC) at equilibrium income, Y3.

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 Determination of National Income Equilibrium

QUESTION 11

Given the value of tax is RM50 million. Answer the following based on the information given.
All figures are in RM million.

Leakage & Injection

S + T = -400 + 0.4 Yd

800 I+G

0
Y0 Y1 National Income (Y)

a) Find the value of Marginal Propensity to Consume (MPC) and Marginal Propensity to
Save (MPS).

b) Calculate the value of equilibrium income at Y1.

c) Calculate government expenditure multiplier and tax multiplier.

d) Based on b), if full employment income level is RM2500, is there an inflationary gap or
deflationary gap? Draw a diagram to show the situation.

e) Calculate the change in investment required to achieve full employment level of income.

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 Determination of National Income Equilibrium

QUESTION 12

Based on the following information, answer the questions below.

(All data are in RM million)

Consumption function (C) = 500 + 0.75Yd

Investment (I) = 300
Government expenditure (G) = 200
Net Export = 400
Tax (T) = 150

a) Calculate national income equilibrium for the above economy by using Aggregate
Demand – Aggregate Supply approach.

b) Assuming income at full employment is RM 4,500 million. What is the problem facing by
this country? How much investment should be needed to overcome this problem and
achieve full employment income?

c) Based on (a), find the new equilibrium income when government expenditure increases
to RM300 million.

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 Determination of National Income Equilibrium

QUESTION 13

The graph below shows the equilibrium level of national income for an economy. (All figures
are in RM million).

Aggregate demand

Y = AD

C+I+G

C+I
700

200

100

500 Y1 Y2 National income

a) Calculate the value of Marginal Propensity to Consume (MPC).

b) Calculate the amount of national income at Y1.

c) Calculate the amount of national income at Y2 if Tax (T) = RM80.

d) Based on c), determine the new equilibrium income if government increase its spending
by RM100.

e) Based on d), if the full employment is RM3200, is there an inflationary gap or

deflationary gap. Draw a diagram to show the situation.

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 Determination of National Income Equilibrium

QUESTION 14

Based on the diagram below, answer the following questions. Given tax is equal to RM50,
Export is 2000, Import is 1000 and S = -500 + 0.5Yd. (All values are in RM Million).

Leakage & Injection

S+T+M

3000 I+G+X

0
Y0 Y1 National Income (Y)

a) Calculate the equilibrium level of national income, Y1.

b) If full employment level is RM10,000, is there an inflationary gap or a deflationary gap.

Give your reason.

c) Determine the new equilibrium income if investment decrease by RM300.

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 Determination of National Income Equilibrium

QUESTION 15

Based on the diagram below, answer the following questions. Given tax is equal to RM30.
(All values are in RM Million).

Leakage & Injection

S’ = -200 + 0.2Y

700 I+G

0
Y0 Y1 National Income (Y)

a) Given the value of Export is RM900 and Import is RM600. Calculate the equilibrium
level of national income for four sector economy, Y1.

b) If full employment level is RM6000, is there an inflationary gap or a deflationary gap.

Give your reason. Draw the gap on the diagram above.

c) Determine the change in investment required to achieve full employment level of

income.

d) Why is saving considered as leakage and investment considered as injection?

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 Determination of National Income Equilibrium

QUESTION 16

Based on the following information, answer the questions below.

(All data are in RM million)

Consumption function (C) = 650 + 0.8Yd

Investment (I) = 150
Government expenditure (G) = 250
Export (X) = 1250
Import (M) = 950
Tax (T) = 100

a) Calculate national income equilibrium for the above economy by using Leakage-
Injection approach.

b) Identify the type of budget implemented by the government at equilibrium income. Give
your reason.

c) Assuming income at full employment is RM 8,500 million. What is the problem facing by
this country? How much government expenditure should be needed to overcome this
problem and achieve full employment income?

d) Based on (a), find the new equilibrium income when investment must be decreases by
RM200 million.

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