Course : Pengantar Ilmu Ekonomi (1508PIE12)

online.uwin.ac.id
Bachelor in Economics (S.E): Manajemen

UWIN eLearning Program

Session Topic : Equilibrium National Income

Course: Pengantar Ilmu Ekonomi
By Tovan Krisdianto, S.E., M.M.

Content

Part 1

Equilibrium National Income

Part 2

Changes in Equilibrium National Income

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Part1: Equilibrium National Income

Equilibrium: Desired Consumption & National Income

Equilibrium National Income

Desired Consumption & National Income
With taxation, YD is less than Y.
Recall we now have a government that taxes private income
C = a + bYD
Where,
YD = Y - T &
T = tY

so that
C = a + b(Y-tY) or C = a + b(1-t)Y

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Equilibrium: Desired Consumption & National Income (Cont.)

Example:
If T = (0.1)Y, then
YD = Y-T
= Y- (0.1)Y = (0.9)Y &
a = 30, b = 0.8
If C = a + bYD & YD = Y - T then
YD = Y - (0.1)Y = 0.9 Y &
C = 30 + (0.8)YD
C = 30 + (0.8)(0.9)Y
C = 30 + (0.72)Y
The MPC out of national income (0.72) is less than the MPC out of
disposable income (0.8).
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Equilibrium: Desired Consumption & National Income (Cont.)

The simple consumption function with taxes is written as:

C = a + b(1-t)Y
If t increases then the slope of the consumption function,
b(1-t), decreases.
C = a + b(1-t)Y
slope = b(1-t)

C = a + b(1-t)Y
slope = b(1-t)
where t > t
Note,
this will cause the slope of
the AE line to decrease also.

Y
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Equilibrium: The AE Function

We then expand the AE function:

AE = C + I + G + NX

Recall that the slope of the AE function is,

the marginal propensity to spend out of national income
we call this z.
In this model, we get:
z = MPC(1 - t) MPM = b(1 - t) m
Clearly, t > 0 & m > 0 lead to a lower value of z.

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Equilibrium: The AE Function (Cont.)

Total desired expenditure on Indonesian goods & services from all sources
AE = C + I + G + NX
45o line (AE=Y)

AE

AE = C + I + G + NX
AE0

Y
Y0

Recall that the slope of the AE function is,

the marginal propensity to spend out of national income
we label this z.
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Equilibrium: The AE Function (Cont.)

The slope of the AE function

AE = C + I + G + NX
If C = a +bYD
I =I
G=G
X =X
M = mY

& YD = Y - tY
autonomous (not influenced by Y)
autonomous (not influenced by Y)
autonomous (not influenced by Y) &
where NX = X - M

Then AE = C + I + G + NX
substituting for the various expenditure components
= a + bYD + I + G + (X - mY)
= a + b(Y - tY) + I + G + (X - mY)
AE = a + I + G + X + [b(1 - t) - m]Y

Recall b is the MPC, m is the MPM, t is the tax rate

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Equilibrium: The AE Function (Cont.)

The intercept & slope of the AE function

AE = C + I + G + NX
AE = a + I + G + X + [b(1 - t) - m]Y
the intercept is
the slope is

a+I+G+X
[b(1 - t) - m]

(autonomous expenditure)
b is the MPC
t is the tax rate
m is the MPM

In this more complete model, we get:

z = b(1 - t) - m
or
z = MPC(1-t) MPM
Clearly, t > 0 & m > 0 lead to a lower value of z.
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Equilibrium: The AE Function (Cont.)

AE = C + I + G + NX
AE

45o line (AE=Y)

AE = C + I + G + NX
slope [b(1 - t) - m]

Intercept
a+I+G+X
Y0

Changes in,
1. a, I, G or X will cause the AE curve to shift
2. b, t or m will cause the AE curve to rotate
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Equilibrium: Equilibrium National Income

As before,
output is assumed to be demand determined in this model:
equilibrium condition is Y = AE(Y)
In words,
equilibrium Y occurs where desired aggregate expenditure
equals
actual national income.
Whenever AE is not equal to Y,
there are unintended changes in inventories &
firms have an incentive to change production.

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Equilibrium: The Aggregate Expenditure Function

Desired Aggregate
Expenditures

The addition of,

government & foreign
trade does not
change the logic of
the equilibrium!

Actual National Income

Desired Expenditure on

Point

Actual
National
Income (Y)

Consumption
(C=30+0.72Y)

Investment
(I=75)

Government
(G=51)

Net Export
(X-IM=72 -0.1Y)

Aggregate
(AE=C+I+G+X -IM)

30

75

51

72

228

150

138

75

51

57

321

300

246

75

51

42

414

600

462

75

51

12

600

900

678

75

51

-18

786

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Equilibrium: Equilibrium National Income (Cont.)

How to Determine Equilibrium National Income

Desired Aggregate Expenditure is AE = C + I + G + NX
From a previous slide we know,
AE = a + I + G + X + [b(1 - t) - m]Y
Now if,
a = 30,
b = 0.8,

t = 0.1,
m = 0.1

I = 75,
G = 51

X = 72

Then,
AE = a + I + G + X + [b(1 - t) - m]Y, & AE = 228 + 0.62Y
In equilibrium Y must equal AE (what firms produce must equal what
economic agents want to buy)
Y = AE
so that in equilibrium
Y = 228 + 0.62Y (AE from above)
Y - 0.62Y = 228
Y(1 - 0.62) = 228
Y = 228/(1 - 0.62) = 228/0.38 = 600
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Equilibrium: How to Check

How to check that your answer is correct

In equilibrium Desired Aggregate Expenditure,
must exactly equal the level of national income Y
We know that in our example, AE = a + I + G + X + [b(1 - t) - m]Y
AE = 228 + 0.62Y
(after substituting for the parameter values for this example)

If Y = 600 (our estimate of equilibrium national income)

Q: What will desired aggregate expenditure by?
A:
AE = 228 + 0.62Y (AE from above)
AE = 228 + 0.62 (600)
AE = 228 + 372
AE = 600
so we did the calculations correctly
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Part2: Changes in Equilibrium National Income

Equilibrium: Changes in Equilibrium National Income

AE

45o line (AE=Y)

AE = C + I + G + NX
slope [b(1 - t) - m]

Intercept
a+I+G+X
Y0

Changes in,
1. a, I, G or X will cause the AE curve to shift
2. b, t or m will cause the AE curve to rotate
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Equilibrium: Changes in Equilibrium National Income (Cont.)

Shift in AE
45o line (AE=Y)
AE

AE0 ( a, I, G &/or X increase)

AE = C + I + G + NX

Intercept
a+I+G+X
Y

Y0

Changes in a, I, G or X will cause the AE curve to shift

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Equilibrium: Changes in Equilibrium National Income (Cont.)

Rotation in AE

45o line (AE=Y)

AE

AE0 (b increased or t
or m decreased)
AE = C + I + G + NX

slope [b(1 - t) - m]

Y0

Changes in b, t or m will cause the AE curve to rotate

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The Multiplier: Taxes & Imports

The Multiplier with Taxes & Imports

Imports & taxes make z smaller
the simple multiplier is also smaller
z = b(1 - t) m
z = AE/Y - slope of the AE curve
The value of z is determined by:
z = b(1-t) - m

AE
e1

AE

AE = Y
E1

AE1

E0

e0

For example,
Y0
suppose b = 0.9 , t = 0.3 & m = 0.4
Then
z = 0.9 (1 - 0.3) 0.4
= 0.23 &
the multiplier is 1 / (1-z) or 1 / (1 - 0.23) = 1.30

Y1

a. z increases as MPC increases & decreases as t & m increase.

b. Try different values for MPC, t, m & recalculate the multiplier.
c. How does the picture change?
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Net Exports: Function

Net Exports
As with other elements of AE:
If NX function shifts,
a. upward, equilibrium Y rises
b. downward, equilibrium Y falls
Exports are,
autonomous with respect to domestic GDP,
but they depend on:
a. Foreign income
b. Domestic & foreign prices
c. Exchange rate
d. Tastes

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Fiscal Policy: Definition

Fiscal policy. Defn:

The use of the governments spending & tax policies.
Any policy that,
attempts to stabilize Y at or near Y* is
called stabilization policy. (lots of problems with this but lets do the
theory anyway)
It is often clear in,
which direction fiscal policy could be adjusted,
but less clear how much is necessary.

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Actual National Income (Y)

Desired Aggregate Expenditures

(AE)

Desired Aggregate Expenditures

(AE)

Fiscal Policy: The Use of Fiscal Stabilization Policy

(i) Equilibrium Y < Y*

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Actual National Income (Y)

(i) Equilibrium Y > Y*

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Equilibrium National Income: Multiplier

Consider some G < 0.

AE

Equilibrium national income will fall:

Y = G x simple multiplier

AE =Y
E0

e0

Y = 228 + 0.62Y (AE from above)

Y - 0.62Y = 228
Y(1 - 0.62) = 228
Multiplier = 1/(1 - 0.62) = 2.63

e1
e1

Y1

For example:
suppose z = 0.62

Y = - $263 million

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AE0
AE1

E1

Y0

multiplier = 2.63.
G = -$100 million.

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Equilibrium National Income: AE Function

The government,
may attempt to change
national income by
changing the net tax rate.

AE

AE=Y

E1

e2

1. A lower t causes the AE

function to become steeper
2. A higher t causes the AE
function to become flatter

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e0

AE0

E0
Y0

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AE1

Y1

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Reference

Ragan, Christopher T.S. & Lipsey, Richard G.

(2010). Macroeconomics, Thirteenth Canadian
Edition. MyEconLab.

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Course : Pengantar Ilmu Ekonomi (1508PIE12)

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