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National Income: Where It Comes

From and Where It Goes

THE ECONOMY OF TWO SECTORS


This chapter addresses four groups of questions about
the sources and uses of a nation’s GDP:

1. How much do the firms in the economy produce?


2. What determines a nation’s total income?
3. Who gets the income from production?
4. How much goes to compensate workers, and how much goes to
compensate owners of capital
5. Who buys the output of the economy?
6. How much do households purchase for consumption, how much
do households and firms purchase for investment, and how much
does the government buy for public purposes?
7. What equilibrates the demand for and supply of goods and
services?
8. What ensures that desired spending on consumption, investment,
and government purchases equals the level of production?
The economy of two sectors
Market for Factor
of Production

Market for good


and service
The relationship between consumption
and income
The relationship between the level of Disposable Consumption Saving
disposable income with consumption Income Expenditure
expenditure and household savings (Yd) (C) (S)
can be seen as follows: 100 125 -25
200 200 0
300 275 25
C = 50 + 0,75 Yd 400 350 50
500 425 75
Yd = C + S
600 500 100
C = Yd – S 700 575 125
S = Yd – C 800 650 150
S=I 900 725 175
1000 800 200
Propensity to consumption and saving

Multiplayer Effect

MPC + MPS = 1
APC + APS = 1
Consumption and Savings Functions
Consumption Function
A curve describing the nature of the relationship between the level of
household consumption in the economy and national income. The
general form:

C = a + bY
Where:
a = Household consumption when national income is 0
the value of a is obtained from: a = (APC-MPC) y
b = Marginal Propensity to Consume
C = consumption level
Y = National Income
Savings Function
A curve describing the nature of the relationship
between the level of household savings in the
economy and national income. The general form
of saving function:

S = - a + (1 - b) Y
Information :
a = Household saving when national income is 0
1-b = Marginal propensity to saving
S = Saving Rate
Y = National Income
C = 50 + 0.75 Y S= -50 + 0.25 Y
Disposable Consumption
Saving (S) MPC APC MPS APS
Income (Yd) Expenditure (C)

100 125 -25 0.75 1.3 0.25 -0.25


200 200 0 0.75 1.0 0.25 0.00
300 275 25 0.75 0.9 0.25 0.08
400 350 50 0.75 0.9 0.25 0.13
500 425 75 0.75 0.9 0.25 0.15
600 500 100 0.75 0.8 0.25 0.17
700 575 125 0.75 0.8 0.25 0.18
800 650 150 0.75 0.8 0.25 0.19
900 725 175 0.75 0.8 0.25 0.19
1000 800 200 0.75 0.8 0.25 0.20
Determinant Consumption
and Saving
Other factors that influence a person for consumption and savings in
addition to national income include:
a. Wealth
b. Interest rate
c. Thrifty attitude
d. State of the economy
e. Income Distribution
f. Availability of sufficient pension funds
Investment
Investment is spending by the firm to buy capital goods
and production equipment to increase the ability to
produce goods and services in the economy.

Determinants of Investment Rate


a. Profit rate
b. Interest rate
c. Forecast about the state of the economy in the future
d. Technology advances
e. National income levels & changes
Investment Function
I = Io + aY
Where:
I = Total investment expenditure
Io = Total investment expenditure when income = 0
a = Marginal Propensity to Saving (MPS) ΔI/ΔY
Y = National Income
Aggregate Expenditure (AE)
Disposable Consumption Aggregate
Investme State of
Income Expenditure Saving (S) Expenditure
nt Economy
(Yd) (C) (AE)
100 125 -25 150 275
200 200 0 150 350
300 275 25 150 425
400 350 50 150 500 Expansion
500 425 75 150 575
600 500 100 150 650
700 575 125 150 725
800 650 150 150 800 Equilibrium
900 725 175 150 875
Contraction
1000 800 200 150 950
In a two-sector economy, the balance of
national income is reached when:
Y = AE or
Y = C + I or C + S, or I = S.

Example: Compute :
Given : 1. Income National Equilibrium
C = a + bYd , C = 50 + 0.75 Yd 2. Consumption rate
I = 200 3. Saving rate
4. I = S
5. Grafik
1. National Income Equilibrium Saving
Y =C+I
S = -a + (1-0.75) Y
= 50 + 0.75 Y + 200
= 250 + 0.75 Y = -50 + (0.25) 1000
Y-0.75Y= 250 = -50 + 250
0.25Y= 250
= 200
Y = 1000

I = S 200 = 200
Consumption
Y =C
C = 50 + 0.75 Y = 50 + 0.75 Y

= 50 + 0.75 (1000) = 50 + 0.75 Y


Y-0.75Y= 50
= 50 + 750
0.25Y= 50
= 800 Y = 200
C,I

Y=AE

Y= C+I
E1

Y=C
250
E0
50

Y
0 200 1000
S= -50 + (1 - 0.75)Y
I, S

200 I

Y
0 200 1000

-50
The economy of three sectors
Aggregate Expenditure Equation
Y = AE or Y = C + I + G Y
C
=
=
C+I+G
a + bYd
Yd = Y-T
Where I = I
Y = National Income G = G

C = Consumption Y = C+I+G
= a + bYd + I + G
I = Investment = a + b (Y-T) + I + G
= a + bY - bT + I + G
G = Government Expenditure Y-bY = a - bT + I + G
Balance Condition: bY = -bT+ a + I + G
Y = 1/1-b (-bT+ a + I + G)
I+G =S+T
C = a + bYd
= a + b (Y-T)

S = -a + (1-b) Yd
= -a + (1-b) (Y-T)
Effects of Taxes on Consumption
and Savings
Fixed tax
The amount of tax is the same at every income level
Yd = Y – T. C= a+ bYd C = a + b (Y-T)
S=-a+(1-b)Yd S= -a + (1-b)(Y-T)
Proportional Tax
The amount of tax depends on income
Example Without tax
Given: S = -50 + 0.25 Y C, I, G
C = 50 + 0.75 Yd = -50 + 0.25 (Y) Y=AE
S = -50 + 0.25 Yd = -50 + 0.25 (1600) Y=C+I+G
E2
I = 200 = -50 + 400
G = 150 = 350 Y= C+I
400 E1
Solution: I+G = S+T
Y= C
Y = C+I+G 200 + 150 = 350 + 0
250
= 50 + 0.75Y + 200 + 150 350 = 350 E0
= 0.75Y + 400 50
= 0.75Y + 400
Y-0,75Y = 400 Y
0 200 1000 1600
0.25 Y = 400
Y = 400/0.25 S, I, G S= -50 + (1 - 0.75)Y
Y = 1600
350 I+G
C = 50 + 0.75 Y 200 I
= 50 + 0.75Y
Y
= 50 + 0.75 (1600) 0 200 1000 1600
= 50 + 1200
-50
= 1250
Example within Fixed tax
Given: C = 50 + 0.75 Yd C, I, G
C = 50 + 0.75 Yd = 50 + 0.75 (Y - T) Y=AE
S = -50 + 0.25 Yd = 50 + 0.75 (1480 -40) E2 Y=C+I+G
I = 200 = 50 + 0.75 (1440)
Y=C+ I
G = 150 = 50 + 1080 400 E1
T = 40
= 1130 Y=C
250
E0
Y = C+I+G
= 50 + 0.75Yd + 200 + 150 S = -50 + 0.25 Yd 50

= 0.75 (Y-T) + 400 = -50 + 0.25 (Y-T)


Y
= 0.75Y- 0.75T + 400 = -50 + 0.25 (1480-40) 0 80 880 1480

= 0.75Y - 0.75 (40) + 400 = -50 + 0.25 (1440) S, I, G S= -50 + (1 - 0.75)Y


= 0.75Y - 30 + 400 = -50 + 360 350 I+G
= 0.75Y + 370 = 310 200 I
Y-0,75Y = 370
0.25 Y = 370 0
Y
I+G = S+T 80 880 1480
Y = 370/0.25
Y = 1480 200 + 150 = 310 + 40 -50

350 = 350
Example within Proportional tax
Given:
C = 50 + 0.75 Yd
C = 50 + 0.75 Yd
= 50 + 0.75 (Y - T)
S = -50 + 0.25 Yd = 50 + 0.75 (1000 -0.20Y)
I = 200 = 50 + 0.75 (1000 - 0.20 (1000)
G = 150 = 50 + 0.75 (800)
t = 0.20Y = 650

Y = C+I+G S = -50 + 0.25 Yd


= -50 + 0.25 (Y-T)
= 50 + 0.75Yd + 200 + 150
= -50 + 0.25 (1000 - 0.20Y)
= 0.75 (Y-T) + 400 = -50 + 0.25 (1000 - 0.20 (1000)
= 0.75Y- 0.75T + 400 = -50 + 0.25 (800)
= 0.75Y - 0.75 (0.20Y) + 400 = 150
= 0.75Y - 0.15Y + 400
= 0.60Y + 400 I+G = S+T
Y-0,60Y = 400 200 + 150 = 150 + 0.2Y
350 = 150 + 0.2 (1000)
0.40 Y = 400
= 150 + 200
Y = 400/0.40 = 350
Y = 1000
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