Class-4 Keynesian theory of income determination.pptx - Keynesian theory of income determination Equilibrium Level of National Income is determined at

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Keynesian theory of income determination Equilibrium Level of National Income is determined at the level where Aggregate Demand (AD) = Aggregate Supply (AS)
Aggregate Demand: 2-Sector Model Two sectors: Household and Business AD = C + I I= Constant In short run AD depends largely on Consumption expenditure
Consumption Function Consumption function: relationship between consumption and its determinants. There are many determinants- income, wealth, interest rate, future expectations etc. Mostly C= f(Y) where Y= Income. Keynes: fundamental psychological law.
Consumption Function C = Total real consumption of households a = Autonomous real consumption of households Y d = Real personal disposable income b = Marginal propensity to consume (MPC) Marginal propensity to consume ‘b’ or MPC represents the proportion of income that goes to consumption and it is always less than one ( why) 1 b 0 0, a ; d bY a C
Derivation of Saving function Y= C+S And S = I Y b a S bY Y a S bY a Y S S bY a Y bY a C But S C Y ) 1 (
Demand for goods & services Components of aggregate demand: C = consumer demand for g & s I = demand for investment goods G = No government and (closed economy: no NX ) CHAPTER 3 National Income
Relationship between Consumption and Saving function Y c a S ) 1 ( cY a C Saving (S) - a a Income (Y) Income (Y) Consumption
exampleFind GDP using following informationC= 100+0.8Y ; and I=1000There is no government and no foreign trade.What will be GDP if investment is increased to 2000? What will be saving function?
Government sector Two changes due to this sector Government expenditure in included Tax is also included Government expenditure directly enters Tax enters via consumption function( indirectly). Y= C+I+G …….. Govt sector included Y=[a + b(Y-T)]+I+G …….. Tax included
Budget balance Budget balance = net tax revenue – Expenditure If revenue exceeds expenditure then it is called Budget surplus If expenditure exceeds revenue then it is called budget deficit.
Impact of govt expenditure Y=AD C+I+G C+I G Y 1 Y 2 B A ∆Y Impact of Government expenditure on Aggregate Demand MPC G Y 1 1 /
Impact of tax 45 0 C +I+G T A B C+I+G Y 2 Y 1 M P C Ct+I+G T b b Y b b dT dY 1 0 1
The Balance Budget Multiplier Impact of Govt exp: Impact of tax: Combined impact: If G b Y 1 1 T b b Y 1 T b b G b Y 1 1 1 G Y G b b G b b b Y 1 1 1 1 1 T G