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Lecturer: Pn. Siti Hajar Binti Md.Jani
Power Point by ; Pn.Azizah Isa. UiTM Kelantan 1
Chapter 3Determination of Equilibrium
National Income
Lecturer: Pn. Azizah Isa 2
BUSINESS CYCLE
Aggregate Econ. Activity
Boom/Inflation
Trough/Depression/Slump/Unemployment
Potential Growth Path
Actual Growth Path
years
(% in real GDP)
Lecturer: Pn. Azizah Isa 3
NATIONAL INCOME EQUILIBRIUM
Keynes argued that “an economy could reach equilibrium but not necessarily at the full employment.”
Lecturer: Pn. Azizah Isa 4
Equilibrium and Full-employment
Equilibrium will occur when there is no tendency for an economy to change. It refers to a situation when all consumers and firms have no incentive to change their behaviour.
Full employment equilibrium is the situation of
equilibrium in an economy at the best efficient and full utilization of resources.
“An economy can be at the equilibrium but not
always to be at full-employment.”
Lecturer: Pn. Azizah Isa 5
Two approaches:
To Determine National Income Equilibrium:
1. Total Approach.
2. Injection-Leakage Approach.
Lecturer: Pn. Azizah Isa 6
i) Total Approach:
Equilibrium may occur when planned aggregate expenditure is equivalent to planned output.
(AD = AS)
(aggregate demand = aggregate supply).
Lecturer: Pn. Azizah Isa 7
i) Leakage-Injection Approach:
Equilibrium also can be determined when: INJECTION = LEAKAGE
Injections are additional spending from:
investments (I), government purchases (G) and exports (X).
Leakages are withdrawals from: savings (S),
tax payment (T) and imports (M).
So, at equilibrium, (I+G+X = S+T+M) (INJECTION = LEAKAGE)
Lecturer: Pn. Azizah Isa 8
DETERMINATION OF EQUILIBRIUM NATIONAL
INCOMEKeynesian model is drawn based on the relationship between income and expenditure:
Y = C + I + G + (X – M)
where,
C = f (Yd) ,
C is a function of Real Disposable Income
(income after tax), where, Yd = Y – t .
Lecturer: Pn. Azizah Isa 9
Components of Aggregate Expenditure:
1. CONSUMPTION, C = f (Yd)
2. INVESTMENT, I = f (i, Y)
3. GOVERNMENT EXPENDITURE, G
4. NET EXPORT (X – M)
Lecturer: Pn. Azizah Isa 10
1. Consumption and Saving
Disposable Income is used for Consumption spending and Saving.
Yd = C + S
and, C = f (Yd), S = f (Yd)
Both C and S is a function of income,Y and having a positive relationships.
( Y rises, C and S also will rise).
Lecturer: Pn. Azizah Isa 11
Given that;
Consumption function: C = a + bYd
and Saving function: S = – a + (1 – b) Yd
There is (two)2 components of Consumption spending by households:
C1, Autonomous Consumption = a
C2, Induced Consumption = bYd
Where,
b is the Marginal Propensity to Consume (MPC).
Lecturer: Pn. Azizah Isa 12
Autonomous Consumption, a and Induced Consumption, bY
C2 = a is a fixed amount irrespective of the income earned,
is the part of consumption which does not vary with the level of income (Y increases but “a” is constant).
C2 = bY is an amount that depends on the disposable income,
is the amount of consumption spending by households that is induced by disposable income (Y increases, C2 increases).
Lecturer: Pn. Azizah Isa 13
CONSUMPTION, C
Consumption function, C = f (Yd)
C C = a + bYd
a
real output, Y
The slope of consumption function is given by:
b = C/ Y
= Marginal Propensity to Consume (MPC)
and the value 0 < b < 1 (positive but less than).
Lecturer: Pn. Azizah Isa 14
Autonomous Consumption,C1 = a
is the vertical intercept of the consumption function,
at a (in the diagram). It is the amount of consumption that
would occur even if the household earned nothing, Y=0.
when Y= 0 (no income earned), C = a.
(basic consumption for living).
C C = a + b Yd
a 0 real output, Y
Lecturer: Pn. Azizah Isa 15
Consumption and Saving schedule
Y C S 0 60 -60
100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140
With no income earned, Y = 0 , autonomous C = a = 60 and dissaving = - a = - 60.While Y = C + S , if Y = 0 , then C = - S.
Lecturer: Pn. Azizah Isa 16
How is the increase in income will increase consumption?
Consumption is induced by
the value of b (that is = MPC),
since,
C = a + bY
Lecturer: Pn. Azizah Isa 17
FOR EXAMPLE: Given that C = a + bY, therefore, if b = 0.6 , how large is the increase in consumption if there is an increase in income?Since C = a + 0.6Y, thus C will increase by 0.6Y , (given a = fixed or autonomous consumption) , so, C will increase by 60% out of total income, Y. Meaning that, for any increase in income, 40% can be saved and 60% will be spend on consumption.
Lecturer: Pn. Azizah Isa 18
For example:
a change in income from RM1000 to RM1500 with the MPC = 0.6,
C = b Y
= 0.6 (500) = 300.
Therefore, consumption will increase by RM300.
Lecturer: Pn. Azizah Isa 19
Consumption and Saving schedule
Y C S 0 60 -60
100 120 -20 200 180 20 300 240 60 400 300 100 500 360 140
In a 2-sector economy, C = a + bY .Since C = a + 0.6Y, and a = 60 thus C = 60 + 0.6Y.
At income 200, C = 60 + 0.6(200) = 60 + 120 = 180 and Y = C + S so , S = Y – C = 200 -180 = 20.
Lecturer: Pn. Azizah Isa 20
Changes in consumption when income change.
consumption
Y = CC = a + b Y
C Y
45°
income
Note: b = C = 400
1000 1500
Y
500
400
Lecturer: Pn. Azizah Isa 21
Changes in consumption when income change.
consumption Y = C
C = a + b Y
C Y
45°
income
Note: b = C
= 400
1000 1500
Y
500
e
a
400
Lecturer: Pn. Azizah Isa 22
SAVINGSSome part of income earned is saved.
two components of savings: autonomous dissaving, S1 = – a
induced saving, S2 = (1 – b)Y
where,
(1 – b) = Marginal Propensity to Save. = S/Y
= slope of saving function.
Lecturer: Pn. Azizah Isa 23
Dissaving and induced saving.
Autonomous dissaving, (- a), is the amount that households draw out from their wealth to consume when no income earned.
Induced saving, (1 –b)Y, is the amount of saving that is induced by earnings of disposable income.
Lecturer: Pn. Azizah Isa 24
Saving Function, S
Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
(1 – b) is the slope of saving function = ΔS/ΔY
Lecturer: Pn. Azizah Isa 25
Consumption & Saving Function,
C,S
Yd (real output)
S = – a + (1– b)Yd
– a
0
C = a + bYd
a
45º
e
Y = C + S,When S = 0,Y = C at the breakeven,
point, e.
Y = C
Y = AD
Lecturer: Pn. Azizah Isa 26
Note that:
MPC + MPS =1, thus MPS = (1 – MPC).
If MPC = b and MPS = (1 – b),
Then,
b + (1 – b) = 1
Lecturer: Pn. Azizah Isa 27
APC, APSThe fraction of income that is used for
consumption is the: Average Propensity to Consume (APC): APC = C YAnd, the fraction of income that is used for
saving is the: Average Propensity to Save (APS): APS = S Y and, at any level of income, APC + APS = 1
Lecturer: Pn. Azizah Isa 28
MPC, MPS, APC, APS
INCOME,Y
CONSUMPTION, C C = a + bYd
0 1600
1200
a
1000
800
Lecturer: Pn. Azizah Isa 29
MPC
INCOME,Y
CONSUMPTION, C C = a + bYd
∆C
∆Y
0 1600
1200
a
MPC = ∆C = 400
∆Y 600
is the slope of the consumption function.
1000
800
Lecturer: Pn. Azizah Isa 30
MPC, APC
INCOME,Y
CONSUMPTION, C C = a + bYd
∆C
∆Y
0 1600
1200
a
MPC = ∆C = 400
∆Y 600 APC = TC = 1200 TY 1600
1000
800
TC
TY
Lecturer: Pn. Azizah Isa 31
MPC, APC
INCOME,Y
CONSUMPTION, C C = a + bYd
0 1600
1200
a
MPC = ∆C = 400
∆Y 600 APC = TC = 1200 TY 1600
1000
800
TC
TY
TC
Lecturer: Pn. Azizah Isa 32
Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
MPS = (1 – b) = ΔS/ΔY
is the slope of saving function.
ΔS
ΔY
MPS, APS
Lecturer: Pn. Azizah Isa 33
Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
while, APS = TS/TY
ΔS
ΔYTS
TY
MPS, APS
TS
Lecturer: Pn. Azizah Isa 34
Saving
Yd (real output)
S = – a + (1– b)Yd
–a
0
while, APS = TS/TY
TS
TY
MPS, APS
TS
Lecturer: Pn. Azizah Isa 35
APC, APS changes with income; MPC, MPS are constant.
APC falls and APS will rise as income increases.
- because as income increases, households consumption will rise but with a smaller percentage compared to the increase in income, while saving will rise with a larger percentage instead.
While MPC and MPS is assume constant as long as the slopes of the consumption and saving curves are constant or assume to be straight lines.
Lecturer: Pn. Azizah Isa 36
EXAMPLE 1
Y C S APC APS MPC MPS 0 60 -60 - - - -
100 120 -20 1.2 -0.2 0.6 0.4 200 180 20 0.9 0.1 0.6 0.4 300 240 60 0.8 0.2 0.6 0.4 400 300 100 0.75 0.25 0.6 0.4 500 360 140 0.72 0.28 0.6 0.4
As income increases, APC falls but APS rises.Meanwhile, MPC and MPS are constant.
Lecturer: Pn. Azizah Isa 37
Other determinants of Consumption:
Wealth The richer the higher is the consumption.
Interest ratesLarge items were bought on loans that pay interest.Expectation of future pricesPrice is expected to increase in future, more consumption now (may involve in hoarding).
Lecturer: Pn. Azizah Isa 38
Consumption in Islam (according to M. Fahim Khan, 1922)
A Muslim has to be rational in their spending.
The rationality of consumption in Islam is:
to spend wisely and moderately: to consume only enough goods for healthy
living. Excessive indulgence in luxurious living is
discouraged: Israf (extravagant or overspending on goods excessively are wasteful and prodigal.
Lecturer: Pn. Azizah Isa 39
to follow the hierarchy of needs: Dharuriyat, Hajiyat, Kamaliat and not to consume the Tarafiat goods.
to consume only permissible goods (halal) but not prohibited goods (haram).
part of his expenditure is also spend for fi-sabilillah (spending for the betterment of Islamic livings)
part of his income is also saved for future expenditure.
Conclusion: spending by Muslim consumers is to achieve the satisfaction in this world and also to earn reward in the hereafter.
Lecturer: Pn. Azizah Isa 40
BREAK-EVEN INCOME is a situation when all the income is just
nice for consumption purposes while no saving at all.
thus, Y = C and S = 0.
S = - a + (1 – b)Y
C = a + bYe
C,S
Y45º
AS=AD
S < 0
S > 0
S = 0
QUESTION TO PONDER: look out in the manual
INCOME(Y) CONSMPTN (C) SAVING(S)
0 140
200 260
400 20
600 500
800
1000
1. Use the given data to answer the following questions. (All figures are in RM million)
a) Fill up the blank with appropriate values.
QUESTION TO PONDER: ANSWER
INCOME(Y) CONSMPTN (C) SAVING(S)
0 140 140
200 260 60
400 120 + 260 = 380 20
600 500 100
800 120 + 500 = 620 180
1000 120 + 620 = 740 260
1. Use the given data to answer the following questions. (All figures are in RM million)
a) Fill up the blank with appropriate values.
Y = 200 and C = 120 , S = 80
Lecturer: Pn. Azizah Isa 43
b) What are the values of MPC and MPS?
c) Write down the consumption function and saving function.
d) What is the amount of break-even income?
Lecturer: Pn. Azizah Isa 44
b) What are the values of MPC and MPS?
MPC = C = 260 - 140 = 0.6 Y 200 – 0
MPS = 1 – MPC = 1 – 0.6 = 0.4
Lecturer: Pn. Azizah Isa 45
c) Write down the consumption function and saving function.
C = 140 + 0.6Y
S = - 140 + 0.4Y
Lecturer: Pn. Azizah Isa 46
d) What is the amount of break-even income?
is a point at e, when S = 0, so Y = C.
S = - 140 + 0.4Y
Since S = 0, 0 = -140 + 0.4Y
140 = 0.4Y
Y = 140/0.4 = 350
S = -140 + 0.4Y
C= 140 + 0.6Ye
C,S
Y45º
S = 0
Additional Question:
INCOME(Y) CONSMPTN (C) SAVING(S)
0 140 140
200 260 60
400 380 20
600 500 100
800 620 180
1000 740 260
Use the given data to answer the following questions. (All figures are in RM million)
Calculate the APC and APS at each level of income.
INCOME
(Y)
CONSMPTN (C)
SAVING
(S)
0 140 140
200 260 60
400 380 20
600 500 100
800 620 180
1000 740 260
ANSWER:
The values for APC and APS at each level of income.
APC APS
- -
1.3 - 0.3
0.95 0.05
0.83 0.17
0.78 0.23
0.74 0.26
Lecturer: Pn. Azizah Isa 49
2. INVESTMENT
Definition:
Investment is defined as the spending or purchase of plants, machineries, buildings and inventories by firms for the purpose of producing goods and services.
Lecturer: Pn. Azizah Isa 50
2 types of INVESTMENT - Keynes
two(2) types of investment spending: i) Autonomous Investment what firms may had intended to plan or
desired or has been fixed and does not depend on income.
ii) Induced Investment actual investment expenditures used to
produce newly produced goods, and depends on the level of:
I = f ( i, e, Y, t…)
Lecturer: Pn. Azizah Isa 51
Investment depends on the level of:
I = f ( i, e, Y, t ….) interest rate, future expected profitability, income, technology, capacity and business taxes.
Lecturer: Pn. Azizah Isa 52
1. Autonomous Investment
As assume by Keynes;
- is a fixed investment that does not change with the change in income,
but ;
there will be a shift in the autonomous horizontal function, up or down when there’re other factors that affect it.
Lecturer: Pn. Azizah Isa 53
1. Autonomous Investment Function
Investment
I1
Autonomous
Investment I0
Diagram: Autonomous InvestmentA shift in autonomous investment upward to I1 may
cause by an increase in expected profit or a fall in interest rate but does not depend on real income.
Example; the government planned spending to provide public goods.
Real Income
refers as a fixed investment that does not change with the change in income.
Lecturer: Pn. Azizah Isa 54
2. Induced Investment Functionreal interest rate (i)
I = f(i, e
)
I = f(i)
I’ I’’ Investment
Diagram: Induced Investment
Induced investment has a negative relationship with real rate of interest.
If future profit is expected to increase, at any given level of real interest rate
the investment function will increase and shift the curve to the right.
i1
i2
refers to an investment that changes with the interest rate, income or expected profitability etc.
Lecturer: Pn. Azizah Isa 55
2. Induced Investment Function investment
I = f(Y)
Income
Diagram: Induced Investment
Induced investment has a positive relationship with aggregate income.
Example is capital investment by the purchase of new plants and equipments.
is the actual investment that is induced by changes in income.
Lecturer: Pn. Azizah Isa 56
Investment From Islamic Perspective
Investment is permissible in Islam but extravagant and maximizing profit in doing any business activities is not allowed.
Muslims are not allowed to freeze their wealth.
Islam encourages Muslim to produce goods and to attain profit but also to give the emphasis on the welfare benefits to the society.
This means, Muslim entrepreneurs were not allowed to maintain maximum profit but only satisfactory profit or responsibility profit, which includes their responsibility to Allah and the responsibility for the benefits of the society.
Lecturer: Pn. Azizah Isa 57
Investment From Islamic Perspective
According to Siddiqui (1979), a relevant profit returns
for a Muslim in production is a “satisfactory profit”
earning, whereby it lies between the maximum profit
that could be allowed by the Islamic principles and the
minimum limit that could cover the cost.
Meaning that, it is the profit that gives satisfaction to
the investor in terms of the well beings and money
returns that could afford to maintain his business and
future business expansion, for the long term benefit of
the consumers, society and government.
Lecturer: Pn. Azizah Isa 58
Investment From Islamic Perspective
Underlying constraints in business activities in Islam involves:
i. Avoid the monopoly profit making. Any control of output and prices are strictly not allowed.
ii. Producing only the permissible (halal) goods but not the forbidden (haram) goods.
iii. Avoid transactions which involve the gharar and gambling activities.
iv. Does not involve in any misused of powers, injustice, suppress others and manipulation – must emphasis on the welfare of the society.
Lecturer: Pn. Azizah Isa 59
Investment From Islamic Perspective
v. Production of goods must follow the hierarchy of needs: Dharuriyat
Hajiyat and
Kamaliat goods
but not the Tarafiat (Tassiniyat)(haram) goods.
vi. Does not involves interest payment or any riba activities, both the riba al-nasiah (the addition to the capital) and the riba al-fadhal (an addition to the exchange of goods or other objects which is of the same nature – e.g. padi, wheat and money). Instead to avoid riba, Muslims are encouraged to have alternatives profit sharing in terms of mudharabah (sharing profit) or musyarakah (joint-venture).
Lecturer: Pn. Azizah Isa 60
Factors that influence Investment in Islam are:
I. Income
II. Expected returns
III. Viability of the projects.
IV. Facilities available or provided by the government.
V. The respond of market demand.
VI. Availability of fund.
Lecturer: Pn. Azizah Isa 61
Investment and SavingInvestment is an injection: could increase aggregate expenditure (AD) and boost up economic growth (income).
Investment spending will multiply through the multiplier effect to increase income. Saving is a leakage: could lower aggregate expenditure (AD) and income.
Saving becomes an outflow of money (leakage) from an economy. It becomes a stock of money that is not spent.At equilibrium,
Saving will be equal to Investment, ( S = I )
Lecturer: Pn. Azizah Isa 62
Equilibrium in 2 sector economy
C,S,I
Yd (real output)
S = – a + (1– b)Yd
– a
0
C = a + bYd
a
45º
C + I
I
Y2Y1
Y=AD
e1
e2
S = I
In 2 sector econ; equilibrium; Y = C + I
Y= C+I
Lecturer: Pn. Azizah Isa 63
Equilibrium in 2 sector economy
C,I
Yd (real output)
045º
C + I
Y2
Y=AD
e2
equilibrium; Y = C + I (in 2 sector economy)
Lecturer: Pn. Azizah Isa 64
Equilibrium in 2 sector economy
C,S,I
Yd (real output)
S = – a + (1– b)Yd
0
I
Y2
e2S = I
In 2 sector econ; equilibrium; S = I
Lecturer: Pn. Azizah Isa 65
QUESTION TO PONDER
1e) If investment is RM150 millions, calculate the equilibrium income
and sketch a diagram to show this.
I = 150
C = 140 + 0.6Y
Lecturer: Pn. Azizah Isa 66
At equilibrium (in 2 sector economy);
(Using Total Approach):
Y = C + I
Y = 140 + 0.6Y + 150
Y – 0.6Y = 290
0.4Y = 290
Y = 290/0.4
Y = 725
ANSWER:
Y = AD
C + I
Y
C,I
e
Ye = 725
45º
ANSWER:
Example: Question to Ponder 2. Refer to this diagram to answer the following questions.
S,I S = -300 + 0.25Yd I2 400 I1
0 Y0 Y1 3500 Income (RM million) -300
o Find the break-even income at Y0 o Find the equilibrium income when investment (I1) is at RM400 million. o How much is the new investment (I2) to achieve equilibrium income of
RM3500 million? o If equilibrium income is RM3500 million, how much is the amount of
saving and consumption? o At income level of RM3500 million, calculate the APS and APC.
Look out: in the manual
3. GOVERNMENT EXPENDITURE
Government Expenditure
Real Income Diagram: Autonomous Government Expenditure
G1
G0
G will be autonomously fixed according to Government Budget Policy for each year.
Equilibrium in 3 sector economy
AD
Yd
S+T
0
C
45º
C + I
I
Y2Y1
Y=AD
e1
e2
C + I +G
I + G
Y3
e3
S+T = I+G
Equilibrium in 3 sector economy
AD
Yd
S+T
045º
Y2Y1
Y=AD
C + I +G
I + G
Y3
e3
S+T = I+G
Lecturer: Pn. Azizah Isa 72
4. NET EXPORT (X – M)
Export is an injection and could increase the national income through the foreign trade multiplier, but import is a leakage.
Thus, net export (X-M), means the real foreign sector minus the total import of goods and services into the economy.
NATIONAL INCOME EQUILIBRIUM in 4 sector
Real Output (National Income)
Expenditure(RM)
Y0 = C+I+G+(X-M)
Y1=C+I+G+(X-M)Y=E
45°
Yfe=C+I+G+(X-M)
Ye0 Yfe Ye1
e0
e1
ef
Lecturer: Pn. Azizah Isa 74
KEYNESIAN EQUILIBRIUM NATIONAL INCOME
Keynesian assume that equilibrium output can be reached not necessarily at the full-employment.
- the equilibrium can be less or more than the full-employment equilibrium, causing the economy with the inflationary or deflationary-gap.
Inflationary & Deflationary Gaps
Real Output (National Income)
Expenditure(RM)
Y0 = C+I+G+(X-M)
Y1=C+I+G+(X-M)Y=E
45°
Yfe=C+I+G+(X-M)
Ye0 Yfe Ye1
Inflationary Gap
Deflationary Gape0
e1
ef
-GDP GapInflationary gap:
Yfe < Ye.
Deflationary gap: Yfe > Ye
+GDP Gap
NATIONAL INCOME EQUILIBRIUM with inflation
Real Output (National Income)
Expenditure(RM)
Y1=C+I+G+(X-M)Y=E
45°
Yfe=C+I+G+(X-M)
Yfe Ye1
Inflationary Gape1
ef
Inflationary gap: Yfe < Ye1
NATIONAL INCOME EQUILIBRIUM with
unemployment
Real Output (National Income)
Expenditure(RM)
Y0 = C+I+G+(X-M)
Y=E
45°
Yfe=C+I+G+(X-M)
Ye0 Yfe
Deflationary Gape0
ef
Deflationary gap: Yfe > Ye0
NATIONAL INCOME EQUILIBRIUM
Real Output (National Income)
Expenditure(RM)
Y0 = C+I+G0+(X-M)
Y1=C+I+G2+(X-M)
Y=E
45°
Yfe=C+I+G1+(X-M)
Y0 Yfe Y1
e0
e1
ef
G
Y
Spending multiplier ,
m =Y Yfe– Y0
Thus , Y = m G
G
+GDP Gap
G1 – G0
=
Lecturer: Pn. Azizah Isa 79
MULTIPLIERS
Any Injection will multiply positively,
while
any Leakage will multiply negatively.
Lecturer: Pn. Azizah Isa 80
i) Investment Multiplier = mI
= 1/MPS = 1/(1 – MPC)
Therefore, Y = 1/MPS x I
= mI x I
Y = mI
MULTIPLIERS
I
Spending Multipliers, m:
Lecturer: Pn. Azizah Isa 81
Example: Investment Multiplier Given, I = RM10 million and MPC = 0.75Therefore,
Y = 1/MPS x I = 1/0.25 X 10 mil. = 4 X 10 mil. = 40 mil.Thus, New Y = Y + 40 mil. If the initial income, Y= 2000, then New Y = 2000 + 40 = 2040 mil.
in the manual
Lecturer: Pn. Azizah Isa 82
MULTIPLIERSii) GOVERNMENT SPENDING MULTIPLIER Y 1 MPS
(assume an economy without tax, Yd =Y)Therefore, Y = 1/MPS X GThus, national income increases by the
amount of Y as Government increases spending.
That is, new Y2 = Y1 + Y
G=
Lecturer: Pn. Azizah Isa 83
iii) Government Multiplier with tax
= 1
MPSt
= 1
= 1
1 – b(1 – t)
(1 – b) + btLook at example 7 and exercise 3 and 4 in the manual.
Lecturer: Pn. Azizah Isa 84
iv) Simple Tax Multiplier, if tax, T = a
Tax Multiplier, mT = 1 – Spending Multiplier
= 1 – 1/MPS
= – MPC/MPS
– b
(1 – b)
And, Y = mT T T = Y mT
=
Lecturer: Pn. Azizah Isa 85
Example:Assume that, to achieve full-employment equilibrium,
the GDP has to be increased by RM 5 billion and MPS is 0.5. Calculate the tax cut
required to achieve this full-employment. tax multiplier, mT = 1 – (1/MPS)
= – MPC/MPS
= 1 – (1/0.5)
= 1 – 2
= – 1
tax cut, T = Y (-1) = - 5/(-1) = - 5By reducing the tax RM5 billion, GDP then will increase
by RM 5 billion.
Lecturer: Pn. Azizah Isa 86
v) If tax, T = a + tY
Tax Multiplier = - b
= - b
1 – b(1 – t)
(1 – b) + bt
Look at example 7 and 8 in the manual.
Now, C = a + b(1-t)Y
Lecturer: Pn. Azizah Isa 87
The effect of a change in Income Tax
A tax reduction may caused to an increase in consumption and thus effect towards a higher income.Assume, T = a + tYAnd the slope of AD is now b(1 – t).
AD0 = C = a + bYd
AD1 = Ct = a + b(1 – t)YdAD
Y
Y = – b . T
1 – b(1 – t)
a tax cut may increase income
Y0 Y1
Lecturer: Pn. Azizah Isa 88
vi) OPEN ECONOMY MULTIPLIER
1
(MPS + MPT + MPM)=
Lecturer: Pn. Azizah Isa 89
Accelerator Principle
state that:
“a change in Consumption would lead to a greater change in Investment.”
i.e. a small change in DD (consumption on output) would lead to a great change in Investment.
∆ C great ∆I
Lecturer: Pn. Azizah Isa 90
Relationship between multiplier and accelerator:
The effect with multiplier is that:
The effect with accelerator is that:
I greater Yby the multiplier, k
C greater Iby the accelerator, a
∆ Y = k ∆ I
∆ I = a ∆ C
Lecturer: Pn. Azizah Isa 91
This means that;
with the multiplier, m and the accelerator, a working together;
I Y C IAD
Lecturer: Pn. Azizah Isa 92
ACCELARATOR – J.M. CLARK
it was then incorporated into Keynesian theory.
- ‘cos it was closely related to multiplier
effect.
(an increase in C would lead to the increase in Investment and Aggregate Demand and thus towards an increase in Income.)
C I Y
Lecturer: Pn. Azizah Isa 93
THANK YOU FOR LEND ME
YOUR EARS.
That’s all for today.
Lecturer: Pn. Azizah Isa 94
3. Balanced Budget Policy
When government expenditure is just equivalent to the tax revenue collection. A balanced budget is also used to increase real output and economic growth. Any increase in government expenditure (which is equal to the amount of tax collection) will increase the real output by the same amount. Its multiplier is equivalent to one (1).
Y = 1 . GThus, the resulting increase in the equilibrium Y is exactly equal to the increase in G or T itself.
∆Y = ∆G = −∆TIt can be conclude that, although the government does not spend more than what it collects in tax revenue, she still can stimulate the economy, since the spending multiplier effect is larger than the tax multiplier effect.