Equilibrium Income and Output

Equilibrium Income and Output: Two-
Sector Economy
Y=C+I+G+E
Aggregate Equilibrium Y = C + I
C = a+bY
_
I = I (It is wholly autonomous
not related to income)
_
Thus E=C+I
Overall equilibrium income and output is determined at the
point
where E= C+I intersects the equality line.
Change in Income and
Output;Investment Multiplier
 The Aggregate Demand and hence Income and Output can
change due to shifts in Consumption or Investment or both.
 We have seen that the Consumption Function is relatively stable

as against the Investment Function.
 Shifts in Aggregate Demand due to shifts in Investment lead to a

magnified change in Equilibrium Aggregate Income and
Output.This is referred to as the Simple Investment Multiplier
which is an important pillar of the the Keynesian Theory.
 The Simple Investment Multiplier is the ratio or coefficient of the

change in Total Income to a given change in the Autonomous
Investment.It maybe expressed as the marginal output-capital
ratio. K = d Y/ d I
Change in Income and Output;Investment
Multiplier
 The Multiplier Theory states that the increase in the Total Income
occasioned by any given increase in Autonomous Investment
Outlay is a certain multiple of the original increase in
Autonomous Expenditure .The magnitude of the increase in Total
Income depends upon the value of the Marginal Propensity to
Consume.
 The higher the MPC,the higher is the Investment Multiplier.
K= 1 or 1
(1-b) mps
(The necessary assumption here is that mpc is positive,constant
and less than1. 0<b<1 )
Multiplier
Multiplier Action
Simultaneous or Static Multiplier-Here there is no time-lag involved
between the increase in Investment and the resulting increase in
Income.
Period or Dynamic or Sequence Multiplier-Here the Income
changes after a certain time-lag.(The important advantage here is
that it focuses on the chain of interactions and exposes the
underlying forces.)
Leakages
The actual Income generated is less than the product of the simple
Multiplier K and the given increase in Autonomous Investment dI
due to certain leakages given below:
Multiplier
Imports,Inflation,Savings,Fiscal Measures,Paying of Debts,Securities,Excess
Stocks of Consumer Goods.
Though it has been criticized on a number of issues like neglect of the role of
induced investment, assumption of surplus capacity, bottlenecks of different
kinds etc, nevertheless it is a bold and challenging piece of analysis.
Important policy decisions which arise from it are that during a period of
depression, even unproductive expenditure is worthwhile.Also,it shows that
the social cost of eliminating unemployment for the community is much less
than the orthodox economic theory would have us believe.
Multiplier
Complex Multipliers
Super-Multiplier
In the simple Keynesian model of Income
determination,Consumption was regarded as a function of
Income while Investment was treated as wholly autonomous.In
reality an increase in Income also causes an increase in
Investment.Induced Investment is positively related to the level of
income.Keynes neglected this because of the Depression.
Thus Total Investment is composed partly of Autonomous
Investment and partly of the Induced Investment.
We have what is termed as the MPI(Marginal Propensity to
Invest) which is the ratio of the change in investment to any given
change in Income. MPI(e) is 0 < e <1 = constant.
Multiplier
An increase in Autonomous Investment apart from causing the
increase in Consumption also increases the Investment and thus
brings about the greater increase in income as compared with the
Simple Multiplier.
_
I = IA + eY Thus the Super Multiplier = dY = 1 = K1
dIA 1-b-e
Government Purchase of Goods and Services,Taxes,Transfers

and Income
3 –sector economy-government sector included. Y=C+I+G
Multiplier
With no increase in the government taxes and the autonomous
investment,the Government Purchases Multiplier will be equal
to the simple investment multiplier.
dY = 1 = Kp
dG 1-b
G = Autonomous government spending
A Government Transfer Multiplier operates like the simple
multiplier except that its value is generally smaller than the value
of the simple multiplier for either the government purchases or
investment because recipients spend only part of the transfer
payments.
Multiplier
A Tax Multiplier would be negative because a tax would cause a negative
change in the disposable personal income of the community. dY = -b = Kt
dT 1-b
The immediate first stage impact on the economy is smaller.
A Balanced Budget Multiplier comes into play when expenditure is equal to the
taxes.The conventional view is that this has a neutral impact on the
economy.however, according to the modern view it exerts a net expansionary
effect.
[Paradox of Thrift :By increasing personal saving the total saving
in the economy may infact decrease.
SF CF Y C I
S and I equilibrium at a lower level ]
Multiplier
Four-sector economy-Foreign Trade sector introduced.
Y=C+I+G+E
The Foreign Trade Multiplier- An autonomous increase in the
exports will lead to an increase in the incomes of the exporters
and the factors employed who would in turn spend a part of the
increase on domestic goods. dY = 1
dX 1-b+m
Accelerator-This involves an action which is the reverse of the

multiplier.This was not taken into account by Keynes.
According to this,when income or consumption
increases,investment will increase by a multiple amount.

Equilibrium Income and Output

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Equilibrium Income and Output: Two-

 We have seen that the Consumption Function is relatively stable

 Shifts in Aggregate Demand due to shifts in Investment lead to a

 The Simple Investment Multiplier is the ratio or coefficient of the

Government Purchase of Goods and Services,Taxes,Transfers

Accelerator-This involves an action which is the reverse of the

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