1) The Simple Keynesian Model (SKM) is used to analyze business cycles and fluctuations in economic activity. It assumes prices are fixed in the short-run and demand determines output.
2) The SKM equilibrium occurs when actual expenditure (aggregate supply) equals planned expenditure (aggregate demand). This is shown as the point where the 45-degree aggregate supply line intersects the aggregate demand line.
3) In a closed economy without government, aggregate demand consists of consumption (C) and investment (I). Equilibrium income is determined by the consumption function C=C0+cY and investment function I=I0.
CU M Com-MEBE-MOD-I-National Income Accounting-Lecture-2Dr. Subir Maitra
The document discusses three methods for measuring national income:
1) Product method - Summing the value added of all sectors in the economy through production.
2) Income method - Summing incomes from factors of production like wages, profits, interest.
3) Expenditure method - Summing expenditures in the economy through consumption, investment, government spending, and trade. It shows how these methods are equivalent.
Cu m com-mebe-mod-i--select questions without answersDr. SUBIR MAITRA
1. The document discusses questions related to national income accounting and the Keynesian model. It provides data for 11 questions related to calculating national income measures like GNP, NNP, GDP, consumption, investment, exports and imports. It also provides structural equations to calculate equilibrium income and the effects of changes in government spending, taxes and money supply in a closed economy.
CU M Com-MEBE-Mod-I-National Income Accounting-Lecture-3Dr. Subir Maitra
This document provides sample problems and explanations related to national income accounting concepts. It begins with 16 questions asking students to explain or demonstrate concepts like gross domestic product, national income, value added, the basic macroeconomic identity for an open economy, and deriving personal income from national income. It then provides sample numerical problems demonstrating how to calculate GDP, NDP, NI and other measures using the value added, income and expenditure methods. It concludes with abbreviations commonly used in national income accounting.
Cu m com-mebe-mod-i-multiplier theory-keynesian approach-lecture-2Dr. SUBIR MAITRA
This document discusses the equilibrium income in the simple Keynesian model (SKM) using the saving-investment approach. It defines realized and planned investment and derives the equilibrium condition as saving plus taxes equaling planned investment plus government spending. Equilibrium income is obtained by setting these terms equal and solving for income. The document also discusses the paradox of thrift, where an increase in thriftiness can result in either no change or a decrease in aggregate savings, contrary to what might be expected.
This document discusses the Keynesian multiplier concept. It defines the autonomous expenditure multiplier as showing how a one unit increase in autonomous expenditure causes an increase in equilibrium income. The multiplier captures the idea that a change in autonomous spending causes a larger change in equilibrium income due to subsequent rounds of spending. The document also derives formulas for different types of multipliers, such as the lump-sum tax multiplier, tax rate multiplier, transfer payment multiplier, and government expenditure multiplier. It explains that the government expenditure multiplier has a larger effect than the tax multiplier. Finally, it discusses how the multiplier is stronger when investment is partly induced by income.
The document discusses the keynesian model of income determination. It introduces concepts like aggregate demand, consumption function, planned investment, government purchases, net exports, and equilibrium income. Equilibrium income is where aggregate demand equals output and income. A change in autonomous spending will lead to a multiplied change in equilibrium income due to the income multiplier effect. The model can also take into account aspects like an open economy and the government sector.
This document discusses macroeconomic equilibrium and the components of aggregate expenditure. It defines equilibrium as occurring when aggregate demand equals aggregate supply. The key components of aggregate demand are defined as private consumption, investment, government spending, and net exports. Private consumption depends on disposable income, while investment depends on factors like demand and business expectations. The document also discusses aggregate supply and how it is represented by a 45-degree line, indicating firms will supply whatever level of output is demanded.
The document summarizes Keynesian income determination through the aggregate demand-aggregate supply model. It defines consumption and investment functions, which together determine aggregate demand. Consumption depends on income through the marginal propensity to consume. Investment is assumed constant in the short-run. Equilibrium income is reached at the point where aggregate demand equals aggregate supply. This can be modeled as either the AD-AS approach where equilibrium Y satisfies C+I=C+S, or the savings-investment approach where I=S. Numerical examples are provided to illustrate the equilibrium income calculation under each approach.
CU M Com-MEBE-MOD-I-National Income Accounting-Lecture-2Dr. Subir Maitra
The document discusses three methods for measuring national income:
1) Product method - Summing the value added of all sectors in the economy through production.
2) Income method - Summing incomes from factors of production like wages, profits, interest.
3) Expenditure method - Summing expenditures in the economy through consumption, investment, government spending, and trade. It shows how these methods are equivalent.
Cu m com-mebe-mod-i--select questions without answersDr. SUBIR MAITRA
1. The document discusses questions related to national income accounting and the Keynesian model. It provides data for 11 questions related to calculating national income measures like GNP, NNP, GDP, consumption, investment, exports and imports. It also provides structural equations to calculate equilibrium income and the effects of changes in government spending, taxes and money supply in a closed economy.
CU M Com-MEBE-Mod-I-National Income Accounting-Lecture-3Dr. Subir Maitra
This document provides sample problems and explanations related to national income accounting concepts. It begins with 16 questions asking students to explain or demonstrate concepts like gross domestic product, national income, value added, the basic macroeconomic identity for an open economy, and deriving personal income from national income. It then provides sample numerical problems demonstrating how to calculate GDP, NDP, NI and other measures using the value added, income and expenditure methods. It concludes with abbreviations commonly used in national income accounting.
Cu m com-mebe-mod-i-multiplier theory-keynesian approach-lecture-2Dr. SUBIR MAITRA
This document discusses the equilibrium income in the simple Keynesian model (SKM) using the saving-investment approach. It defines realized and planned investment and derives the equilibrium condition as saving plus taxes equaling planned investment plus government spending. Equilibrium income is obtained by setting these terms equal and solving for income. The document also discusses the paradox of thrift, where an increase in thriftiness can result in either no change or a decrease in aggregate savings, contrary to what might be expected.
This document discusses the Keynesian multiplier concept. It defines the autonomous expenditure multiplier as showing how a one unit increase in autonomous expenditure causes an increase in equilibrium income. The multiplier captures the idea that a change in autonomous spending causes a larger change in equilibrium income due to subsequent rounds of spending. The document also derives formulas for different types of multipliers, such as the lump-sum tax multiplier, tax rate multiplier, transfer payment multiplier, and government expenditure multiplier. It explains that the government expenditure multiplier has a larger effect than the tax multiplier. Finally, it discusses how the multiplier is stronger when investment is partly induced by income.
The document discusses the keynesian model of income determination. It introduces concepts like aggregate demand, consumption function, planned investment, government purchases, net exports, and equilibrium income. Equilibrium income is where aggregate demand equals output and income. A change in autonomous spending will lead to a multiplied change in equilibrium income due to the income multiplier effect. The model can also take into account aspects like an open economy and the government sector.
This document discusses macroeconomic equilibrium and the components of aggregate expenditure. It defines equilibrium as occurring when aggregate demand equals aggregate supply. The key components of aggregate demand are defined as private consumption, investment, government spending, and net exports. Private consumption depends on disposable income, while investment depends on factors like demand and business expectations. The document also discusses aggregate supply and how it is represented by a 45-degree line, indicating firms will supply whatever level of output is demanded.
The document summarizes Keynesian income determination through the aggregate demand-aggregate supply model. It defines consumption and investment functions, which together determine aggregate demand. Consumption depends on income through the marginal propensity to consume. Investment is assumed constant in the short-run. Equilibrium income is reached at the point where aggregate demand equals aggregate supply. This can be modeled as either the AD-AS approach where equilibrium Y satisfies C+I=C+S, or the savings-investment approach where I=S. Numerical examples are provided to illustrate the equilibrium income calculation under each approach.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
This chapter discusses how to determine national income and its fluctuations. It introduces the concepts of aggregate expenditure (AE), equilibrium income, the consumption function, savings function, investment, and the multiplier. AE is the total planned spending in the economy. Equilibrium occurs when AE equals national income (Y). The chapter shows that an increase in investment (I) or autonomous consumption will increase AE and equilibrium Y through the multiplier effect. It also discusses the "paradox of thrift" where an increase in savings can reduce income.
The document summarizes key aspects of the Keynesian economic model, including:
1) The multiplier effect, where any change in aggregate demand is amplified through subsequent rounds of spending.
2) How the model shows equilibrium output (Y) is determined by the multiplier and total injections (autonomous consumption and investment).
3) The paradox of thrift, where if the whole economy tries to increase savings simultaneously, it can reduce aggregate demand and output.
4) Keynes' critique of the neoclassical theory of savings and investment, disagreeing that savings is a function of interest rates or that investment can be analyzed while holding expectations constant.
This document provides an overview of a simple Keynesian model in an open economy. It defines an open economy and the three types of openness. It then outlines the key components of the model, including consumption, disposable income, taxes, investment, government expenditure, exports, and imports. It shows how these are used to derive the equilibrium income and various multipliers in the open economy model. Specifically, it shows the investment, government expenditure, export, tax, and transfer payment multipliers, as well as demonstrating that the balanced budget multiplier in this open economy model is not equal to one.
This document discusses key concepts in the simple Keynesian theory of income determination, including:
1. Endogenous and exogenous variables - endogenous variables are explained by the theory, while exogenous variables are taken as given. Real output and consumption are initially treated as endogenous.
2. The consumption function - consumption is explained as autonomous consumption plus the marginal propensity to consume times disposable income. This can be shown graphically.
3. Induced saving and the marginal propensity to save - as disposable income increases, the remaining portion after consumption is induced saving. Actual U.S. data from 1929-2001 is presented to illustrate these concepts.
Measurement of equilibrium level of national incomeShiva Jaiswal
The equilibrium level of national income is reached when aggregate demand equals aggregate supply. Aggregate demand includes both consumer demand and producer demand. Similarly, aggregate supply includes both consumption goods and investment goods produced. Equilibrium occurs at the level of income where total goods demanded equals total goods supplied, so that there is neither excess supply nor shortage. According to the Keynesian view, savings and investment may not always be equal since they are undertaken by different economic agents and their decisions may differ. Equilibrium is characterized by equality between real savings and real investment.
This document discusses the concept of equilibrium level of national income. It provides three main methods to measure national income - the product method, income method, and expenditure method. It explains that equilibrium occurs when aggregate demand (AD) equals aggregate supply (AS). The document uses a table to illustrate different scenarios when AD is greater than, less than, or equal to AS, and whether the economy is in a state of expansion, contraction, or equilibrium. It also gives examples of how governments may intervene to maintain equilibrium, such as by controlling consumption or subsidizing prices. Finally, it notes that while the Keynesian model shows savings equal to investment at equilibrium, this perfect equality does not always hold in reality due to differences between real and
This document discusses the determination of national income through aggregate expenditure and the relationship between aggregate expenditure, national output, and equilibrium income. It defines aggregate expenditure as the total planned spending in an economy by households, firms, government, and foreigners. Equilibrium income is reached when aggregate expenditure and national output are equal. The multiplier effect is explained as how a change in autonomous investment results in a multiplied change in equilibrium income. The paradox of thrift is also introduced, where attempting to increase savings can reduce overall equilibrium income in an economy.
This document discusses key concepts in macroeconomics including aggregate demand, consumption, investment, aggregate supply, and the equilibrium level of national income. It defines consumption and investment demand, presents the consumption function, and shows how aggregate demand is determined by adding consumption and investment. The aggregate supply curve is derived from the production function. Equilibrium occurs where aggregate demand equals aggregate supply. The multiplier effect and how changes in investment affect the equilibrium level of national income are also examined.
This document provides an overview of key macroeconomic concepts including aggregate demand, aggregate supply, factors that influence them, and how they interact in the aggregate demand-supply model. It discusses the consumption and investment functions, the multiplier effect, and how shifts in aggregate demand and supply can impact output and prices. Supply-side policies aim to shift the aggregate supply curve to increase potential output. The accelerator model and limitations of the multiplier approach are also summarized.
This document discusses macroeconomic equilibrium. It defines macroeconomic equilibrium as being determined by aggregate demand and aggregate supply. Equilibrium occurs when aggregate demand equals aggregate supply (AD=AS) and income equals expenditure (Y=E). The document provides details on the components of aggregate demand (consumption, investment, government spending, exports) and aggregate supply (consumption, savings, taxes, imports). It also discusses concepts like the consumption function, marginal propensity to consume, and how equilibrium can be shown using schedules, equations, and graphs.
The document discusses key concepts related to determining national income, including:
1) The circular flow of income between producers, consumers, and factors of production.
2) The equilibrium level of national income is reached when total injections (spending) equals total withdrawals (saving) in the economy.
3) Fiscal policy tools like changes in government spending and taxation can be used to reduce inflationary or deflationary gaps between the actual and full employment levels of national income.
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Myassignmenthelp.net helps to complete your assignments with the complete solution of assignment.The assignments are completely plagarism free. We provide the full solutrion of the assignments which reduce the overhead of the students
The document defines the investment multiplier as the ratio of change in national income due to a change in investment. It explains that an initial increase in investment can lead to an even greater increase in national income through subsequent rounds of spending. The multiplier effect is dependent on the marginal propensity to consume. The document also outlines the assumptions, workings, and limitations of the multiplier model.
This document is a lecture on macroeconomic equilibrium using the IS-LM model. It discusses how the IS and LM curves intersect at a single point of general equilibrium where both the goods and money markets are in balance. It then explains how different points on or outside the curves represent disequilibrium situations, and how economic forces push the economy toward the equilibrium point through adjustments in interest rates and output levels. The lecture concludes by showing graphically how an economy initially in disequilibrium will gradually move along the curves toward the point of general equilibrium.
Agri 2312 chapter 12 product markets and national outputRita Conley
This document summarizes key concepts from a chapter on product markets and national output. It discusses how gross domestic product is measured as the total value of final goods and services produced domestically in a year. GDP is the sum of consumption, investment, government spending, and net exports. The chapter examines how consumption and investment are influenced by factors like disposable income, wealth, interest rates, and profits. It introduces the concept of product market equilibrium, where aggregate demand equals aggregate supply at full employment output, and how gaps can cause inflationary or recessionary pressures. The next chapter will focus on using monetary and fiscal policy tools to address such gaps.
The document discusses the IS-LM model for analyzing macroeconomic equilibrium. It explains that output (Y) and the interest rate (i) are jointly determined by equilibrium in the goods market and financial markets. The goods market equilibrium is represented by the IS curve, which shows the negative relationship between Y and i. The financial market equilibrium is represented by the LM curve, which shows the positive relationship between Y and i. Where the IS and LM curves intersect is the overall general equilibrium for the economy, with simultaneous equilibrium in both markets. Fiscal policy actions like tax changes can shift the IS curve to impact output and interest rates.
This document provides an overview of Keynesian theory of income determination. It discusses some key points:
1) According to Keynes, the equilibrium level of national income and employment is determined by the interaction of aggregate demand (C+I) and aggregate supply (C+S). This equilibrium is called the effective demand point.
2) The effective demand point may be below full employment, indicating under-employment. Government spending can increase aggregate demand and raise income to the full employment level.
3) Determinants of income are aggregate demand, influenced by consumption and investment, and aggregate supply, influenced by the level of employment. The equilibrium between these curves determines the effective demand point and income level.
This document provides an overview of Keynesian theory of income determination. It discusses some key concepts:
1) According to Keynes, the equilibrium level of national income and employment is determined by the interaction of aggregate demand (C+I) and aggregate supply (C+S). This equilibrium is called the effective demand point.
2) Effective demand represents the total spending in the economy that matches aggregate supply. It is the level of income and employment where there is no tendency to increase or decrease production.
3) The effective demand point may be below full employment, indicating underemployment. Government spending can increase aggregate demand and move the economy to a new equilibrium with higher income and full employment.
This document provides an overview of the IS-LM model of aggregate demand. It begins by discussing how Keynes criticized classical economic theory and proposed that low aggregate demand is responsible for economic downturns. It then introduces the IS curve, which plots the relationship between interest rates and income in goods markets, and the LM curve, which plots the relationship between interest rates and income in money markets. The intersection of the IS and LM curves determines aggregate demand and income in the economy. Shifts in these curves due to factors like fiscal policy changes, money supply changes, and price level changes cause fluctuations in equilibrium income.
This document provides an overview of the simple Keynesian model of income determination. It discusses the key components of aggregate expenditure, including consumption which depends on disposable income, and investment which depends on the marginal efficiency of capital and interest rates. The aggregate output is determined by the factors of production using a production function. Equilibrium income is reached at the point where aggregate expenditure and aggregate output intersect, establishing equilibrium in the goods market.
This document provides an overview of macroeconomics and the circular flow of income through several models. It discusses key concepts such as:
1. Macroeconomics studies the economy as a whole by looking at aggregates like total output and income, whereas microeconomics looks at individual units.
2. Common macroeconomic policy objectives are full employment, price stability, economic growth, and balance of payments equilibrium.
3. The circular flow of income can be modeled in a two-sector closed economy with households and firms or a three-sector model that includes government. Savings and investment are incorporated through financial markets to achieve equilibrium.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
This chapter discusses how to determine national income and its fluctuations. It introduces the concepts of aggregate expenditure (AE), equilibrium income, the consumption function, savings function, investment, and the multiplier. AE is the total planned spending in the economy. Equilibrium occurs when AE equals national income (Y). The chapter shows that an increase in investment (I) or autonomous consumption will increase AE and equilibrium Y through the multiplier effect. It also discusses the "paradox of thrift" where an increase in savings can reduce income.
The document summarizes key aspects of the Keynesian economic model, including:
1) The multiplier effect, where any change in aggregate demand is amplified through subsequent rounds of spending.
2) How the model shows equilibrium output (Y) is determined by the multiplier and total injections (autonomous consumption and investment).
3) The paradox of thrift, where if the whole economy tries to increase savings simultaneously, it can reduce aggregate demand and output.
4) Keynes' critique of the neoclassical theory of savings and investment, disagreeing that savings is a function of interest rates or that investment can be analyzed while holding expectations constant.
This document provides an overview of a simple Keynesian model in an open economy. It defines an open economy and the three types of openness. It then outlines the key components of the model, including consumption, disposable income, taxes, investment, government expenditure, exports, and imports. It shows how these are used to derive the equilibrium income and various multipliers in the open economy model. Specifically, it shows the investment, government expenditure, export, tax, and transfer payment multipliers, as well as demonstrating that the balanced budget multiplier in this open economy model is not equal to one.
This document discusses key concepts in the simple Keynesian theory of income determination, including:
1. Endogenous and exogenous variables - endogenous variables are explained by the theory, while exogenous variables are taken as given. Real output and consumption are initially treated as endogenous.
2. The consumption function - consumption is explained as autonomous consumption plus the marginal propensity to consume times disposable income. This can be shown graphically.
3. Induced saving and the marginal propensity to save - as disposable income increases, the remaining portion after consumption is induced saving. Actual U.S. data from 1929-2001 is presented to illustrate these concepts.
Measurement of equilibrium level of national incomeShiva Jaiswal
The equilibrium level of national income is reached when aggregate demand equals aggregate supply. Aggregate demand includes both consumer demand and producer demand. Similarly, aggregate supply includes both consumption goods and investment goods produced. Equilibrium occurs at the level of income where total goods demanded equals total goods supplied, so that there is neither excess supply nor shortage. According to the Keynesian view, savings and investment may not always be equal since they are undertaken by different economic agents and their decisions may differ. Equilibrium is characterized by equality between real savings and real investment.
This document discusses the concept of equilibrium level of national income. It provides three main methods to measure national income - the product method, income method, and expenditure method. It explains that equilibrium occurs when aggregate demand (AD) equals aggregate supply (AS). The document uses a table to illustrate different scenarios when AD is greater than, less than, or equal to AS, and whether the economy is in a state of expansion, contraction, or equilibrium. It also gives examples of how governments may intervene to maintain equilibrium, such as by controlling consumption or subsidizing prices. Finally, it notes that while the Keynesian model shows savings equal to investment at equilibrium, this perfect equality does not always hold in reality due to differences between real and
This document discusses the determination of national income through aggregate expenditure and the relationship between aggregate expenditure, national output, and equilibrium income. It defines aggregate expenditure as the total planned spending in an economy by households, firms, government, and foreigners. Equilibrium income is reached when aggregate expenditure and national output are equal. The multiplier effect is explained as how a change in autonomous investment results in a multiplied change in equilibrium income. The paradox of thrift is also introduced, where attempting to increase savings can reduce overall equilibrium income in an economy.
This document discusses key concepts in macroeconomics including aggregate demand, consumption, investment, aggregate supply, and the equilibrium level of national income. It defines consumption and investment demand, presents the consumption function, and shows how aggregate demand is determined by adding consumption and investment. The aggregate supply curve is derived from the production function. Equilibrium occurs where aggregate demand equals aggregate supply. The multiplier effect and how changes in investment affect the equilibrium level of national income are also examined.
This document provides an overview of key macroeconomic concepts including aggregate demand, aggregate supply, factors that influence them, and how they interact in the aggregate demand-supply model. It discusses the consumption and investment functions, the multiplier effect, and how shifts in aggregate demand and supply can impact output and prices. Supply-side policies aim to shift the aggregate supply curve to increase potential output. The accelerator model and limitations of the multiplier approach are also summarized.
This document discusses macroeconomic equilibrium. It defines macroeconomic equilibrium as being determined by aggregate demand and aggregate supply. Equilibrium occurs when aggregate demand equals aggregate supply (AD=AS) and income equals expenditure (Y=E). The document provides details on the components of aggregate demand (consumption, investment, government spending, exports) and aggregate supply (consumption, savings, taxes, imports). It also discusses concepts like the consumption function, marginal propensity to consume, and how equilibrium can be shown using schedules, equations, and graphs.
The document discusses key concepts related to determining national income, including:
1) The circular flow of income between producers, consumers, and factors of production.
2) The equilibrium level of national income is reached when total injections (spending) equals total withdrawals (saving) in the economy.
3) Fiscal policy tools like changes in government spending and taxation can be used to reduce inflationary or deflationary gaps between the actual and full employment levels of national income.
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Myassignmenthelp.net helps to complete your assignments with the complete solution of assignment.The assignments are completely plagarism free. We provide the full solutrion of the assignments which reduce the overhead of the students
The document defines the investment multiplier as the ratio of change in national income due to a change in investment. It explains that an initial increase in investment can lead to an even greater increase in national income through subsequent rounds of spending. The multiplier effect is dependent on the marginal propensity to consume. The document also outlines the assumptions, workings, and limitations of the multiplier model.
This document is a lecture on macroeconomic equilibrium using the IS-LM model. It discusses how the IS and LM curves intersect at a single point of general equilibrium where both the goods and money markets are in balance. It then explains how different points on or outside the curves represent disequilibrium situations, and how economic forces push the economy toward the equilibrium point through adjustments in interest rates and output levels. The lecture concludes by showing graphically how an economy initially in disequilibrium will gradually move along the curves toward the point of general equilibrium.
Agri 2312 chapter 12 product markets and national outputRita Conley
This document summarizes key concepts from a chapter on product markets and national output. It discusses how gross domestic product is measured as the total value of final goods and services produced domestically in a year. GDP is the sum of consumption, investment, government spending, and net exports. The chapter examines how consumption and investment are influenced by factors like disposable income, wealth, interest rates, and profits. It introduces the concept of product market equilibrium, where aggregate demand equals aggregate supply at full employment output, and how gaps can cause inflationary or recessionary pressures. The next chapter will focus on using monetary and fiscal policy tools to address such gaps.
The document discusses the IS-LM model for analyzing macroeconomic equilibrium. It explains that output (Y) and the interest rate (i) are jointly determined by equilibrium in the goods market and financial markets. The goods market equilibrium is represented by the IS curve, which shows the negative relationship between Y and i. The financial market equilibrium is represented by the LM curve, which shows the positive relationship between Y and i. Where the IS and LM curves intersect is the overall general equilibrium for the economy, with simultaneous equilibrium in both markets. Fiscal policy actions like tax changes can shift the IS curve to impact output and interest rates.
This document provides an overview of Keynesian theory of income determination. It discusses some key points:
1) According to Keynes, the equilibrium level of national income and employment is determined by the interaction of aggregate demand (C+I) and aggregate supply (C+S). This equilibrium is called the effective demand point.
2) The effective demand point may be below full employment, indicating under-employment. Government spending can increase aggregate demand and raise income to the full employment level.
3) Determinants of income are aggregate demand, influenced by consumption and investment, and aggregate supply, influenced by the level of employment. The equilibrium between these curves determines the effective demand point and income level.
This document provides an overview of Keynesian theory of income determination. It discusses some key concepts:
1) According to Keynes, the equilibrium level of national income and employment is determined by the interaction of aggregate demand (C+I) and aggregate supply (C+S). This equilibrium is called the effective demand point.
2) Effective demand represents the total spending in the economy that matches aggregate supply. It is the level of income and employment where there is no tendency to increase or decrease production.
3) The effective demand point may be below full employment, indicating underemployment. Government spending can increase aggregate demand and move the economy to a new equilibrium with higher income and full employment.
This document provides an overview of the IS-LM model of aggregate demand. It begins by discussing how Keynes criticized classical economic theory and proposed that low aggregate demand is responsible for economic downturns. It then introduces the IS curve, which plots the relationship between interest rates and income in goods markets, and the LM curve, which plots the relationship between interest rates and income in money markets. The intersection of the IS and LM curves determines aggregate demand and income in the economy. Shifts in these curves due to factors like fiscal policy changes, money supply changes, and price level changes cause fluctuations in equilibrium income.
This document provides an overview of the simple Keynesian model of income determination. It discusses the key components of aggregate expenditure, including consumption which depends on disposable income, and investment which depends on the marginal efficiency of capital and interest rates. The aggregate output is determined by the factors of production using a production function. Equilibrium income is reached at the point where aggregate expenditure and aggregate output intersect, establishing equilibrium in the goods market.
This document provides an overview of macroeconomics and the circular flow of income through several models. It discusses key concepts such as:
1. Macroeconomics studies the economy as a whole by looking at aggregates like total output and income, whereas microeconomics looks at individual units.
2. Common macroeconomic policy objectives are full employment, price stability, economic growth, and balance of payments equilibrium.
3. The circular flow of income can be modeled in a two-sector closed economy with households and firms or a three-sector model that includes government. Savings and investment are incorporated through financial markets to achieve equilibrium.
The document discusses John Maynard Keynes' theory of aggregate demand and how it provides an alternative to classical economic theory. It introduces Keynes' view that low aggregate demand is responsible for economic downturns and high unemployment. It then presents the IS-LM model as the leading interpretation of Keynes' work, showing how it uses the IS and LM curves to determine equilibrium income levels based on interest rates, investment, consumption and money supply changes. The document also discusses how the IS-LM model can be used to analyze the effects of fiscal and monetary policy on aggregate demand.
The circular flow of income model describes the reciprocal flow of money between households and firms. Households supply factors of production like labor to firms and receive income, while firms supply goods and services to households in exchange. This forms a continuous loop referred to as the circular flow of income, with payments in each direction. The model can be expanded to include government and foreign trade. It helps explain macroeconomic concepts like GDP, equilibrium, and the effects of policies.
The document provides an overview of the IS-LM model of aggregate demand. It explains that the IS curve models the goods market relationship between interest rates and income, while the LM curve models the money market relationship between interest rates and income. It also discusses the Keynesian cross diagram and how it can be used to analyze how changes in fiscal policy like government purchases or taxes will affect equilibrium income levels through multiplier effects. The document concludes by explaining that the intersection of the IS and LM curves determines the aggregate demand equilibrium for a given price level.
The document discusses the economic concept of the multiplier. It provides three key points:
1) A multiplier measures how much an economic variable (like income or output) changes in response to a change in another variable (like investment or government spending). For example, a $100 increase in investment may lead to a $300 increase in income, so the multiplier is 3.
2) The multiplier captures the ripple effect of spending as income from the initial transaction is spent again and again in the economy. This leads to a larger increase in overall income than the initial change in spending.
3) The size of the multiplier depends on the marginal propensity to consume (MPC). A higher MPC means more
Determination of income and employment important notesVijay Kumar
This document defines key macroeconomic concepts related to aggregate demand and supply. It explains that:
1. Aggregate demand is the total planned expenditure on final goods and services and equals consumption + investment + government spending + net exports. Consumption and investment make up aggregate demand in a simple two-sector economy.
2. Aggregate supply is the total planned output of final goods and services and equals national income. National income equals consumption + savings at the national level.
3. The consumption function shows the relationship between consumption and national income, where consumption has an autonomous and induced component. The marginal propensity to consume is the change in consumption from a change in income.
The document defines key macroeconomic concepts such as aggregate demand, aggregate supply, and their components. It discusses how equilibrium output is determined by the intersection of the aggregate demand and aggregate supply curves. The saving-investment approach to determining equilibrium is also covered, where equilibrium occurs at the point where planned saving equals planned investment. Factors that can cause excess demand and deficient demand are explained, along with their impacts and appropriate policy responses.
The document discusses key macroeconomic concepts including aggregate demand, aggregate supply, the consumption function, investment function, and the multiplier. It provides the following key points:
- Aggregate demand is the total demand for final goods and services in an economy. It is affected by factors like money, taxes, prices, and trade.
- Aggregate supply represents the maximum output an economy can produce at full employment. It can shift due to changes in inputs like labor, capital, technology and costs.
- The consumption function explains autonomous and induced consumption and how consumption relates to disposable income based on the marginal propensity to consume.
- The investment function depends on interest rates, profit expectations and taxes, and
Aggregate demand is the total demand for final goods and services in an economy at a given time and price level. It is the sum of consumption, investment, government spending, and net exports. The aggregate demand curve slopes downward, showing that as price levels increase, aggregate output decreases. Aggregate supply is the total supply of goods and services in an economy. In the short run, the aggregate supply curve slopes upward as firms are slow to adjust prices and wages. In the long run, as costs fully adjust, the aggregate supply curve becomes vertical at the natural level of output. Keynesian economics emphasizes that economies may fail to reach full employment without government intervention, due to sticky wages and prices and a tendency for increased savings to reduce
The document discusses key macroeconomic concepts including aggregate demand, aggregate supply, the consumption function, investment function, and the multiplier. It provides details on how each of these factors impact macroeconomic variables like output, employment, prices, and trade. It also examines the relationship between aggregate demand and supply using the AD-AS framework and how this intersection determines macroeconomic equilibrium.
Introduction to Macroeconomics: National IncomeUpananda Witta
This document provides an overview of macroeconomics concepts across several chapters. It defines macroeconomics as dealing with aggregate economic metrics rather than individual parts. Key concepts discussed include the circular flow of income and goods between households, firms, and the government. The document also examines gross domestic product, national income, consumption, investment, fiscal and monetary policy, and how international trade impacts a country's national income. Multiple diagrams and equations are presented to illustrate macroeconomic relationships between sectors.
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Cu m com-mebe-mod-i-multiplier theory-keynesian approach-lecture-1
1. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 1
2.1 Introduction:
If we plot the values of GDP of any country over a period of say, fifty years, we will find a
periodic fluctuation around some trend line. These systematic fluctuations in the level of aggregate
economic activity is known as business cycles consisting of booms or expansions and recessions or
contraction. The long run model of the economy cannot explain recession or boom when the economy
deviates from its long run path.
GDP
Time
Figure: 1
To understand what kind of forces is responsible for these fluctuations in real output relative
to trend, we develop ‘Keynesian Model’. The cornerstone of this model is the mutual interaction
between output and spending: spending determines output and income, and at the same time, output
and income also determine spending.
We shall first develop a very simple model of income determination known as Simple
Keynesian Model. This most important assumption of this model is that prices are constant. In the
short run, firms stand ready to supply whatever output their customers want at the given prices. Thus,
demand becomes the ruling force in this model. If demand is strong, real GDP exceeds potential. In
recession, when demand is weak, real GDP drops below potential.
2.2 Simple Keynesian Model:
The Simple Keynesian Model is a static model of the economy which helps us to determine
equilibrium real national income based on ‘effective demand’ principle.
Equilibrium Income: Cases of Open and Closed Economies, Multiplier theory-
Keynesian Approach
Lecture-1
2. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 2
2.2.1 Assumptions:
(i) One-sector model: The SKM is a one-sector model which includes only the goods
market.
(ii) Absence of monetary sector: There is no monetary sector in the SKM.
(iii) Static model: The SKM is a static model. The model solves for static equilibrium
level of real output, which is the value of real output that has no tendency to change
once it has been established.
(iv) Closed economy with or without Government: The SKM assumes a closed
economy (i.e. without foreign trade) with or without Government.
(v) Constant prices: In stark contrast to the quantity theory model, the SKM assumes
an exogenously fixed price level.
(vi) Short-run model: The model is a short-run model and determines the value of real
national output for a particular period of time, such as a year.
(vii) Fixed stock of capital and labour: The model assumes that both the stock of
capital and the labour force, which when fully utilised determine the maximum level
of real output the economy can produce, are constant.
(viii) Profit maximization: An underlying behavioural assumption of the model is that
firms act as profit maximisers. If demand for their output exceeds supply, firms
increase production, providing there are spare resources put to work. Conversely if
supply exceeds demand, firms reduce output.
(ix) Effective demand principle: The SKM is based on Keynesian ‘effective demand
principle’. According to this principle, since commodities are necessarily produced
for a market, the size of the market must regulate the level of commodity production.
Put differently, effective demand refers to that level of the value of aggregate output
which, if produced and paid out as income, will be matched by an equivalent amount
of expenditure.
2.3 Equilibrium Income (AD—AS Approach):
Equilibrium in the SKM requires that the supply of real national output, Y, equals the quantity
of national output which people wish to buy, E. The condition for static equilibrium in this model is
therefore
Y = E ..............(1)
3. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 3
where E is the ‘desired’ Aggregate Demand or, alternatively, ‘Planned Expenditure’. Alternatively,
we can interpret Y as ‘Aggregate Supply’ or ‘Actual Expenditure’ in the economy and rewrite the
above condition as
Actual Expenditure (Aggregate Supply) = Planned Expenditure (Aggregate Demand) …(2)
2.4 Simple Keynesian Model without Government and Foreign Trade:
We now discuss SKM without government and foreign trade. Thus the economy is closed one
without any government expenditure (G) as well as taxes (T).
2.4.1 Aggregate Demand (Planned Expenditure) in SKM without Government:
Aggregate Demand or planned expenditure in SKM without government is composed of real
consumption expenditure C, and real investment expenditure, I.
2.4.2 Consumption Function:
Although many factors affect consumption, aggregate disposable income is the most important
one. Consumption is assumed to vary directly with income (Y). Specifically, consumption is assumed
to increase as income increases, with the increase in consumption being less than the increase in
income. In equation form, the consumption function is
C = C0 + c Y (C0 >0, 0<c<l) ….......(3)
where C and Y represent real consumption and real income, respectively. The equation indicates that
consumption is a linear function of disposable income. In the equation, C0 and c are constants, called
parameters. Consumption C and income Y are variables.
The constant C0 is called autonomous consumption or ‘subsistence consumption’. When Y
= 0, C = C0. It is that level of consumption which people must have in order to subsist even if income
level falls to zero and it is exogenously given.
The parameter c, called the marginal propensity to consume or MPC, is the slope of the
consumption function. If ∆Y denotes a change in income and ∆C denotes the change in consumption
associated with the change in income, the MPC, equals ∆C / ∆Y. For example, if Y increases by
Rs.200 and, as a result, consumption increases by Rs.150, the MPC is 150/200 = 0.75. Thus
consumption increases as Y increases, but by a smaller amount. This implies that, the MPC, must be
between 0 and 1, an assumption which is in accord with the empirical evidence.
We can graphically represent (Fig:2) the consumption function. We know that ' C0 ' is the
intercept parameter and 'c' is the slope parameter. Once the intercept and slope are specified, a straight
line is completely determined. For example, if C0 =100 and c = 0.75, the function will start at C0 =
100 and have a slope c = 0.75. If there is a change in C0, the consumption function will shift so that
4. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 4
the new function is parallel to the old. If there is a change in c, the function will rotate about the
intercept, C0 and will be either steeper or flatter.
C0
Figure: 2
2.4.3 Investment Function:
Like consumption, investment depends on many factors, including interest rates. In the SKM,
however, investment is assumed to be an autonomous or exogenous variable -- a variable whose
value is determined outside the model. Thus, investment is a constant, I0 (I0 >0).
Since investment is assumed to be constant at the Ī level, the investment function is
I = I0 (I0 >0) ………(4)
where I represents real investment and Ī represents a given, positive level of investment. Suppose I0
equals Rs. 50. With investment on the vertical axis and income on the horizontal, the investment
function is plotted as the horizontal line in Figure: 3,indicating that investment does not vary with
the level of income.
C = C0 + c.Y
Income (Y)
Consumption (C)
Investment (I)
I = I0
Income (Y)
Figure: 3
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2.5 Equilibrium Income in Simple Keynesian Model without Government:
The economy in the SKM is said to be in equilibrium when
Actual Expenditure (Aggregate Supply) = Planned Expenditure (Aggregate Demand)
i.e. Y = C + I ….(5)
Y = C0 + c Y + I0
Y = C0+ c.Y + I0
Y = C0 + c.Y + I0 …..(6)
By rearranging we get:
YE = [{C0 + I0} / (1 – c)] ….(7)
where YE is the equilibrium level of income in the SKM without government -- that level of income
which makes actual expenditure (AD) in the economy same as planned expenditure (AS).
2.6 Graphical Illustration:
The aggregate supply-aggregate demand approach is developed graphically in Figure: .
Aggregate supply, the output of goods and services, is depicted by the 45° line. With the same scales
on both axes, output on the vertical axis equals output or income on the horizontal axis for all points
on the 45° line. The 45° line is not a 'true' aggregate supply curve. For example, it indicates that any
amount, from 0 to infinity, may be produced. This is not possible; production is limited by the nation's
resources and its technology. Nevertheless, in the development of the model, it is helpful to think of
the 45° line as an aggregate supply curve.
YE
Figure: 4
Aggregate demand represents society's demand for goods and services. With no foreign trade sector,
it consists of the demand for consumer goods and services, the demand for investment goods and
government purchases. Consequently,
AD = C + c.Y + I
Aggregate Supply (Y)
Aggregate Demand (AD)
6. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 6
AD = C + I
= (C0 + c.Y + I0 )
Graphically, the aggregate demand line is the positively sloped line AD whose intercept is
equal to (C0 + I0 ) and slope is equal to 0 < c < 1.
With the 45° line representing ‘aggregate supply’ or ‘actual expenditure’ and the AD line
representing ‘aggregate demand’ or ‘planned expenditure’, the equilibrium level of income is YE.
Income level YE is the equilibrium level since it is the only level for which aggregate supply equals
aggregate demand. At income levels greater than YE, aggregate supply (represented by the 45° line)
is greater than aggregate demand (represented by the AD line), and income has a tendency to fall. At
income levels less than YE, aggregate supply is less than aggregate demand, and income has a
tendency to rise.
When AS > AD, Y tends to fall because of the unplanned inventory accumulation
by the firms (Iu = ∆inv. > 0), as producers are unable to sell their products.
When AD > AS, Y tends to increase because of the unplanned depletion in
inventories by the firms (Iu = ∆inv. < 0) to meet increased demand.
When AD = AS, Y is at its equilibrium level.
Since income tends to fall when AS > AD and to rise when AD > AS, income
eventually gravitates to its equilibrium level => stable equilibrium.
2.7 Economic Explanation:
If the nation's income (output) equals the equilibrium income (output), firms will be able to sell
their entire output. Consequently, no incentive exists for them to alter their production and income
remains at the equilibrium level.
If the nation's output exceeds the equilibrium output, firms are unable to sell their entire output
and experience a buildup in their inventories. An incentive exists, therefore, for them to reduce
production. As a result, output falls until it equals the demand for goods and services. Similarly, if
the nation's output is less than the demand for goods and services, firms sell more than they are
producing and experience a depletion of their inventories. An incentive exists, therefore, for them to
increase production. As a result, output rises until it equals the demand for goods and services.
2.8 Equilibrium Income in Simple Keynesian Model with Government:
We now discuss SKM with government but without foreign trade. Thus the economy is closed
one but government plays an active role in the economy. Thus, government spends (G) as well as
taxes (T).
7. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 7
2.8.1 Aggregate Demand (Planned Expenditure) in SKM with Government:
Aggregate Demand or planned expenditure in SKM with government is composed of real
consumption expenditure C, and real investment expenditure, I and real government purchases, G.
Consumption and investment functions have been discussed above. But the presence of government
makes certain changes in the C function.
2.8.2 The Consumption Function in SKM with government:
In the presence of a government, imposing taxes on income, consumption is assumed to vary
directly with disposable income (YD). Specifically, consumption is assumed to increase as disposable
income increases, with the increase in consumption being less than the increase in disposable income.
In equation form, the consumption function is
C = C0 + c YD (C0 >0, 0<c<l) ….....(8)
where C and YD represent real consumption and real disposable income, respectively. The equation
indicates that consumption is a linear function of disposable income. In the equation, C0 and c are
constants, called parameters. Consumption, C, and income, Y, are variables.
Disposable income (YD) is equal to income plus transfers (TR) less taxes(T):
YD ≡ Y + TR – T …….(9)
The constant C0 is called autonomous consumption or ‘subsistence consumption’. When YD
= 0, C = C0. It is that level of consumption which people must have in order to subsist even if income
level falls to zero and it is exogenously given. The parameter c, called the marginal propensity to
consume or MPC, is the slope of the consumption function. We can graphically represent the
consumption function same as in Figure:2.
2.8.3 Government purchases:
Like investment, real government purchases are also exogenously given. Government
expenditure includes such items as national defense expenditures, salaries of government employees
etc. G is a policy variable, whose value is determined by the Government. In a democratic country
like ours, G is decided after prolonged discussion in the Parliament. Hence we can write:
G = G0 ……..(10)
2.8.4 Taxes and Transfers:
Transfers (or transfer payments) are those payments that are made to people without their
providing a current service in exchange. Typical transfer payments are social security benefits and
unemployment benefits. In the SKM, transfers are assumed to be exogenously given
i.e. TR = TR0 ……(11)
Taxes are compulsory payments to be made by the citizens of a country. Taxes may or may
not depend on the income. For example,
8. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 8
(i) If the taxes are lump-sum, T = 𝑇̅ (𝑇̅ >0) ……(12)
(ii) If taxes are function of income: T = T(Y), 0< TY <1 ……(13)
(iii) If taxes are proportional to income: T = t. Y, 0 < t < 1 …..(14)
(iv) If taxes are partly lump-sum and
partly proportional: T = 𝑇̅ + t.Y (𝑇̅> 0; 0 < t < 1) .…(15)
Note that ∂T/ ∂Y = TY represents the change in T due to one unit change in Y which is the
tax rate. Under proportional income tax, ∂T/ ∂Y = t where ‘t’ is the fixed tax rate such that 0 < t <
1. Obviously, T and t are decided by the Government and is therefore exogenously given.
2.8.5 Equilibrium Income in Simple Keynesian Model with Government:
The economy in the SKM is said to be in equilibrium when
Actual Expenditure (Aggregate Supply) = Planned Expenditure (Aggregate Demand)
i.e. Y = C + I + G ….(16)
Y = C0 + c YD + I0 + G0
Y = C0 + c.( Y + TR0 –T0) + I0 + G0
Y = C0 + c.(Y + TR0 – t .Y) + I0 + G0
(assuming proportional taxes) …..(17)
By rearranging we get:
YE = [ 1 / {1 – c(1-- t)}]{ C0 + c.TR0+ I0 + G0} ….(18)
where YE is the equilibrium level of income-- that level of income which makes actual
expenditure(AD) in the economy same as planned expenditure(AS).
Alternatively, the AD equation can also be written as:
AD = { C0 + c.TR0 + I0 + G0} + c.(Y – t .Y)
= 𝐴̅ + c (1 – t) Y …..(19)
where 𝐴̅ = { C0 + c.TR0 + Ī + G0} is the autonomous part of AD.
The equilibrium condition:
Y = 𝐴̅ + c (1 – t) Y
=> YE = [ 1 / {1 – c(1-- t)}]. 𝐴̅ ……(20)
If the nation's income (output) equals the equilibrium income (output), firms will be able to
sell their entire output. Consequently, no incentive exists for them to alter their production and
income remains at the equilibrium level.
If the nation's output exceeds the equilibrium output, firms are unable to sell their entire output
and experience a buildup in their inventories. An incentive exists, therefore, for them to reduce
9. SM/CU/MCOM/FIRST YEAR/MEBE/MOD-I/2017-18 MOOCS: subirmaitra.wixsite.com/moocs 9
production. As a result, output falls until it equals the demand for goods and services. Similarly, if
the nation's output is less than the demand for goods and services, firms sell more than they are
producing and experience a depletion of their inventories. An incentive exists, therefore, for them to
increase production. As a result, output rises until it equals the demand for goods and services.
2.8.6 Graphical Illustration:
The determination of equilibrium income in SKM with government is shown graphically in
Figure: . Aggregate supply, the output of goods and services, is depicted by the 45° line. With the
same scales on both axes, output on the vertical axis equals output or income on the horizontal axis
for all points on the 45° line. The 45° line is not a 'true' aggregate supply curve. For example, it
indicates that any amount, from 0 to infinity, may be produced. This is not possible; production is
limited by the nation's resources and its technology. Nevertheless, in the development of the model,
it is helpful to think of the 45° line as an aggregate supply curve.
Aggregate demand represents society's demand for goods and services. With no foreign trade
sector, it consists of the demand for consumer goods and services, the demand for investment goods
and government purchases. Consequently,
AD = C + I + G
= {C0 + c.TR0 + I0 + G0} + c.(Y – t .Y)
= 𝐴̅ + c (1 – t) Y
Graphically, the aggregate demand line is the positively sloped line AD whose intercept is equal to
A and slope is equal to 0 < c (1 – t) < 1.
YE
Fig: 5
With the 45° line representing ‘aggregate supply’ or ‘actual expenditure’ and the AD line
representing ‘aggregate demand’ or ‘planned expenditure’, the equilibrium level of income is YE.
AD = 𝑨̅ + c (1 – t) Y
Aggregate Supply (Y)
Aggregate Demand (AD)
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Income level YE is the equilibrium level since it is the only level for which aggregate supply equals
aggregate demand. At income levels greater than YE, aggregate supply (represented by the 45° line)
is greater than aggregate demand (represented by the AD line), and income has a tendency to fall. At
income levels less than YE, aggregate supply is less than aggregate demand, and income has a
tendency to rise.
When AS > AD, Y tends to fall because of the unplanned inventory accumulation by the firms
( Iu = ∆inv. > 0), as producers are unable to sell their products.
When AD > AS, Y tends to increase because of the unplanned depletion in inventories by the
firms ( Iu = ∆inv. < 0) to meet increased demand.
When AD = AS, Y is at its equilibrium level.
Since income tends to fall when AS > AD and to rise when AD > AS, income eventually
gravitates to its equilibrium level => stable equilibrium.
2.9 Is equilibrium income = full employment income?
In the SKM with or without government, the equilibrium level of income may or may not
represent a full-employment level. That is, full-employment may or may not exist at the equilibrium
level of income. Unemployment may exist at the equilibrium level of income because, for the model
in question, the equilibrium level of income is merely the level where intended investment equals
saving or, alternatively, aggregate supply equals aggregate demand. Here, we assume that
unemployment exists so that increases in aggregate demand result in increases in production.
2.10 Existence of Equilibrium:
Once the equilibrium in the SKM is established one may question whether is exists or not.
The equilibrium exists if AD and AS curves intersect each other in positive quadrant so that YE > 0.
For this sufficient condition (with 𝐴̅ >0) is that AD must be flatter than AS. Since slope of AD is c
(1 – t) and that of AS is 1, the sufficient condition for the existence of equilibrium is c (1 – t) < 1
which always holds as 0 < c (1 – t) < 1 (Fig: 5). That equilibrium would not exist if c (1 – t) > 1
may be seen from the Fig: where AD is steeper than AS so that no intersection is possible in the
positive quadrant.
2.11 Stability of Equilibrium:
That equilibrium in the SKM is stable can be realized from the fact that a disturbance in the
equilibrium causing the income Y to be different from YE, generates such forces which brings back
the economy back to equilibrium once again. With 𝐴̅ > 0, the sufficient condition for this stability
is that AD is flatter than AS i.e. c (1 – t) < 1. Since 0 < c (1 – t) < 1 always, the SKM gives a stable
equilibrium. The economic interpretation of this stability is:
When AD < AS
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Unplanned accumulation of inventories by the firms (Δinv >0)
Unplanned or unintended investment ( Iu) > 0
Reduction in production by the firms,
Y falls till Y = YE
Again when AD > AS
Unplanned decumulation of inventories by the firms (Δinv < 0)
Unplanned or unintended investment ( Iu) < 0
Increase in production by the firms,
Y increases till Y = YE
Stable Equilibrium.