ECONTWO

Reviewer: National Income Determination Answers

Esperidion, Richmond M.
Prof: J. Tanchuco

1.) Aggregate expenditure is a measure of national income (defined as the current value
of all finished goods and services). The two are related but different (aggregate expenditures =
expenditures at a given level, aggregate demand = whole range of expenditures at a range of
price levels).

- Household Consumption – total amount of money that individuals spend on goods and
services over the course of a year
- Investment – money that people and businesses invest on capital expenditures
- Government Spending – money spent by the government
- Net Exports – determined by subtracting the total imports of a country by the total exports

2.) Consumption is the value of goods and services bought by people. It is normally the
largest GDP component.

- C0 – autonomous consumption, or the level of consumption that would still exist even if
income was $0
- C1 – marginal propensity to consume, which is the ratio of consumption to income changes
- Yd – Real disposable income

*It is between 0 & 1 because incremental income can be either consumed (MPC = 1) or entirely
saved (MPC = 0)

2b.)
- Autonomous Saving – Slope, measures the change in saving resulting in change in income
- Induced Saving – Intercept, measures amount of savings undertaken if income is 0

*Slope = MPC = 1 & Intercept = MPC = 0

3.) Aggregate Income Level – total of all incomes in an economy w/o taking inflation and
taxes into account
No, because Aggregate supply is total supply of goods and services produced within an
economy at a given overall price level in a given time period.
Aggregate Output (Supplied) = Y = Yad = C + I + G +NX

Components of Aggregate Output:

Yad – Aggregate demand
C – Consumer Expenditure
I – Investment
G – Government Spending
NX – Net Exports

4.) Equilibrium Income Level – when aggregate supply (AS) is equal to aggregate
demand (AD)

Aggregate expenditures (AE) is equal to C + I + G + NX, which are all necessary for getting
aggregate output as well, thus it can be concluded that if AE goes down, AD would as well. This
goes the same for if AE were to go up, or reach equilibrium, then it would reflect the same way
on AD.

5.) Full Employment Income Level – embodies highest amount of skilled and unskilled
labor that can be employed within an economy in the most economically efficient way.
The government can possibly increase income level by using the Fiscal Multiplier, which is the
ratio of a change in national income to the change in government spending that causes it

6.) Above Full Employment Equilibrium –A macroeconomic term used to describe the
real gross domestic product (GDP) is currently in excess of its long-run average, or some other
historical measure. Accordingly, the amount that the current real GDP is greater than the
historic average is called an inflationary gap, as this will create inflationary pressures in this
particular economy.

A given economy is producing goods, as measured by its GDP, at a higher level then it
usually does. Because this market is in equilibrium, there will not be any excess supply in the
short run, but this overly active economy will create more demand for goods and services, which
will push prices upwards and possibly, lead to a greater level of inflation.

Underemployment Equilibrium - A condition where underemployment in an economy is

persistently above the norm and has entered an equilibrium state. This, in turn, is a result of the
unemployment rate being consistently above the natural rate of unemployment or non-
accelerating inflation rate of unemployment (NAIRU due to sustained economic weakness.

Underemployment in an economy implies that workers have to settle for jobs that require less
skill than they possess, or that offer lower wages or fewer hours than they would like. The
degree of underemployment is dictated by the strength (or lack thereof) of the job market, and
tends to rise when the economy and employment are weak. Advocates of Keynesian economics
suggest that a solution to an underemployment equilibrium state is through deficit spending and
monetary policy to stimulate the economy.

Full Employment Equilibrium - A situation in which all available labor resources are being
used in the most economically efficient way. Full employment embodies the highest amount of
skilled and unskilled labor that could be employed within an economy at any given time. The
remaining unemployment is frictional.

Frictional unemployment is the amount of unemployment that results from workers who are in
between jobs, but are still in the labor force. Full employment is attainable within any economy,
but may result in an inflationary period. The inflation would result from workers, as a whole,
having more disposable income, which would drive prices upward.
7.) Yes, I agree with the statement because of the definition of a multiplier, “The term
investment multiplier refers to the concept that any increase in public or private investment
spending has a more than proportionate positive impact on aggregate income and the general
economy. The multiplier attempts to quantify the additional effects of a policy beyond those that
are immediately measurable”.

Example: Government spending on roads increases the income of the construction workers as
well as the suppliers of the materials needed for the road.

7b.) Marginal Propensity to Consume (MPC) - the additional amount of aggregate

consumption that the members of the economy will desire to undertake, for each additional
dollar of income they receive.

*The MPC is always positive (since when people earn more, they will consume more).
*The MPC is also less than 1. That is we assume that some part of each extra dollar earned is
saved.

Marginal Propensity to Save (MPS) - is the fraction of an increase in income that is not spent
on an increase in consumption. That is, the marginal propensity to save is the proportion of
each additional dollar of household income that is used for saving.

8.) Tax Multiplier - A measure of the change in aggregate production caused by changes in
government taxes. The tax multiplier is the negative marginal propensity to consume times one
minus the slope of the aggregate expenditures line. The simple tax multiplier includes ONLY
induced consumption. More complex tax multipliers include other induced components. Two
related multipliers are the expenditures multiplier, which measures the change in aggregate
production caused by changes in an autonomous aggregate expenditure, and the balanced-
budget multiplier which measures the change in aggregate production from equal changes in
both taxes and government purchases.

Basically, Taxes are all the income and sales and other taxes the government takes out of the
income flow.

9.) Fiscal Policy - means by which a government adjusts its spending levels and tax rates
to monitor and influence a nation's economy. It is the sister strategy to monetary policy through
which a central bank influences a nation's money supply.
9a.) Using the Fiscal policy, the government can increase taxes to decrease the aggregate
income level.

9b.) Using the Fiscal policy, the government may choose to decrease taxes to help increase
aggregate income.

10.)

i.) There should be existing productive capacity

If short-run aggregate supply is inelastic, the full multiplier effect is unlikely to occur, because
increases in AD will lead to higher prices rather than a full increase in real national output. In
contrast, when SRAS is perfectly elastic a rise in aggregate demand causes a large increase in
national output.

*inelastic - situation in which the supply and demand for a good or service are unaffected when
the price of that good or service changes.

ii.) Presence of an efficient government (governance) of economic activities

Increased government spending or lower taxes can lead to a rise in government borrowing
and/or inflation which causes interest rates to rise and has the effect of slowing down economic
activity.

iii.) Available complementary institutions

These influence the multiplier of an economy in such a way that these institutions take care of
the welfare of the people. By doing so, people are taken care of and are able to work, resulting
in more income. Thus, more taxes may also be seen because of the greater number of tax
payers.

iv.) An Efficient Financial System

A more efficient financial system helps the economy have a better income cash flow which in
turn would increase the size of the multiplier.

11.) Terms to Remember:

Aggregate Demand - Aggregate demand is the demand for the gross domestic product (GDP)
of a country, and is represented by this formula: Aggregate Demand (AD) = C + I + G + (X-M) C
= Consumers' expenditures on goods and services. I = Investment spending by companies on
capital goods.
Aggregate Income (Y) - Total of all incomes in an economy, without taking inflation and taxes
into account.

Aggregate Expenditures - the current value of all the finished goods and services in the
economy. The aggregate expenditure is thus the sum total of all the expenditures undertaken in
the economy by the factors during a given time period.

Aggregate Supply - total supply of goods and services that firms in a national economy plan on
selling during a specific time period. It is the total amount of goods and services that firms are
willing and able to sell at a given price level in an economy.

Autonomous Consumption Spending (C0) - The minimum level of consumption that would
still exist even if a consumer had absolutely no income

Consumption Expenditures (C) - A measure of price changes in consumer goods and

services. Personal consumption expenditures consist of the actual and imputed expenditures of
households; the measure includes data pertaining to durables, non-durables and services.

Consumption Function - a mathematical formula laid out by famed economist John Maynard
Keynes. The formula was designed to show the relationship between real disposable income
and consumer spending, the latter variable being what Keynes considered the most important
determinant of short-term demand in an economy. (C = A + MD)

Consumption Multiplier (∆Y/∆C) - a factor that quantifies the change in total income as
compared to the injection of capital deposits or investments which originally fueled the growth. It
is usually used as a measurement of the effects of government spending on income, and it can
be calculated as one divided by the marginal propensity to save.

Equilibrium Income (Ye) - The state in which market supply and demand balance each other
and, as a result, prices become stable. Generally, when there is too much supply for goods or
services, the price goes down, which results in higher demand. The balancing effect of supply
and demand results in a state of equilibrium.

Export Expenditures (X) - The value of a country's total exports minus the value of its total
imports. It is used to calculate a country's aggregate expenditures, or GDP, in an open
economy.

Exports Multiplier (∆Y/∆X) - amount by which national income of a nation will be raised by a
unit increase in domestic investment on exports; otherwise known as foreign trade multiplier.

Fiscal Policy - means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation's economy. It is the sister strategy to monetary policy through
which a central bank influences a nation's money supply.
Full Employment Income (Yf) - A situation in which all available labor resources are being
used in the most economically efficient way. Full employment embodies the highest amount of
skilled and unskilled labor that could be employed within an economy at any given time. The
remaining unemployment is frictional.

Government Expenditures (G) - What a government spends in order to achieve its planned
budget

Government Spending Multiplier (∆Y/∆G) - The ratio in which the change in a nation's income
level is affected by government spending. The fiscal multiplier is used to measure the effect of
government spending (fiscal policy) on the subsequent income level of that country.

Import Expenditures (M) - The value of a country's total exports minus the value of its total
imports. It is used to calculate a country's aggregate expenditures, or GDP, in an open
economy.

Imports Multiplier (∆Y/∆M) - It augments the slope of the aggregate expenditures line and is
part to the multiplier process. A related marginal measure is the marginal propensity to
consume. The marginal propensity to import (MPM) indicates the extent to which imports are
induced by changes in income or production.

Investment Expenditures (I) - An expenditure by the business sector on final goods and
services, in particular, capital goods like factories and equipment, undertaken in a given time
period.

Investment Multiplier (∆Y/∆I) - refers to the concept that any increase in public or private
investment spending has a more than proportionate positive impact on aggregate income and
the general economy.

Marginal Propensity to Consume (C1) - Marginal propensity to consume is a component of

Keynesian macroeconomic theory and is calculated as the change in consumption divided by
the change in income. MPC is depicted by a consumption line- a sloped line created by plotting
change in consumption on the vertical y axis and change in income on the horizontal x axis. The
marginal propensity to consume (MPC) is equal to ΔC / ΔY, where ΔC is change in
consumption, and ΔY is change in income. If consumption increases by 80 cents for each
additional dollar of income, then MPC is equal to 0.8 / 1 = 0.8.

Marginal Propensity to Save (S 1) - The proportion of an aggregate raise in pay that a

consumer spends on saving rather than on the consumption of goods and services. Marginal
propensity to save is a component of Keynesian macroeconomic theory and is calculated as the
change in savings divided by the change in income. (Change in Saving/Change in Income)

Multiplier - factor that quantifies the change in total income as compared to the injection of
capital deposits or investments which originally fueled the growth. It is usually used as a
measurement of the effects of government spending on income, and it can be calculated as one
divided by the marginal propensity to save.

Productive Capacity - maximum possible output of an economy. According to the United

Nations Conference on Trade and Development (UNCTAD), no agreed-upon definition of
maximum output exists.

Productive Linkages - when an investor is able to purchase a security on one financial

exchange and sell it on another.

Savings - the amount left over when the cost of a person's consumer expenditure is subtracted
from the amount of disposable income that he or she earns in a given period of time.

Savings Function - disposable income minus the consumption function. It is also equal to the
amount of induced saving minus autonomous consumption. S = −a + sYD.

Tax Multiplier (∆Y/∆Tx) - the negative marginal propensity to consume times one minus the
slope of the aggregate expenditures line. The simple tax multiplier includes only induced
consumption

Tax Revenue (Tx) - the revenues collected from taxes on income and profits, social security
contributions, taxes levied on goods and services, payroll taxes, taxes on the ownership and
transfer of property, and other taxes.