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The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• The circular flow of income• The circular flow of income
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
– the injections curve
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
– the injections curve
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
– the injections curve
– equilibrium
• Effect on national income of a change in injections and/or withdrawals
– J>W : national income rises
– W>J : national income falls
• The Keynesian diagram: the withdrawals and injections approach
– the withdrawals curve
– the injections curve
– equilibrium
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• The Keynesian diagram: the income and expenditure approach
– the 45° line
• The Keynesian diagram: the income and expenditure approach
– the 45° line
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• The Keynesian diagram: the income and expenditure approach
– the 45° line
– the expenditure curve
• The Keynesian diagram: the income and expenditure approach
– the 45° line
– the expenditure curve
The Equilibrium Level ofNational Income
The Equilibrium Level ofNational Income
• The Keynesian diagram: the income and expenditure approach
– the 45° line
– the expenditure curve
– equilibrium
• The Keynesian diagram: the income and expenditure approach
– the 45° line
– the expenditure curve
– equilibrium
The MultiplierThe Multiplier
• The multiplier: introduction
– the circular flow of income and effects of changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach
– graphical analysis: shift in the J line
• The multiplier: introduction
– the circular flow of income and effects of changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach
– graphical analysis: shift in the J line
OY
W
J1
J2
Ye1
a
Ye2
b
Y
c
WJJ1
J2
Multiplier = Y / J
= Y / W= ca / bc
W, JThe multiplier: (a) a shift in injections
The MultiplierThe Multiplier
• The multiplier: introduction– the circular flow of income and effects of
changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line
– the formula : 1/mpw
– or : 1/(1–mpcd)
• The multiplier: introduction– the circular flow of income and effects of
changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line
– the formula : 1/mpw
– or : 1/(1–mpcd)
OY
W
J1
J2
Ye1
a
Ye2
b
Y
c
WJJ1
J2
Multiplier = Y / J= Y / W= ca / bc
= 1/mpw
W, JThe multiplier: (a) a shift in injections
The MultiplierThe Multiplier
• The multiplier: introduction– the circular flow of income and effects of
changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line
– the formula : 1/mpw
– or : 1/(1–mpcd)
– graphical analysis: shift in the W line
• The multiplier: introduction– the circular flow of income and effects of
changes in injections
– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line
– the formula : 1/mpw
– or : 1/(1–mpcd)
– graphical analysis: shift in the W line
b
OY
W1
J
Ye1
a
W, J
W2
Ye2
c
Y
W
Multiplier = Y / W= ca / ab
The multiplier: (b) a shift in withdrawals
The MultiplierThe Multiplier
• The multiplier: introduction– the circular flow of income and effects of
changes in injections– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line– the formula : 1/mpw– or : 1/(1–mpcd)– graphical analysis: shift in the W line
• The income and expenditure approach
• The multiplier: introduction– the circular flow of income and effects of
changes in injections– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line– the formula : 1/mpw– or : 1/(1–mpcd)– graphical analysis: shift in the W line
• The income and expenditure approach
The MultiplierThe Multiplier
• The multiplier: introduction– the circular flow of income and effects of
changes in injections– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line– the formula : 1/mpw– or : 1/(1–mpcd)– graphical analysis: shift in the W line
• The income and expenditure approach– graphical analysis: shift in the E line
• The multiplier: introduction– the circular flow of income and effects of
changes in injections– definition of the multiplier: ΔY/ΔJ
• The withdrawals and injections approach– graphical analysis: shift in the J line– the formula : 1/mpw– or : 1/(1–mpcd)– graphical analysis: shift in the W line
• The income and expenditure approach– graphical analysis: shift in the E line
OY
Y
E1
Ye1
E2
Ye2
Multiplier = Y / J= ca / ba
a
c
Y
J
E, W, J
b
The multiplier: (c) a shift in the expenditure curve
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income
– implications for shape of AS curve
• 'Full-employment' national income
• 'Gap' analysis– the deflationary gap
– the inflationary gap
– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income
– implications for shape of AS curve
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• 'Full-employment' national income• 'Gap' analysis
– the deflationary gap– the inflationary gap– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income– implications for shape of AS curve– effect of an increase in aggregate demand
• 'Full-employment' national income• 'Gap' analysis
– the deflationary gap– the inflationary gap– policy implications
• Inflation and unemployment together– inflationary pressures before the full-
employment level of income– implications for shape of AS curve– effect of an increase in aggregate demand
O
Pric
e le
vel
National output
YP
The effects of increases in aggregate demandon national output
AS
O Y1
Pric
e le
vel
National output
Y2
AS
Y3 Y4 YP
AD3AD2AD1
AD4
The effects of increases in aggregate demandon national output
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• The Phillips curve– the shape of the curve
• The Phillips curve– the shape of the curve
0
1
2
3
4
5
6
7
8
9
0 1 2 3 4 5 6
The original Phillips curve
Unemployment (%)
Wa
ge in
flatio
n (
%)
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• The Phillips curve– the shape of the curve
– the position of the curve
• The Phillips curve– the shape of the curve
– the position of the curve
0
1
2
3
4
5
6
7
8
9
0 1 2 3 4 5 6
The original Phillips curve
Unemployment (%)
Wa
ge in
flatio
n (
%)
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
– the breakdown of the curve
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
– the breakdown of the curve
The Keynesian Analysis of Unemployment and InflationThe Keynesian Analysis of
Unemployment and Inflation
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
– the breakdown of the curve
– recent relationship between inflation and unemployment
• The Phillips curve
– the shape of the curve
– the position of the curve
– policy implications of the curve
– the breakdown of the curve
– recent relationship between inflation and unemployment
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6763
6265
6664
60
61
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6763
6265
6664
60
61
Original Phillips curve
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
74
7173
7072
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6968
6763
6265
6664
60
61
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
75
74
76
77
79
7173
7072
78
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6968
6763
6265
6664
60
61
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
75
74
8076
77
79
7173
7072
78 82
8384
85
81
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6968
6763
6265
6664
60
61
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
75
74
8076
77
79
7173
7072
78
90
89
9188
95
82
8384
85
86
93
8792
94
81
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6968
6763
6265
6664
60
61
0
2
4
6
8
10
12
14
16
18
20
22
24
26
0 1 2 3 4 5 6 7 8 9 10 11 12 13
75
74
8076
77
79
7173
7072
78
90
89
9796
9188
95
82
8384
85
86
93
8792
94
81
Inflation (%)
Unemployment (%)
The breakdown of the Phillips curve?
6968
6763
6265
6664
60
6199
98
0001
Keynesian Analysis ofthe Business Cycle
Keynesian Analysis ofthe Business Cycle
• The accelerator
– changes in national income and induced investment
– the accelerator effect
– the instability of investment
• The multiplier/accelerator interaction
• Fluctuations in stocks
• The accelerator
– changes in national income and induced investment
– the accelerator effect
– the instability of investment
• The multiplier/accelerator interaction
• Fluctuations in stocks
Keynesian Analysis ofthe Business Cycle
Keynesian Analysis ofthe Business Cycle
• Determinants of the course of the business cycle– why do booms and recessions persist?
• time lags• 'bandwagon' effects
– why do booms and recessions end?• ceilings and floors• echo effects• the accelerator• random shocks• changes in government policy
• Determinants of the course of the business cycle– why do booms and recessions persist?
• time lags• 'bandwagon' effects
– why do booms and recessions end?• ceilings and floors• echo effects• the accelerator• random shocks• changes in government policy
The Role of Fiscal PolicyThe Role of Fiscal Policy
• The purpose of fiscal policy
– correcting a fundamental disequilibrium
– fine tuning
• Deficits and surpluses
– central government deficits and surpluses
– public-sector deficits and surpluses
– the PSNCR
– the national debt
• The purpose of fiscal policy
– correcting a fundamental disequilibrium
– fine tuning
• Deficits and surpluses
– central government deficits and surpluses
– public-sector deficits and surpluses
– the PSNCR
– the national debt
The Role of Fiscal PolicyThe Role of Fiscal Policy
• The use of fiscal policy
– automatic fiscal stabilisers
– discretionary fiscal policy
• The use of fiscal policy
– automatic fiscal stabilisers
– discretionary fiscal policy
Effectiveness of Fiscal PolicyEffectiveness of Fiscal Policy
• Factors determining the effectiveness of fiscal policy
– accuracy of forecasting
– effect on J and W
– effect of changes in J and W on national income
– timing of the effects
– effects on the various macro objectives
• Factors determining the effectiveness of fiscal policy
– accuracy of forecasting
– effect on J and W
– effect of changes in J and W on national income
– timing of the effects
– effects on the various macro objectives
Effectiveness of Fiscal PolicyEffectiveness of Fiscal Policy
• Discretionary policy– problems of forecasting the magnitude of
the effects• effects of changes in government expenditure• crowding out• effects of changes in taxes• size of the multiplier and accelerator effects• random shocks
– problems of timing and time lags• various time lags• policy may be destabilising
• Discretionary policy– problems of forecasting the magnitude of
the effects• effects of changes in government expenditure• crowding out• effects of changes in taxes• size of the multiplier and accelerator effects• random shocks
– problems of timing and time lags• various time lags• policy may be destabilising
Fiscal policy: stabilising or destabilising?
O
Rea
l nat
iona
l inc
ome
Time
1
2
3
4
1
2
3
4
Path (a): no intervention
O
Rea
l nat
iona
l inc
ome
Time
1
2
3
4
1
2
3
4
Path (a): no intervention
Path (b): policy stabilises
Fiscal policy: stabilising or destabilising?
O
Rea
l nat
iona
l inc
ome
Time
1
2
3
4
1
2
3
4
Path (a): no intervention
Path (c): policy destabilisesPath (b): policy stabilises
Fiscal policy: stabilising or destabilising?
Effectiveness of Fiscal PolicyEffectiveness of Fiscal Policy
• Side-effects of discretionary policy
– cost inflation
– welfare and distributive justice
– incentives
• A rules-based approach to fiscal policy
– a 'steady-as-you-go' policy
– the EU Stability and Growth Pact
– UK Labour government's 'Golden Rule'
• Side-effects of discretionary policy
– cost inflation
– welfare and distributive justice
– incentives
• A rules-based approach to fiscal policy
– a 'steady-as-you-go' policy
– the EU Stability and Growth Pact
– UK Labour government's 'Golden Rule'