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Capadosa

ECONOM1 Module 8

**National Income Determination • Demand estimation (consumption, savings,
**

investment, government expenditure)

• Fiscal Policy (during recession and inflation)

Demand Estimation: Consumption Function and Savings

Consumption Function/Propensity to

**Consume – the schedule that relates consumption
**

to disposable income

** Marginal Propensity to Consume (mpc) –
**

slope of the consumption function

Indicates the percentage of each additional peso of disposable income that will be consumed Value is less than 1 Denoted as b (basic assumption: At zero disposable income, consumption takes place); for consumption function C = a + by Refers to change in the level of consumption that occurs as a consequence of a change in income (mpc= C/ Y)

Demand Estimation: Consumption Function and Savings – cont’d

SAVING – the difference

**between consumption and income (S = Y – C)
**

MARGINAL PROPENSITY

**TO SAVE (mps) – the slope of the saving function
**

Expesses the ration of the change in the level of savings ( S) that occurs as a consequence of a change in income ( Y) (mps = S/ Y)

2002 .Schedule of Income and Consumption (in billion pesos) Income (Y) 100 200 300 Consumption (C) 125 200 275 400 500 600 350 425 500 Source: Pagoso et al.

& Savings (in billion pesos) Income (Y) 100 200 300 400 500 Consumption (C) 125 200 275 350 425 Savings -25 0 25 50 75 600 500 100 Source: Pagoso et al. Consumption. 2002 .Schedule of Income.

2002 . Consumption. & Savings (in billion pesos) Income (Y) 100 200 300 400 500 Consumption (C) 125 200 275 350 425 Savings -25 0 25 50 75 600 500 100 Source: Pagoso et al.Schedule of Income.

85 500/600=0.75 75/100=0.75 75/100=0.75 75/100=0.83 75/100=0.87 425/500=0.Average and Marginal Propensity to Consume (hypothetical data in million pesos) Income (Y) Consumption (C) APC MPC 100 200 300 400 500 600 125 200 275 350 425 500 200/200 = 1 275/300=0.75 Source: Pagoso et al. 2002 .91 350/400=0.75 75/100=0.

The Consumption-Savings Function 700 600 Y=C+S C=C(y) Income/Consumptio n 500 400 300 200 100 0 0 100 200 300 400 500 600 S=Y-C -100 100 200 Income .

John Maynard Keynes . is that men are disposed. but not as much as the increase in their income. to increase their consumption as their income increases.“The fundamental psychological law...” . as a rule and on the average.

Schedule of Income and Total Saving (in billion pesos) Income (Y) Consumption (C) Savings Investment C+I 100 200 300 400 500 125 200 275 350 425 -25 0 25 50 75 50 50 50 50 50 175 250 300 400 475 600 500 100 50 600 Source: Pagoso et al. 2002 .

C Income= Consumption+Investment Y=C+S C+ I 700 600 500 400 300 C 200 100 50 0 0 50 100 150 200 250 300 350 400 450 500 550 600 Y S I -50 Income .

political conditions. mood of investors Components: business fixed investment.Investment Refers to the decision made by firms to spend on capital goods Determinants: economic factors. net change in business inventories . peace and order situation. residential construction.

Multiplier The number of times money has changed hands and generate income Multiplier K K = 1/(1-mpc) Amount of Income Generated Yg = I x K .

Relevant Formulas & Symbols: Yd = Disposable Income = Y Consumption Function: C = a + by (a= C at zero y or • • the y-intercept.= --------(slope of S function) Y run mps + mpc = 1 S=Y-C . b=mpc or slope) mpc = C rise -----.= --------(slope of C function) Y run Savings Function: S = Y – C mps = S rise -----.

the multiplier • Y=IxM • Yg = G x K or IxK .= ---------1 – mpc mps .Relevant Formulas & Symbols-contd: M or K = 1 1 --------.

A Demo Problem .

SCENARIO 1 (SIMPLE ECONOMY): GNI = C + S Given: a = P50B 1.75 y (1 – 0.75) y = 50 Y = 50 ----.25 . the pt where c = Y 0. b = 75% The Consumption Function: C = 50 + 0. Getting the Break-even Point (C=Y): C = a + by C=Y a + by = Y Y = a + by Y = 50 + 0.= 200.75 y 2.

dissavings If Y = 400 C=? C = 50 + 0.75 y 3. Getting the C & S under different Y’s: If Y = 100 C=? C = 50 + 0.75 y S=? .SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75% The Consumption Function: C = 50 + 0.75 y C = 50 + 0.75 (100) = 50 + 75 = 125 S=? S = Y-C = 100 – 125 = -25.

75 (100) = 50 + 75 = 125 S=? S = Y-C = 100 – 125 = -25.75 (400) = 50 + 300 = 350 S=? =Y-C = 400 .SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75% The Consumption Function: C = 50 + 0.350 = 50.75 y C = 50 + 0.75 y 3. dissavings If Y = 400 C=? C = 50 + 0. + savings . Getting the C & S under different Y’s: If Y = 100 C=? C = 50 + 0.75 y = 50 + 0.

= -----------Y 400 .75 y 4. Computing for MPS: If Y S Mps = from 300 t0 400 from 25 to 50 S 50 – 25 ---.SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75% The Consumption Function: C = 50 + 0.25 .300 = 25 ---100 If Y S from 400 to 500 from 50 to 75 ? mps = = 0.

75 y 4.= ---------Y 500 – 400 = 25 ---100 mps = = 0.25 .SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75% The Consumption Function: C = 50 + 0.25 = 0.= -----------Y 400 . Computing for MPS: If Y S Mps = from 300 t0 400 from 25 to 50 S 50 – 25 ---.300 = 25 ---100 If Y S from 400 to 500 from 50 to 75 S 75 – 50 ----.

(GNI = C + I) b = 75% I = 50 Solving for equilibrium Y when there are values for C & I Y = C + I. the equilibrium income .75 y = 100 0. C = a + by Y = a + by + I Y = 50 + 0.75 y + 50 Y – 0.25 y = 100 Y = 400.SCENARIO 2 (ECONOMY w HH & investors): Given: a = P50B 1.

Sample Problem for C & I: 1. Assume : INCOME 50 CONSUMPTION 100 100 150 200 250 300 350 400 450 500 125 150 175 200 225 250 275 300 325 What is the equilibrium income and consumption? .

Sample Problem for C & I: Assume : INCOME 50 CONSUMPTION 100 100 150 200 250 300 350 400 450 500 125 150 175 200 225 250 275 300 325 What is the equilibrium income and consumption? 150 .

Construct a new schedule with investment equal to 25: INCOME 50 100 150 200 CONSUMPTI INVESTMEN ON T 100 125 150 175 C+I 250 300 350 400 450 500 200 225 250 275 300 325 What is the new equilibrium income? .Sample Problem for C & I: 2.

Sample Problem for C & I: 2. Construct a new schedule with investment equal to 25: INCOME 50 CONSUMPTI INVESTMEN ON T 100 25 C+I 125 100 150 200 250 300 350 400 450 500 125 150 175 200 225 250 275 300 325 25 25 25 25 25 25 25 25 25 150 175 200 225 250 275 300 325 350 What is the new equilibrium income? 200 .

Ye (new) = 150 + 50 = 200 Y = I x M = 25 x 2 = 50 .5 .5 = 2.5. M = 1 / 0. mps = 0.Sample Problem for C & I: 2. Construct a new schedule with investment equal to 25: INCOME 50 100 150 200 250 300 350 400 450 500 CONSUMPTION 100 125 150 175 200 225 250 275 300 325 INVESTMENT 25 25 25 25 25 25 25 25 25 25 C+I 125 150 175 200 225 250 275 300 325 350 What is the new equilibrium income? 200 CHECK: mpc = 0.

mps = 0. Assume Y = 50. C = 40. I = 10. M = ? .2.Sample Problem for C & I: 3.

I = 10. M = ? M = 1 / mps = 1 / 0. Assume Y = 50. mps = 0.5? .Sample Problem for C & I: 3.2 = 5 a.2. What would be additional Income and Consumption if Investment were to increase by 7. C = 40.

5 50 ________ 40 _______ 10 _______ _______ _______ . What would be additional Income and Consumption if Investment were to increase by 7. C = 40.5 x 5 = 37.2.5? Y = add’l I x K = 7. I = 10. Assume Y = 50.2 = 5 a. M = ? M = 1 / mps = 1 / 0.Sample Problem for C & I: 3.5. mps = 0. the additional Y Y C I S (Y-C) I = 10 I = 17.

2 = 5 a.5 50 _______ 40 _______ 10 _______ 10 _______ (1) . M = ? M = 1 / mps = 1 / 0. C = 40. Assume Y = 50. the additional Y b.2. mps = 0. What would be total Y and C as a result of the foregoing? Y C I S (Y-C) I = 10 I = 17. I = 10. What would be additional Income and Consumption if Investment were to increase by 7.Sample Problem for C & I: 3.5.5 x 5 = 37.5? Y = add’l I x K = 7.

total Y Y = C + I.5 70 (2) (50+37.Sample Problem for C & I: 3.5 x 5 = 37.5 = 70.5) (4)(87.5 = 87.5) .2. mps = 0. the additional Y b.5? Y = add’l I x K = 7.5-17.5 10 _______ (1) 87. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37. Assume Y = 50.5. total C Y C I S (Y-C) I = 10 I = 17.5 – 17. What would be additional Income and Consumption if Investment were to increase by 7.5. C = Y – I C = 87. M = ? M = 1 / mps = 1 / 0.2 = 5 a.5) (3)(10+7. I = 10.5 50 40 10 17. C = 40.

5 x 5 = 37.5) (4) .5-17. M = ? M = 1 / mps = 1 / 0.2 = 5 a.3. the additional Y b. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37.5) (3)(10+7. C = 40.5. C = Y – I C = 87. I = 10.5 50 40 10 17.5 70 (87. Compute Additional Savings Y C I S (Y-C) I = 10 I = 17.5.5 – 17. Assume Y = 50.5 10 _______ (1) 87.5? Sample Problem for C & I: Y = add’l I x K = 7.5 = 70. total Y Y = C + I. mps = 0.5) (2)(50+37.5 = 87. total C c. What would be additional Income and Consumption if Investment were to increase by 7.2.

5) (3)(10+7.5 S = Snew – Sold = 17. mps = 0. M = ? M = 1 / mps = 1 / 0.5 – 17. C = 40. What would be additional Income and Consumption if Investment were to increase by 7.5 – 10 = 7.5? Sample Problem for C & I: Y = add’l I x K = 7.5) (87.5 x 5 = 37.5-17. total C c. Compute Additional Savings S = Y – C = 87.5 10 17.5 70 (4) (2) (50+37.2.5 = 87.5. additional S Y C I S (Y-C) I = 10 I = 17.5) .2 = 5 a.3.5. Assume Y = 50.5 50 40 10 17. the additional Y b.5 (5) (1) 87. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37. C = Y – I C = 87.5 = 70.5.5 -70 = 17. total Y Y = C + I. I = 10.

Reminder: Submission of Takehome quiz on C & I function is next meeting .

(GNI = C + I + G) b = 75% I = 50 Yg=100 Solving for full employment equilibrium Y when there are values for C & I & G can be computed .SCENARIO 3 (ECONOMY w HH & investors & Government): Given: a = P50B 1.

75 y (y – 0.75y) = 125 Y = 500.75 = 1/0.75 y + 50 + 25 = 125 + 0. M or K = 1 / 1-mpc = 1/ 1-0.SCENARIO 3 (ECONOMY w HH & investors & Government): Given: a = P50B 1. the full employment equilibrium Ye . the Government Spending G Y = a + by + I + G = 50 + 0.25 = 4 100 = G x 4 G = 100 / 4 = 25. (GNI = C + I + G) b = 75% I = 50 Yg=100 Solving for full employment equilibrium Y when there are values for C & I & G can be computed Yg = G x K.

C+I. I = 50. Ye =500 Y. G=25. C+I+G Y . b = 75%. Yg=100.SCENARIO 3 (ECONOMY w HH & investors & Government – cont’d): (GNI = C + I + G) Given: a = P50B.C.

Graph the aforementioned equations. How much is equilibrium income where Y = C + I assuming investment is P50B? 3. 5. How much is equilibrium income where Y = C = I + G if Government Spending is P20B? 4. Assume that C = 50 + ½ yd 1. Compute the multiplier at each of the ff mpc’s given an investment of P5B: Mpc Multiplier Yg (Income Generated) 50% 45% .Practice Exercise (ECONOMY w HH & investors & Government): Compute and graph. Compute for the break-even point . 2.

G is value of government spending (Yg= G x K) . and government sectors. Y = C + I + G.Government Spending As determined from the HH. investors.

Full Employment Equilibrium The level of income where there is no available and useful resource that is wasted .

Inflationary Gap Occurs when aggregate demand C + I + G exceeds equilibrium income Y Deflationary Gap Occurs when aggregate demand C + I + G fall short of equilibrium income Y .

Schedule of Income and Total Spending (in billion pesos) Y C I G C+I + G 100 125 50 25 200 200 300 400 500 200 275 350 425 50 50 50 50 25 25 25 25 275 350 425 500 Source: Pagoso et al. 2002 .

C Full Employment Equilibrium Y=C+S C+ I C+I+G 700 600 500 400 300 C 200 100 50 0 0 50 100 150 200 250 300 350 400 450 500 550 600 Y S I -50 Income .

Fiscal Policy When the government uses its powers to influence total spending either directly by changingits purchases of goods and services or indirectly by altering the disposable incomes of persons to changes in the level of taxation or transfer outlays .

Fiscal Policies 1) Periods of deflation Deficit budget (government spending more than what it collects through taxes) or tax cuts 2) Periods of inflation Surplus budget (government spending less than its budget) or balanced budget or tax increases .

Major Macroeconomic Effects of Government Expenditure and Tax Policy The Expenditure Impact The Financial Impact The Supply Impact .

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