Scribd Logo
Upload

Welcome to Scribd!

  • 288 views

    CH 8 Income Determination & Multiplier

    Uploaded by

    Mishti Ghosh
    The document discusses the concept of the investment multiplier in macroeconomics. It defines the multiplier as the ratio of the change in income to the change in investment. The multiplier process is explained using an example where government investment increases by Rs. 100 crores. This leads to an initial increase in income of Rs. 100 crores. With a MPC of 0.5, consumption increases by Rs. 50 crores in the first round. This continues in subsequent rounds, leading to a total increase in income of Rs. 200 crores, which is twice the initial investment. The multiplier value is calculated using formulas that incorporate MPC and MPS.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd

    CH 8 Income Determination & Multiplier

    Uploaded by

    Mishti Ghosh
    288 views42 pages
    The document discusses the concept of the investment multiplier in macroeconomics. It defines the multiplier as the ratio of the change in income to the change in investment. The multiplier process is explained using an example where government investment increases by Rs. 100 crores. This leads to an initial increase in income of Rs. 100 crores. With a MPC of 0.5, consumption increases by Rs. 50 crores in the first round. This continues in subsequent rounds, leading to a total increase in income of Rs. 200 crores, which is twice the initial investment. The multiplier value is calculated using formulas that incorporate MPC and MPS.

    Original Title

    Ch 8 Income Determination & Multiplier.pptx

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    The document discusses the concept of the investment multiplier in macroeconomics. It defines the multiplier as the ratio of the change in income to the change in investment. The multiplier process is explained using an example where government investment increases by Rs. 100 crores. This leads to an initial increase in income of Rs. 100 crores. With a MPC of 0.5, consumption increases by Rs. 50 crores in the first round. This continues in subsequent rounds, leading to a total increase in income of Rs. 200 crores, which is twice the initial investment. The multiplier value is calculated using formulas that incorporate MPC and MPS.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    288 views42 pages

    CH 8 Income Determination & Multiplier

    Uploaded by

    Mishti Ghosh
    The document discusses the concept of the investment multiplier in macroeconomics. It defines the multiplier as the ratio of the change in income to the change in investment. The multiplier process is explained using an example where government investment increases by Rs. 100 crores. This leads to an initial increase in income of Rs. 100 crores. With a MPC of 0.5, consumption increases by Rs. 50 crores in the first round. This continues in subsequent rounds, leading to a total increase in income of Rs. 200 crores, which is twice the initial investment. The multiplier value is calculated using formulas that incorporate MPC and MPS.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    You are on page 1of 42

    INCOME DETERMINATION

    AND MULTIPLIER
    CHAPTER-8
    MACROECONOMICS
    DETERMINATION OF EQUILIBRIUM

    According to Keynesian theory, an economy is in


    equilibrium when planned aggregate demand for
    goods and services is equal to planned
    aggregate supply during a given period of time ,
    or when Ex –ante savings are equal to Ex-ante
    investment during a given period of time.
    TWO APPROACHES OF EQUILIBRIUM
    LEVEL OF INCOME AND EMPLOYMENT

    AD=AS S=I
    ASSUMPTIONS

    ► This approach is studied in the context of two sectors


    only. So there are no government and no foreign
    sector.
    ► It is assumed that investment is autonomous.
    ► Price level is assumed to be constant.
    ► Equilibrium output is to be determined in the context of
    short run.
    AD - AS APPROACH
    AD –AS APPROACH
    AD-AS APPROACH

    At point E, AD is
    equal to AS. OY
    is the equilibrium
    level of income.
    EFFECTIVE DEMAND

    ► The equilibrium level income is at E, when AD =


    AS = 160 Crores
    ► It is a situation of “EFFECTIVE DEMAND”
    ► EFFECTIVE DEMAND refers to the level of AD at
    equilibrium. It is called effective because it is
    equal to AS and is able to establish equilibrium.
    AD > AS (to the left of E)

    Output will
    increase until
    the economy
    Firms will resort
    is back at
    to increase in
    Inventories equilibrium
    employment.
    fall below the level.
    desired level
    AD < AS (to the right of E)
    7.9 EX-ANTE INVESTMENT AND EX- ANTE SAVINGS
    EX-POST INVESTMENT AND EX-POST SAVING

    Ex-post saving Ex-post investment


    1.

    2.
    refers to the refers to actual or
    actual or realised realised
    savings in an investment in an
    economy during economy during a
    a year. year.
    POINTS TO NOTE (NCERT)

    ► EQUILIBRIUM level of income is determined at a level, when


    Ex-ante saving = Ex-ante investment (PS = PI)
    ► It is a RARE phenomenon, because savers and investors are two
    different entities with different motives
    ► Whenever PS ≠ PI, OUTPUT adjusts in such a way that these two
    become equal.
    ► Ex- post (actual) level of investment of firms are always equal to
    ex-post (actual) savings by households at any level of income (as
    savings finance investment).
    POINTS TO NOTE (NCERT)

    Actual Investment = Planned Investment + Unplanned Investment


    Actual investment > Planned Investment (Unplanned investment will be positive)
    Actual investment < Planned Investment (Unplanned investment will be negative)
    ► Change in inventory can be negative or positive – if there is a rise in the inventory, it
    is positive inventory investment, while a depletion of inventory is negative inventory
    investment.
    ► Inventory investment can take place due to 2 reasons:
    a) Firm decides to keep some stocks for various reasons (Planned inventory
    investment)
    b) The sales differ from the planned level of sales, so the firm has to add to / run down
    existing inventories (Unplanned inventory investment)
    SAVING INVESTMENT APPROACH

    EQUILIBRIUM Ex- post (actual) AD = AS


    1. Meaning

    2. Ex-post

    3. Derivation
    level of income level of
    is determined investment of C + I = C + S.
    firms are always
    at a level, equal to ex-post Therefore,
    when Ex-ante savings by
    (planned) households at I=S
    saving = any level of
    Ex-ante income (as
    (planned) savings finance
    investment. investment).
    SAVING INVESTMENT APPROACH
    SAVING INVESTMENT SCHEDULE
    SAVING > INVESTMENT (RIGHT SIDE)

    • Households are S>I • Reduction in


    not consuming employment
    • Inventories rises
    as the firms and output.
    above the
    expect them
    desire level.

    S>I S=I
    SAVING < INVESTMENT (LEFT SIDE)

    S<I S<I S=I


    • Households • Planned • Firms will
    are inventories increase
    consuming will fall below EMPLOYMENT
    more and the desire • And OUTPUT
    saving less level till S = I
    SAVING IS MORE THAN INVESTMENT

    ► Suppose, Saving is greater than Investment (S>I). High saving


    means lower consumption. Lower consumption leads to fall in
    Aggregate Demand. Inventories increase. This will make the
    producers to reduce production. Aggregate Supply falls and
    becomes equal to Aggregate Demand. When AD and AS are
    equal S and I will also be equal.
    SAVING IS LESS THAN INVESTMENT

    ► Suppose, Saving is less than Investment (S < I). Low saving means
    higher consumption. Higher consumption leads to rise in
    Aggregate Demand. Inventories fall. This will encourage the
    producers to increase production. Aggregate Supply increases
    and becomes equal to Aggregate Demand. When AD and AS are
    equal S and I also will be equal.
    ► At point E the economy is in equilibrium because at that point
    Saving and Investment are equal.
    Let’s study the
    explanation of
    this diagram
    given on Pg
    8.4
    “ The difficulty lies not so much in
    developing new ideas as in
    escaping from old ones.
    ”
    JOHN MAYNARD KEYNES
    Equilibrium level
    ● According to the classical economists, equilibrium level of
    income is attained always at full employment level. However,
    as per the Keynesian theory, equilibrium level can be
    achieved at:

    ● Full employment level.


    ● Underemployment level.
    ● Over full employment level.
    Under
    Over Full
    Full Employment Employment
    Employment
    equilibrium - It equilibrium - It
    equilibrium - It
    refers to a refers to a
    refers to a
    situation when the situation when the
    situation when the
    aggregate demand aggregate demand
    aggregate demand
    is equal to the is equal to the
    is equal to the
    aggregate supply aggregate supply
    aggregate supply
    at full employment when resources
    beyond the full
    level are not fully
    employment level
    employed

    Let’s read all three in detail with the help of diagrams given on Pg 8.5 and 8.6
    Let’s read all three in detail with the help of diagrams given on Pg 8.5 and 8.6
    INVESTMENT
    MULTIPLIER
    JOHN M KEYNES

    Economic Development - the multiplier effect - YouTube

    The Multiplier Effect (In less than 5 minutes) - YouTube


    MEANING OF INVESTMENT MULTIPLIER

    1.MEANING
    2. FORMULAE
    The investment
    Multiplier is 3. MPC and K
    1. K=∆Y, ∆Y=
    defined as the k(∆I)
    ratio of the 1.Higher the MPS, less is
    ∆I the multiplier (Inverse
    change in relation).
    income to the 2. K = _ 1__
    2.Higher the MPC more
    change in 1-MPC will be the value of
    investment multiplier and vice versa
    3. K = _ 1__ (Direct relation)
    MPS
    INVESTMENT MULTIPLIER

    Change in income is a multiple of change in investment. That is, multiplier


    explains how many times the income increases when investment
    increases by a certain amount.
    ASSUMPTIONS OF MULTIPLIER

    Assumptions
    One person’s expenditure
    is other person’s income
    Govt invests ₹ 100 crores

    Value of MPC = 0.5


    MULTIPLIER PROCESS

    Change in Change in Change in Change in


    Investment (∆I) Income (∆Y) Consumption (∆C) Saving (∆S)
    100 100 50 50
    - 50 25 25
    - 25 12.5 12.5
    - 12.5 6.25 6.25
    - ----- ---- ----
    - ----- ---- -----
    100 200 100 100
    INVESTMENT PROCESS

    ► An additional investment of ₹100 crores leads to an increase in income of


    ₹100 crores in the first round.
    ► MPC is 0.5. So, 50% of additional income of ₹100 crores (₹ 50 crores) is
    consumed and another 50% (₹ 50 crores) is saved.
    ► One man’s expenditure is another man’s income. So, in the next round,
    consumption of ₹ 50 crores creates an income of ₹ 50 crores. 50% of this
    additional income of ₹ 50 crores (₹ 25 crores) is consumed and remaining
    50% is saved.
    ► This will go on until consumption becomes zero.
    ► Total income generated will be 200. K = 1 / 1- MPC = 1/ 0.5 = 2
    ∆ Y = K (∆ I) = 2 (100) = 200
    MULTIPLIER PROCESS
    MULTIPLIER THROUGH A DIAGRAM

    Initial Equilibrium is at point E (AD intersects AS)


    Equilibrium income is OY

    When investment increases by ∆I, AD curve shifts up


    New Equilibrium is established at E’ (AD’ intersects AS)
    New Equilibrium level of income is OY’
    Increase in income is YY’

    From the diagram, it is clear that ∆Y > ∆I


    ∆Y = k (∆I)
    VALUE OF MULTIPLIER

    MPC = 0
    • K = I/1-MPC
    • K = 1/0 = ∞ • K= 1/1-MPC • VALUE OF K
    • K=1/1-0 = 1 • 1 TO ∞

    MPC = 1 K = 1 to ∞
    REVERSE MULTIPLIER
    “ LET’S CHECK OUT THIS VIDEO

    ”
    PARADOX OF THRIFT (for reference only)
    AN EXAMPLE
    FORMULAE AT A GLANCE

    AD = C+I At BEP APS = S/Y


    AS = Y Y = C, S=0 APC = C/Y

    At Eqm, K = ∆Y/∆I APC+APS = 1


    Y=C+I or S = I ∆Y = K(∆I) MPC+MPS = 1

    AD = C+by+I K = 1/MPS MPC = ∆C/∆Y


    AD = A+bY
    A – Autonomous expenditure K = 1/1-MPC MPS = ∆S/∆Y
    Numerical practice (solved examples)

    Let’s try out the following examples


    today

    Pg 8.15 to Pg 8.26 Example 8, 10, 13,


    16, 18, 24, 25, 33 and 34
    Numerical practice (unsolved practicals)

    Let’s try out the following questions


    today:

    Pg 8.44 onwards Q14, Q17, Q27,


    Q29, Q38, Q50, Q85, Q86, Q87,
    Q88 and Q89

    You might also like