MACRO-

ECONOMICS
 Introduction ( Recap)
o Economics is concerned with the well-being of all people

o The study of economics is based on the issue of Scarcity.

o In economics, the micro decisions of individual businesses are

influenced by whether the macroeconomy is healthy

o In turn, macroeconomy’s performance ultimately depends on

the microeconomic decisions that individual households and
businesses make.
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 MACROECONOMICS
o Macro-Economics is concerned with:
• What determines the ability of the economy to use resources
productively, change and grow?
o Macroeconomics is based upon four propositions:
1. Issues of economic well-being
2. Economic well-being can be "captured" by
macroeconomic variables (e.g., unemployment, inflation
rates, etc.)
3. There are stable relationships between macro variables
4. Economic variables can be managed by policy officials.
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 MACROECONOMICS
o There are four(4) interactive markets:
• Goods market
• Money market
• Bonds/Capital market
• Labor market
Important macroeconomic variables include:
• GDP (Gross Domestic Product): measure of aggregate output
• GDP per Capita: proxy of the welfare per person
• Inflation rate
• Unemployment rate
• Exchange rate, etc.
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 National Income
o The macro-economy is influenced by input and output variables.
o Input variables include: external factors(i.e., Natural factors), Micro
policy( e.g., Price Control or Liberalization) and Macro policy(e.g.,
Fiscal policy)
o Output variables include: GDP, Balance of trade(BOT), Inflation, etc.

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 National Income Accounting
o National Income provides the measure of the total value at
factor cost of final goods and services which are available for
either consumption or addition of wealth.
o The main objective is to of national income accounting is the
determination of the total monetary value of total production of
goods and services by residents of a country for a given period.
o It helps determine the economic performance of a country as
well as in policy formulation and implementation

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 Key Concepts
o Gross Domestic Product(GDP)
Total monetary value of final goods and services produced in an
economy in a given period of time, usually one year.
o Final Goods and Value Added:
By final goods, means goods and services which are being
purchased for final use and not for resale or further
manufacturing.
Value added; the extra worth that a firm adds to a product in the
course of its production.
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 Key Concepts
o Current Output:
The values of output currently produced which are included in
the GDP.
o Market Prices and Factor cost:
GDP values goods and services at market prices. The effects of
indirect taxes and subsidies distort market prices of many goods
and services.
Factor price is the amount received by the factors of production
in that productive activity.
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 Key Concepts
o GDP vs GNP:
GNP is the total market value of final goods and services
produced by domestically owned factors of production within a
given period. The differences between GDP and GNP arises
because some of the factors of production are owned by
foreigners but sited within the country.
o Real and Nominal GDP:
Nominal GDP measures the monetary value of output in a
given period in the prices of that period.
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 Key Concepts
o Real GDP
Measures changes in physical output in the economy between
different time periods by valuing all goods and services
produced in two periods at the same price.
o Gross and Net Domestic Product
Capital stock wears out or depreciates whiles it is being used to
produce output.
To account for the usage of capital in production, depreciation
or capital consumption allowance is subtracted from GDP to
arrive at NDP.
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 Cont’d
o Gross National Product: Gross national product at current prices does
not reflect real values since it is in nominal values.
o These nominal values may be affected by many factors such as inflation,
deflation etc.
o To overcome the problem of rising price, nominal GNP must be
converted to real GNP.
o Real GNP is nominal GNP adjusted for price changes or deflated by an
appropriate price index.

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝑁𝑃
o Real GNP = ∗ 100
𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥

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Treatment of indirect Taxes
Price
S+ Tax
S= MC
P2
P1 Amount of Tax Imposed

P3 D
Marginal cost of producing
Qth unit of output

Q2 Q1 Qd/Qs 12
Treatment of subsidies
Price
S= MC

P3 S= MC= Subsidy
P1 Subsidy Paid to
producers
P2

Q1 Q2 13
 Circular Flow of Income
o National Income can be calculated by three approaches:
• Income Approach
• Product/ Output Approach
• Expenditure Approach
o These approach can be illustrated by the circular flow of Income
o Assumptions:
• The economy is made up two sectors.
• The diagram does not capture the role of savings and
investment in the economy.
• The role of government and foreign sector not captured
• There is free flow of economic activities 14
 Circular Flow Diagram
Factor Services
Factor Income( Income approach)

Households Firms

Expenditure (Expenditure approach)

Goods and Services (output approach)

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 Income Approach
o The income approach sums up all the factor income in an
economy.
o GNI at factor cost: equals all personal incomes before taxes
minus transfer payments plus undistributed profits of firms and
the surpluses of state enterprise plus or minus net factor income
from abroad.
o NNI at factor cost : GNI at factor cost minus depreciation
(capital consumption allowance) equals, which is identical to
NI.
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 Income Approach
Advantages:
o It shows the functional distributions of income
o It provides data for income tax planning
Disadvantages:
o Difficulties in ascertaining all factor incomes
o Problem of transfer payment
o Fringe benefits
o Owner occupied houses
o Net factor income from abroad
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 Output/ Product Approach

o GDP_output: The summation of the final value of goods and services

at market prices.

o GNP_output: GDP_output plus or minus net property income from

abroad.

o NNP_output: GNP_output less capital consumption allowance.

o NNP_output at factor cost: GNP_output minus indirect taxes plus

subsidies.

o NNPf is identical to National Income 18

 Output/ Product Approach
Advantages:
o The product approach breaks down the economy into sectors
and sub-sectors.
o It indicates structural changes that are occurring in an economy
o It avoids unnecessary reliance on population projection, as is the
case under the expenditure approach.
Disadvantages:
o Valuation of goods and services produced and consumed
o Some personal services
o Multiple counting
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 Expenditure Approach
• This approach involves totaling expenditure by individual, firms
and the state on goods and services, be they consumption or
investment goods.
• It also covers export and import spending
• Based on this, economy is divided into four spending sectors:
• Personal consumption expenditure (C): made up of expenditure
by households on durable and non-durable goods and services.
E.g., Cars, Shoes, etc.

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 Expenditure Approach
• Gross Private Domestic Investment (I): covers business fixed investment,
all construction and changes in inventory.

• Government expenditure (G): Total government expenditure on the

execution of the various function of the government. For example,
Purchases of final goods and services, central government expenditure on
defence, wages and salaries of government employees and expenditures
of local authorities, etc.

• Net Export (X-M): Total export expenditure of goods and services less
total imports expenditure of goods and services. 21
 Expenditure Approach
Symbolically;
• GDE= C+I+G+(X-M)
• Total Domestic Expenditure(TDE) @ market price= C+I+G,
• Gross National Expenditure(GNE)= GDE± Net property income from
aboard
• Net National Expenditure(NNE)= GNE-Depreciation
• NNE@ factor cost= NNE@ market price–indirect tax+ Subsidies
• NNE@ factor cost= National income

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 Expenditure Approach
Advantages:
o The expenditure indicates the levels of private consumption,
government, gross private investment expenditures and net
exports.
o It shows the extent of changing patterns of private consumption.
o It indicates the rate at which the economy is expanding its
productive capacity

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 Expenditure Approach

Disadvantages:
o A good deal of the estimates of private consumption relies on
population.
o Difficult in estimating export and import values
o Multiple Counting

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 General Problems Relating NI Estimates
o Changing prices of goods and service
o Multiple or double counting
o Marketability of goods
o Depreciation
o Inadequate statistical data

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 Special Problems Relating to Developing
Countries

o Low degree of marketability of goods and services

o Valuation of houses
o Valuation of food produced and consumed on the farm
o Lack of information on income

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 Uses of NI Estimates or Statistics
o Indices of Economic Welfare
o Use for Economic planning
o Helps policy makers to understand the economic structure of a
country
o Use to approximate the potential demand
o National income is use to determine the subscriptions of nations
to international bodies.
o National income estimates are useful as a basis for inter-
temporal and international comparison of living standards.
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 Economic Welfare
o The main purposes of production are to satisfy people’s wants
and to increase economic welfare of the people, that is, to raise
their economic welfare by enabling them to satisfy their wants.
o Standard of living is the quality of life based on the amount of
goods and services, leisure time, and so forth that a population
has.
o Economic welfare clearly depends on the volume of production
in real terms rather than the growth in population size.

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 Economic Welfare
o A person’s economic welfare depends on how goods and
services produced are distributed among members of his
community.
o Generally, the more equal the distributions of income, the
greater will be the economic welfare of the community.
o This presupposes that standard of living can be raised without
increasing production.

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 Economic Welfare
o Generally, the higher the GNP in real terms, the higher the
standard of living of people who generate that GNP.
o The limitation of this approach is it does not take the population
of the country into consideration.
o The meaningful measure of economic well-being is real per
capita income or output.
o Because GNP measures the size of total output , which may
misrepresent changes in the standard of living of individual
households in the economy.
o Per capita income maybe relatively constant or even decline
implying that economic welfare is relatively constant or has
declined. 30
 Problems with GNP/GDP and Per Capita
income measures of the standard of living

o Non-market transaction
o Leisure
o Product Quality
o The composition and distribution of output
o GNP and the Environment

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 Problems Encountered in Inter-temporal
and International Comparison of per capita
income
o Differences in prices
o Differences in currencies
o Differences in product
o Differences in distribution of income
o Differences in the level of accuracy in measurement
o Intangibles 32
NATIONAL INCOME
DETERMINATION

33
 Introduction
• National Income Identity equation
• Income Approach =Expenditure Approach = Output Approach
• Macroeconomic school of thought:
• Fundamental economic theories or perspectives that explains the
working of the economy
• Two broad categories:
• Classical / Neoclassical school of thought
• Keynesian school of thought

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Keynesian Income Determination Models
• The model categories the economy into three main sectors
• Private sector
• Consumption demand
• Investment Demand
• Supply & demand for money
• Public Sector
• Government expenditure
• Government taxes
• Monetary policy manipulation of money supply
• International/foreign
• imports, exports, net exports
 Aggregate Expenditure
o It can be defined as the total planned or desired spending in the
economy during a given period by the various sectors of the
economy on newly produced final goods and services.
o The economy is divided into four main sectors, namely; the
household sector, business sector, government sector and the
foreign sector.
o Spending by these sectors are dubbed as consumption(C),
domestic investment (I), government expenditure(G), and net
export (NX) respectively.
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 Models of the Economy
o A closed economy without government activity. Referred to as
Two sector economy.
o AE= C+I
o A closed economy with government activity. Also referred to as
Three sector economy.
o AE= C+I+G
o An open economy. It is an economy open to the rest of the
world. Also referred to as a four sector economy.
o AE= C+I+G+NX, Where NX= Export- Import
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 Consumption Expenditure
o Consumption expenditure is the total spending by individuals on consumer goods and
services during a given period.
o This is principally determined by disposable income.
o Consumption function is the schedule relating the total consumption expenditure to
corresponding disposable income.
• 𝐶 = 𝑓(𝑌𝑑)
• 𝐶 = 𝑎 + 𝑏𝑌𝑑 𝑎 > 0; 0 ≤ 𝑏 ≥ 1
• 𝑎 = 𝑎𝑢𝑡𝑜𝑚𝑜𝑢𝑠 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑟 𝑛𝑜𝑛 − 𝑖𝑛𝑐𝑜𝑚𝑒 𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 𝑐𝑜𝑚𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑐𝑜𝑚𝑝𝑜𝑛𝑒𝑛𝑡
• 𝑏 = marginal propensity to consume (MPC) or proportion of income spent on consumption
• 𝑏𝑌𝑑= income dependent consumption component

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 Consumption Expenditure
Expenditure (C)

𝐶 = 𝑎 + 𝑏𝑌𝑑
∆C

a ∆Yd

Disposable Income
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 Savings Function
o The savings function is a mathematical relationship that exist between
savings and disposable income.
o Disposable income is either saved or consumed.
o 𝑆 = 𝑓(𝑌𝑑)
o 𝑌𝑑 = 𝑆 + 𝐶
o S= 𝑌𝑑 − 𝐶
o S= 𝑌𝑑 − (𝑎 + 𝑏𝑌𝑑)
o S= −𝑎 + 𝑌𝑑 − 𝑏𝑌𝑑
o S= −𝑎 + (1 − 𝑏)𝑌𝑑 -a <0; (1- b) <1
o -a is the non-income induced saving or autonomous saving (dissaving)
o (1-b) is the marginal propensity to save (MPS)
o (1-b)Yd is the income induced saving
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 Savings Function
Saving S= −𝑎 + (1 − 𝑏)𝑌𝑑

0
Disposable Income
-a

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 Propensities to Consume and Save
Average Propensity to consume (APC) is the fraction or percentage
of any total income, which is consumed.
𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒(𝐶)
APC=
𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 (𝑌𝑑)
Marginal Propensity to consume (MPC) is the ratio of a change in
consumption to a change in disposable income.
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒(∆𝐶)
MPC=
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 (∆𝑌𝑑)

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 Propensities to Consume and Save
Average Propensity to save (APS) is the fraction or percentage of
any total income, that is saved.
𝑆𝑎𝑣𝑖𝑛𝑔𝑠(𝑆)
APS=
𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 (𝑌𝑑)
Marginal Propensity to save(MPS) is the ratio of a change in
savings to a change in disposable income.
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑣𝑖𝑛𝑔 (∆𝑆)
MPS=
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 (∆𝑌𝑑)

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 Propensities to Consume and Save
APC falls and APS rises as income increase,
APC+APS=1
MPC+MPS = 1
APC is greater than MPC, As income increases, APC falls in many
cases and MPC remains constant.
MPS is greater than APS. As income increases, APS increases but
MPS remains constant

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Factors that Explain the level of
consumption Expenditure and Saving
o The level of disposable income
o Stock of durable goods on hand
o Wealth
o Expectation
o Availability of credit
o Aggregate Household indebtedness
o Level of prices
o Fiscal policy
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 Investment Expenditure
o Investment as a component of aggregate expenditure is defined
as spending devoted towards increasing or maintaining the stock
of capital.
o Investment as defined above does not include buying a bond,
purchasing stocks, creating deposits through the commercial
banks etc.
o Investment in this context includes expenditure on housing
construction (residential and business), purchase of machinery
and additions to a firm’s inventory of goods.
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 Planned Investment
o These are determined by the decisions of firms who make plans
to accumulate new building, plant and machinery and additional
inventories bases on their assessment of future profit prospect
and the cost of borrowing.
o They are the intended purchases of new or replacement
residence and non-residential structures, producer durable
equipment and additions to inventories that business firms plan
to undertake during the year (ex ante investment).

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 Gross Private Domestic (actual) Investment
o It defines the actual investment spending which firms made
during the year (ex-post investment).
o This differ from planned investment by the extent to which
firms end up with unplanned or unintended net changes in their
inventories.
o Example: Suppose Fan Milk Gh.Ltd produced 1000 units of
Fanice, which it expects to sell during the coming weekend.
Suppose again that by the end of the week only 700 units of
Fanice was sold. The 300 units not sold are the unplanned or
unintended addition to Fan Milk Gh. Ltd. Inventory .
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 Gross investment and Net Investment
o Gross investment includes capital consumption allowance or
depreciation.
o This is larger than net investment since net investment excludes
depreciation.
o It must be noted that it is net investment that adds to a nation’s
capital stock thereby enabling economic growth to occur by
creating the potential to produce large output in the future.

49
Determinants of Autonomous Investment
Expenditure
o Expected rate of return or Profit
o The real interest rate
o The cost of capital goods
o Technological change
o Public policy in terms of taxes

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 Investment Expenditure
Investment Exp

2500 Io

Y1 Y2 Real Income
51
 Government Expenditure
o The government influences aggregate expenditure and level of
national income equilibrium in two main ways.
1. Government purchase of final goods and service is a
component of aggregate expenditure.
2. Taxes and transfer payment affect the relation between
aggregate income and disposable income, which invariably
affect household consumption expenditure.
o Taxes that affect business profit can indirectly affect aggregate
expenditure by changing firms demand for investment.
o Investment demand as well as consumer demand is influenced
by government policies relating to taxes and transfers. 52
 Government Expenditure
Gov’t Exp

1500 G0

Y1 Y2 Real Income
53
 Net Export
o Net exports are the difference between exports and imports
expenditures on goods and services.
o Export earnings are goods and services produced in a nation but
are sold to consumers in other nations.
o Export does not depend on current aggregate income but the
aggregate incomes of importing nations.
o Import expenditure are the spending by individuals, firm and
government of an economy on goods and services produced in
foreign nations

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 Net Export
o Imports depend directly on a nation’s aggregate income, i.e.
o 𝑀 = 𝑓(𝑌)
o 𝑀 = 𝑀𝑜 + 𝑚𝑌 𝑀𝑜 > 0; 0 < 𝑚 < 1

o 𝑀𝑜 = Autonomous imports which depends on such things as the

exchange rate and the terms of trade
o 𝑚𝑌 = Income induced imports
o 𝑚= the marginal propensity to import

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Net Export

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 Determination of Equilibrium National
Income

Aggregate Expenditure –National Output Approach:

o Under this section we will determine the equilibrium national
income by finding the real national income at which planned
aggregate expenditures are equal to national (aggregate output)

57
 Determination of Equilibrium National
Income
Aggregate Expenditure
o An aggregate expenditure line relates the total monetary value
of newly produced final goods and services that consumers,
business firms and the government are willing and able to
purchase to the level of real income or output prices held
constant.
o Or it is a schedule, which shows the total amounts spent on final
goods and services at different level of real aggregate income or
real aggregate output.
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 Determination of Equilibrium National
Income
Agg. Exp.
AE

Z.

Real Income/ Output

59
 Determination of Equilibrium National Income
o Z= the sum of all the autonomous components.

o The components of Z also depend on the economic model.

o => 𝐴𝐸 = 𝐶 + 𝐼; 𝑡ℎ𝑒𝑛 𝑍 = 𝑎 + 𝐼𝑜

o ⇒ 𝐴𝐸 = 𝐶 + 𝐼 + 𝐺; 𝑡ℎ𝑒𝑛 𝑍 = 𝑎 + 𝐼𝑜 + 𝐺𝑜

o => 𝐴𝐸 = 𝐶 + 𝐼 + 𝐺 + 𝑋 − 𝑀; 𝑡ℎ𝑒𝑛 𝑍 = 𝑎 + 𝐼𝑜 + 𝐺𝑜 + Xo − Mo

o NB: if tax effect is considered then the Z the three and four sector
economy will include bT𝑜
60
Determination of Equilibrium National Income
o AE model is derived by adding the various expenditure components of
the economy. That is
o Consumption (C)
o Gross private domestic investment (I),
o Government expenditure (G) and
o Net exports (NX).

o 𝐴𝐸 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝐸

o 𝐴𝐸 = 𝐶 + 𝐼 + 𝐺 + 𝑋 − 𝑀

o 𝐴𝐸 = 𝑎 + 𝑏𝑌𝑑 + 𝐼𝑜 + 𝐺𝑜 + 𝑋𝑜 − 𝑀𝑜 − 𝑚𝑌
61
 𝟎
The 45 Line Expenditure = Income Line
o This line depicts various possible levels of total output or income, which the
business sector might produce at various level aggregate expenditure (AE).

o It is usually taken to typify aggregate output schedule

o 450 line is also referred to as the aggregate income equals aggregate output
identity (Y=AE identity ).

o This line is a useful guideline, which denotes the fact that any point on the line is
equidistance to the two axes.

o It, therefore depicts the fact that business will produced any given level of
aggregate national product or income only when they expect a level of total
spending (AE) just sufficient to dispose of that output.
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 𝟎
The 45 Line Expenditure = Income Line
Agg. Exp.

Y=AE identity

45 0
Real Income/ Output
63
 EQUILIBRIUM NATIONAL INCOME
1. Actual Aggregate Output Produced (Y)=Planned Aggregate Expenditure (AE)
2. Leakage and Injection Approach

Y=AE Approach
• Assumed to occur when total level of output produced in the economy exactly
matches the level of total spending (aggregate expenditure) in the economy
• 𝑌 = 𝐴𝐸
• Where
• Y represents net national product (actual aggregate production of goods & services)
• AE represent actual aggregate expenditure
• This mean that
• 𝑌 = 𝐴𝐸 = 𝐶 + 𝐼 + 𝐺 + 𝑋 − 𝑀
• Mathematical example demonstrated in class

64
 EQUILIBRIUM NATIONAL INCOME
Agg. Exp
Y= AE

E0 AE= C+I+G+NX

0 Y1 Y0 Y2 Real Output 65
 EQUILIBRIUM NATIONAL INCOME
Leakage and injections Approach
o A leakage (L) of spending represents a portion of income that is not used to purchase
domestically produced goods and services during the year.
o
o In an open economy there are three main types of leakage of spending power from the
circular flow;

1. Net taxes: the difference between real taxes paid to government and transfer
payment (T)

2. Savings (S)
3. Import purchase (M)

• 𝑳=𝑺+𝑻+𝑴
66
 EQUILIBRIUM NATIONAL INCOME
o Injections (J) of spending are purchase made by business firms, governments or
foreign buyers that increase the flow of income in a nation.

o Injections of purchasing power increase aggregate expenditure in the economy.

o These injections are in the form;

1. Investment (I)

2. Government purchase (G)

3. Export (X)

• 𝑱=𝑰+𝑮+𝑿 ⇒ 𝑱𝒐 = 𝑰𝒐 + 𝑮𝒐 + 𝑿𝒐
67
 EQUILIBRIUM NATIONAL INCOME
o Income is used for consumption purchase(C), household and business savings(S) and
paid as taxes(T) to the government.
o Aggregate income (Y) is expressed as the sum of the uses of aggregate income as;

o =>𝑌 = 𝐶 + 𝑆 + 𝑇
o => AE= 𝐶 + 𝐼𝑜 + Go + Xo – M

o At equilibrium , Y= AE

o 𝐶 + 𝑆 + 𝑇 = 𝐶 + 𝐼𝑜 + Go + Xo – M
o 𝑆 + 𝑇 = 𝐼𝑜 + Go + Xo – M
o 𝑆 + 𝑇 + 𝑀 = 𝐼𝑜 + Go + Xo
68
 EQUILIBRIUM NATIONAL INCOME
L and J L=S + T + M

E0
Jo=Io + Go + Xo

0
Y0 Real Income 69
 WHY EQUILIBUIM INCOME CHANGES
Changes in Injections
o Changes in the component of injection causes changes in national income.

o when investment, government expenditures and export earnings changes the

aggregate expenditure function is affected.

o For instance:
o A rise in investment, export or government expenditures raises the
aggregate injection function, leading to a rise in equilibrium nation
income
o A fall in investment, export or government expenditures lowers the
aggregate injection function, leading to a fall in equilibrium nation
income
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 E.g. Effect of Changes in Investment ….. Change in J
Y=AE identity
Agg. Exp • A fall in investment, government
expenditure or exports lowers the
AE1 = (I1)
E1 aggregate leakage function and
AE0= (I0) lowers equilibrium national income
E0 AE2= (I2)
• A rise in investment, government
E2 expenditure or exports raises the
aggregate leakage function and
Real Income raises equilibrium national income
-∆𝑌 +∆𝑌 L = S+T+M
J&L • A fall in investment, government
E1 J1=(I1) expenditure or exports lowers
J0=(I0) equilibrium national income
E0 J2= (I2)
+I • A rise in investment, government
E2 expenditure or exports raises
−I equilibrium national income
Real Income
 WHY EQUILIBUIM INCOME CHANGES
Changes in Leakage
o Changes in the component of leakage causes changes in national income.

o when saving, taxes or import expenditures changes the aggregate expenditure

function is affected.

o For instance:
o A rise in taxes, saving or import expenditures raises the aggregate
leakage function, leading to a fall in equilibrium nation income

o A fall in taxes, saving or import expenditures lowers the aggregate

leakage function, leading to a rise in equilibrium nation income
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 E.g. Effect of leakages and Injection… change in L
Y=AE identity
Agg. Exp • A fall in taxation, savings or
import lowers the aggregate
AE1 = (I1)
E1 leakage function and raises
AE0= (I0) equilibrium national income
E0 AE2= (I2)
• A rise in taxation, saving or import
E2 raises the aggregate leakage
function and lowers equilibrium
Real Income national income
+∆𝑌
-∆𝑌
J&L L2=S+T+M +L • Assignment: Discuss, using
L0=S+T+M appropriate diagrams, the effect of
−L a corresponding rise in injections
L1=S+T+M
E0 and a fall in leakage in equilibrium
E2 J = I + G+ X national income
E1
• Submission: One week time

Real Income
 The Multiplier
o An increase in injections or decrease in leakage will lead to rise
in national income and also a rise in the employment of factors
of production provided that factor employment is less the full
employment level.
o In order to show how this will come about and the magnitude,
Keynes employs the concept of the multiplier.
o The multiplier can be defined as the numerical coefficient that
is multiplied by a change in any of the autonomous components
of aggregate expenditure to arrive at the resultant change in
national income.
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 WHY EQUILIBUIM IN CHANGES
Chan

75
 The Multiplier
o Consider a two sector model in which AE=C + I.
o Assume that due to an improvement in business expectation,
investment expectations rises permanently from I, to I2 per
period of time.
o The investment schedule will shift hence aggregate expenditure
function will be affected.
o This is indicated by an upward shift in the aggregate
expenditure line from AE, to AE2 and also by an upward shift in
the investment schedule from "I" _1 to "I" _2in figures
3.12Aand 3.12B below respectively.
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 The Multiplier
o Consid

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 Explanation of the Working of the
Multiplier
o Assume that in a two sector economy firms decide to increase
investment spending because of long –run anticipation.
o As investment spending increases factor incomes in the capital
goods industry increase.
o The income receivers will decide to consume and to save out of
the additional income according to the MPC and MPS.
o As they spend portions of their incomes, incomes in the
consumption goods industries increase.
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 Explanation of the Working of the
Multiplier
o The additional incomes in the consumption also result in
spending and saving and in the process create additional income
for others so on.
o The rate of spending of the additional increment of incomes
when added together will result in total change in income.
o At each round of this race of spending process, the amount
spent gets smaller and gradually becomes insufficient.

79
 Cont’d
o This is because the MPC is smaller than 1 and not all of
increments in income are spent but at each stage some of the
incomes leak into savings.
o Income that is not spent on goods and services is saved
(Y=C+S).
o The multiplier derived above is called the investment
multiplier because it measures the effect of an autonomous
change in investment on the level of equilibrium national
income i.e.
1
∆Y = × (∆I)
1−𝑏
80
 The Algebra of the Multiplier
Suppose AE= C+I. In equilibrium
o Y= C+I
o C= a+bY
o I= I0
o Y= a+bY+I0
o Y-bY= a+I0
1
o Y= (a+I0 )
1−𝑏

81
 The Algebra of the Multiplier
Determination of equilibrium income and the multiplier in an
Economy with income tax only;
Y= C+I +G
C= a+bYd a>0; 0<b<1
Yd= Y-T
T=T0 +tY T0 >0; 0<t<1
I= I0
G= G0 ,
X= X0 Then the multiplier will be
M=M0 +mY a>0; 0<b<1
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 The Algebra of the Multiplier
1
Y= *(a-bT0 +I0 +G0 +X0 -M0 )
1−𝑏 1−𝑡 +𝑚

∆𝑌 1
=
∆𝑎 1−𝑏(1−𝑡)

∆𝑌 1
=
∆I0 1−𝑏(1−𝑡)

∆𝑌 1
=
∆G0 1−𝑏(1−𝑡)

83
 The Algebra of the Multiplier
Determination of equilibrium income and the multiplier in an
Economy with only lump sum tax only;
Y= C+I +G
C= a+bYd a>0; 0<b<1
Yd= Y-T T= T0
I= I0
G= G0 , Then the multiplier will be
1
Y= *(a-bT0 +I0 +G0 )
1−𝑏

84
 The Algebra of the Multiplier
∆𝑌 1
=
∆𝑎 1−𝑏

∆𝑌 1
=
∆I0 1−𝑏

∆𝑌 −𝑏
=
∆T0 1−𝑏

∆𝑌 1
=
∆G0 1−𝑏

85
 The Algebra of the Multiplier
o Determination of equilibrium income and the multiplier in an
Economy with only lump sum tax, income tax and foreign
sector;
o Y= C+I +G
o C= a+bYd a>0; 0<b<1
o Yd= Y-T T= T0
o I= I0
o G= G0 , Then the multiplier will be
1
o Y= *(a-bT0 +I0 +G0 )
1−𝑏
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 The Algebra of the Multiplier
∆𝑌 1
=
∆𝑎 1−𝑏 1−𝑡 +𝑚
∆𝑌 1
=
∆I0 1−𝑏 1−𝑡 +𝑚
∆𝑌 −𝑏
=
∆T0 1−𝑏 1−𝑡 +𝑚
∆𝑌 1
=
∆G0 1−𝑏 1−𝑡 +𝑚
∆𝑌 1
=
∆X0 1−𝑏 1−𝑡 +𝑚
∆𝑌 1
=
∆M0 1−𝑏 1−𝑡 +𝑚
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 The Importance of the Multiplier
o Planning to increase employment
o To analyze the effects of export price fluctuations on national
income
o To determine the effects of changes in government expenditure
on income
o To determine the expected effects of changes in tax rates on
national income
o To determine the size of government expenditure and private
business investment needed to achieved a desired level of
income and employment.
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 Limitation of the Multiplier
o Constant marginal propensity to consume
o Problem of estimating the propensities
o The extent of leakages
o Rising price levels
o Unequal distribution of income

89
 ALL THE BEST IN
YOUR
EXAMINATIONS
YOU”LL BE FINE

9/20/2022 PRESENTATION TITLE 90