Eco o jcs-rop 7

Consumption
A consumpton functon showsthe re1ationsh betWeen planned oonsumpton
e

enditure and inGOme in an ecOnomy

A lhear consl mptonI:i1mdon cm be expressed as follows

w
0

umginal

I 1
C=a bY
n
change h C when there an hcrease in$1

propens

bY induced oonsumption expenditure

ofY,C/ Y

the

^C

'

lQ

n
Y

cozIle hmane )
Wea1th


'

o,, ~

Investnent

An hves ent

fm on shows e

reJa

ae

and come an econom

/es enr

reIax d s assumpJon

The reve fhves enris h uen d by interest mte orin me For I0ty puvose,we assume as an autonomous v iaue C Ler on,we wm

hves e fmction can e

expresse

(o oo/la

Equilibrh 1

'

Y e or45 e

It shows allthe points where aggregate expenditure CAD,equals h ome

All the
AD

along the45

hne hdc eY=AD

e{

!'

1
i

?tC"'

ItJQ

J roJ,fc7 B%s ess Eco a

ction Aggregate expenditure An aggregate expenditure mction shows the relationsh p between plarlned aggregate

expendimre and income1n an economy

Planned aggregate expend" Fe is the sun1ofplanned conslImption and planned
invest1ment

C ven:C=a+bY

andI=I

AD=a+bY+I AD=0+I )+bY

I come

deter ination

The equilibritIm level ofincOme CYe) atthe level ofincome where Y AE

AD

AD (a+I )+bY

Y1

Ye

\
at Y1:plamed expend hventories

Y2

>income u

fl.1..s increase production to neetthe extra demand and to rnaIntah e hventory

stocks

Y Co Ye)

at Y2:expenditure(income

inventories
o n ..s decrease production

Y Co Ye)

Bzsjness Eco o s-roJ, 7

Movement along the cl rve

Dueto Y movement along e

AD

AD ct rve

shift of e

cl

rve

L/) / )
due to the change in wealth,expected pri

shift ofthe AD clIrve level or avolab ty ofcredt,etc

Rotation ofthe cl rve sma11er b es1ope of e consunption func

m ethe

AD ct

rve

larger b:1he slope ofthe consunption function bec 111es steeper

^ AD

`-;

; 9


B ss Eco o Jcs-r

The multip er

An autonomous change in aggregate expendinre wm Iead t

1ncome.
one person s

a mult pher

c e

in

expendi becomes another person

Th

income The increase in autonomous

expendewill

hitiate consumption spendi n e second, ird,fo romds

suppose ere is an increase ofautonomous expenditwe by$1and b=o.8

Romd
I

Increase in spending
1

De o

CtImulathe total
1

Ex

2
3

0.8

1.8

0.64

2.44 2.952

4
5

0.512
o

4096

3.3616

Behav
Total
r

([:;1,'

The cumulative slIm ofincrease in spending is:

=$1+1(0.8)1+1(0.8)2

1(0.8)3+

+1(0.8)=1/(1-0.8)=5

The greater e value of b,the greater

11be the propo tion of the initiaI increase

income spent in e seGOnd,third,foHh rounds, Hence, he larger the change income.

zh

The pwpose of e mult l r to calculate the ma.g" de ofincome change at from e`autonomous change in the aggregate expend"vre

results

M0l er k,=Changeih hGOme/Cha e

in aut

nomous expen

k Y/AA 1/(1~b)

{
Fo

Gove

PG

 s-rt, fc7 sJ Eco,

IV

Three-sector Model

There are three sectors-fl s,households and thc govement The role offoreign sector is ignored

Deflnition equatio s EXpendi es are on C,Iand G

/a

With a govennent sector,households have to pay taxes(T) Income recoved by

households used for consumpton(C)or saving6)as well as payhg taxes(T).

E)isposable income=hcOme-taX+goVerlment subsidy

Yd=Y-T

subs y can be regarded as a negat e tax

ctio s Behavioural f
r

c ,FrJ9 B9dtre/JJ JJ

The govementexpend vFe

function is an exogenous or auto omous fmCtion.

The arn unt ofgoven.nent expen

PmFJJ9 c:o,9

m
T

can be considered asthe amomt oflump su

@/
n taXes

lIi

CeL 1
`)

tY is the amount ofpropoHionalincome tax whereas t is the lnarghaltax rate

T/ Y o

Gover

is a de c"budget ll s 1 .rG(T, e a surphs budg

;

If C;=T,there is a balance budget

B ss Ec

-Top 7

B sJss

Govemme t and aggregate demand

F

Fiscal p|

@JJfp ,r dbcmgJ g,,Brm B,9J em

It d
eGO11o

It
to sl

outp

cJr cJ9gB fJJr rcJF o,B rfpJJf

AD=Y
AD

AD

AD

% c D g cforg, J

lW u

spe gc,9J JJpJJf

o MP

?x\
r
t

BoJs ss

Eco a -rp'c7

Fiscal po cy

It refers to the use of goven nent eXpend vne and taxation to achieve certain goals in the

ecOnomy,such as high eInplo e y,and so on ,p ce stab

R involves an exp
to staJoiI e output level

change in goverrment expenditure and taxation pohcies in order

the level of aggregate demand close to the potenthl or hll-employme

When a denati nar/ or recessionary gap exists, the gover1ment can raise the aggregate expend"ure by inoreasing expend
measures
u e,

by reducing taxes, or by both

)AD Y to Yf

. u Yd C E Y to Yf

AD=Y
AD

AD

Y Ye
Ye

=Yf

C D

Bms ess&o n -roP 7

BaJsJ

ssG

. p@

When an hnat nary gap exists,the goverrunent can lower the aggreg e expende
by reduchg expendture,by increasing taxes,or by both measures
.

Fo s

AD

Y to Yf

lJ De

Yd C E Y to Yf
AD

Ab

Expe1

Beha 0

t
Ye

Ye =Yf


s-ToP'c7 Jzs ess Eco o
Fol r sector Model

n Four sectors-flI Is,households,govementand1he ore

sectors

io equatio s De

Expenditures are on C,I,G and NX

AD C+I+G+(X-~o
ctions BehaviouraI f

. r J:c:o99

R is assl med

thatthe amount of eXports1s a Constant

s

rnporJrJJ

The a1nomt of exports only a functon of the income of e forelgn comtr

d e

,/ F~ b

M=M M

a constant dm

MP AM/

Pc

AD

=C+I G+(X-M) AD=C+I+G

AD