determination of income

8/8/2019 Determination of Income

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Determination of OutputDetermination of Output

Keynesian TheoryKeynesian Theory


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KEYNESIAN THEORYKEYNESIAN THEORY

Aggregate demandAggregate demand

Simple ModelSimple Model The MultiplierThe Multiplier


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Aggregate demandAggregate demand

Aggregate demand is the total amount ofAggregate demand is the total amount ofgoods and services demanded in thegoods and services demanded in theeconomy.economy.

Components:Components:

Consumption (C)Consumption (C)

Investment (I)Investment (I)


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Consumption FunctionConsumption Function

Relation between consumption spendingRelation between consumption spendingand current disposable incomeand current disposable income


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GFCF at 2004GFCF at 2004--05 prices05 prices

28

29

30

31

32

33

34

35

36

37

2004-05 2005-06 2006-07 2007-08 2008-09

year

as%o

fGDP


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Investment FunctionInvestment Function

Investment is spending devoted toInvestment is spending devoted toincreasing or maintaining the stock ofincreasing or maintaining the stock of

capital.capital.

Gross investment represents totalGross investment represents totaladditions to capital stock.additions to capital stock.

Net Investment = Gross investmentNet Investment = Gross investment --DepreciationDepreciation


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Components of InvestmentComponents of Investment

Business fixed investmentBusiness fixed investment

Residential investmentResidential investment

Inventory investmentInventory investment


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Business Fixed InvestmentBusiness Fixed Investment

Factors affecting business fixedFactors affecting business fixedinvestmentinvestment

Expected level of outputExpected level of output

Cost and return of using capitalCost and return of using capital


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Residential InvestmentResidential Investment

Building of housesBuilding of houses

Factors affecting residential investmentFactors affecting residential investment

Price of housingPrice of housing

Wealth of an individualWealth of an individual

Real return available on other assetsReal return available on other assets Net Real return obtained by owning houseNet Real return obtained by owning house


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Inventory InvestmentInventory Investment

Raw materials, goods in the process ofRaw materials, goods in the process ofproduction and finished goodsproduction and finished goods

Inventories are heldInventories are held

To meet fluctuating demandTo meet fluctuating demand

To minimise cost of transportinggoodsTo minimise cost of transportinggoodsvery frequentlyvery frequently


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Equilibrium OutputEquilibrium Output

Output (Y) is at its equilibrium level whenOutput (Y) is at its equilibrium level whenthe quantity of output produced in thethe quantity of output produced in the

economy is equal to the quantityeconomy is equal to the quantitydemanded.demanded.

Y = C + IY = C + I

AutonomousAutonomous aggregate demandaggregate demand


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Planned aggregate spendingPlanned aggregate spending

GDP(Rs) YD C I planned AE planned

0 0 300 500 800

500 500 600 500 1100

1000 1000 900 500 1400

1500 1500 1200 500 1700

2000 2000 1500 500 2000

2500 2500 1800 500 2300

3000 3000 2100 500 2600

3500 3500 2400 500 2900


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Inventory adjustmentInventory adjustment

GDP(Rs) AE planned AE unplanned

0 800 -800

500 1100 -600

1000 1400 -400

1500 1700 -200

2000 2000 0

2500 2300 200

3000 2600 400

3500 2900 600


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Equilibrium OutputEquilibrium Output

Actual output = Planned spending +Actual output = Planned spending +unintended inventory adjustmentunintended inventory adjustment


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The MultiplierThe Multiplier

What the multiplier tells us is that aWhat the multiplier tells us is that achange in autonomous consumptionchange in autonomous consumption

results in a multiple change in equilibrium.results in a multiple change in equilibrium.


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Round

Increase in

spending

Total

spending

1 100 100

2 80 180

3 64 244

4 51.2 295.2

5 40.96 336.2

6 32.77 368.9

7 26.21 395.1

8 20.97 416.1

9 16.78 432.9

10 13.42 446.3


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The MultiplierThe Multiplier

The MPC here is taken as 0.8The MPC here is taken as 0.8

The value of the multiplier isThe value of the multiplier is

MPC1

1

determination of income

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