Topic 8

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Topic 8

  1. 1. Determination of National Income EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Chapter #10, 11
  2. 2. PRODUCERS Y = $40M CONSUMERS S = $6M S T = $4M M = $10M Factors of Production Goods and Services X = $7M G = $5M I = $8M C D = $20M Circular Flow of Income EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  3. 3. Injections (J) <ul><li>Investments spending, </li></ul><ul><li>Government spending </li></ul><ul><li>Exports (spending by foreigners) </li></ul><ul><li>J = I + G + X </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  4. 4. Withdrawals (W) <ul><li>Saving </li></ul><ul><li>Taxation </li></ul><ul><li>Imports </li></ul><ul><li>W = S + T + M </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  5. 5. Injections and Withdrawals Injections Withdrawals CIRCULAR FLOW OF INCOME EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  6. 6. Injections (J) and Withdrawals (W) C D = C T - M J = I + G + X W = S + T + M AE = C T + I + G + X – M EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Y C T I G X M S T C D J W AE 0 20 25 35 10 10 -20 0 10 70 -10 80 100 90 25 35 10 20 0 10         200 160 25 35 10 30 20 20         300 230 25 35 10 40 40 30         400 300 25 35 10 50 60 40        
  7. 7. Equilibrium Level of National Income – Injections and Withdrawals Y W/J 200 W = S+T+M E J= X + G + I 70 EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  8. 8. Aggregate Expenditure Y AE 200 80 AE 1 100 300 140 200 260 EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  9. 9. Equilibrium Level of National Income – 45  Diagram Y AE E 1 45  200 Y=AE AE 1 200 EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  10. 10. National Income Equilibrium and Disequilibrium EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Condition W = J or Y = E W > J or E < Y J > W or E > Y Classification Equilibrium Disequilibrium Disequilibrium Effect Income is Stable Income Contracts Income Expands
  11. 11. Equilibrium Level of National using Equations <ul><li>Given that: </li></ul><ul><li>C T = 0.7Y+20 </li></ul><ul><li>I = 25, G = 35, X = 10 </li></ul><ul><li>M = 0.1Y+10 </li></ul><ul><li>  C D = 0.6Y +10 </li></ul><ul><li>  Formulate an equation which gives aggregate expenditure as a function of Y. </li></ul><ul><li>Use this equation to calculate the equilibrium level of national income. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  12. 12. Equilibrium Level of National using Equations <ul><li>What is the new equilibrium level of national income if government expenditure increases by 10. </li></ul><ul><li>What is the change in national income and the value of the multiplier. </li></ul><ul><li>Use another method to determine the value of the multiplier. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  13. 13. An Increase in Aggregate Expenditure EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Y AE E 1 45  200 Y=E 225 E 2 120 130 AE 2 AE 1
  14. 14. An Increase in Injections EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Y AE 200 W 225 E 1 E 2 J 1 = X + I + G 1 J 2 = X + I + G 2 80 70
  15. 15. June 2009 <ul><li>Q6 You are given the following information about a closed economy: </li></ul><ul><li>C = 200 + 0.5Y </li></ul><ul><li>G = 500 </li></ul><ul><li>I = 500 </li></ul><ul><li>Where, C, G and I, refer, respectively, to consumer, government and investment expenditures, and where Y refers to national income. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  16. 16. June 2009 <ul><li>(a) Determine the equilibrium level of national income. (5 marks) </li></ul><ul><li>(b) (i) Explain what happens to the equilibrium level of national income if the marginal propensity to consume (mpc) increases to 0.75. (10 marks) </li></ul><ul><li>(ii) Explain what happens to the equilibrium level of national income if the country now trades and net exports of 500 are added to the expenditure function. (10 marks) </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  17. 17. June 2008 <ul><li>Q6 Using a Keynesian Cross Diagram and starting from a position of equilibrium, explain how the following affect the level of national income in an economy: </li></ul><ul><li>(a) an increase in the marginal propensity to consume; (5 marks) </li></ul><ul><li>(b) an increase in the marginal propensity to import; (10 marks) </li></ul><ul><li>(c) the full employment level of income is greater than the existing equilibrium level of </li></ul><ul><li>national income. (10 marks) </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  18. 18. Inflationary and Deflationary Gaps <ul><li>The inflationary and deflationary gaps exist whenever the equilibrium income level for the economy does not correspond to the full employment level of income. </li></ul><ul><li>An inflationary gap exists when the equilibrium level of income exceeds the full employment level of income Y F. </li></ul><ul><li>A deflationary gap exists when the equilibrium level of income is below the full employment level of income Y F. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  19. 19. Inflationary Gap EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) Y E X Y E AE 1 45  Y F Y=E Y E1 FE Output Gap
  20. 20. Deflationary Gap Y E F G E AE 2 45  Y F Y=E Y E2 FE Output Gap EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  21. 21. Fiscal Policy <ul><li>Fiscal policy is the management of the economy through the level of government expenditure and taxation. </li></ul><ul><li>That is, the government can use this demand management tool to achieve its macroeconomic objectives by manipulating the fiscal budget. </li></ul><ul><li>Since it involves public spending and taxation, the arm of government which is in charge of this policy option is the Ministry of Finance. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  22. 22. Expansionary or Reflationary Fiscal Policy <ul><li>Increase in government spending </li></ul><ul><li>Decrease in Taxes </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) 45  FE Y=E AE 1 AE 2 E 1 E 2 F G AE 0 Y Y 1 Y F
  23. 23. Deflationary or Contractionary Fiscal Policy <ul><li>Decrease in government spending </li></ul><ul><li>Increase in Taxes </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) 45  FE Y=E AE 1 AE 2 E 1 E 2 Y Y 1 Y F 0 AE
  24. 24. Dec 2009 <ul><li>Q7 (a) Explain what is meant by the following terms and use an appropriate diagram to illustrate each of your answers: </li></ul><ul><li>(i) An inflationary gap </li></ul><ul><li>(ii) A deflationary gap (12 marks) </li></ul><ul><li>(b) Explain how fiscal policy can be used to eliminate an inflationary gap. (13 marks) </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
  25. 25. June 2009 <ul><li>Q7 Using aggregate demand (AD) and aggregate supply (AS) analysis, explain how the equilibrium position of an economy would be affected by each of the following: </li></ul><ul><li>(a) a decrease in government expenditure; (5 marks) </li></ul><ul><li>(b) an increase in the price of oil (assume the economy is an oil importer); (10 marks) </li></ul><ul><li>(c) an increase in the domestic rate of interest. (10 marks) </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)

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