Rose Nonette C.

Capadosa

ECONOM1 Module 8

National Income Determination Demand estimation (consumption, savings,

investment, government expenditure)

Fiscal Policy (during recession and inflation)

Demand Estimation: Consumption Function and Savings

Consumption Function/Propensity to

Consume the schedule that relates consumption

to disposable income

Marginal Propensity to Consume (mpc)

slope of the consumption function
Indicates the percentage of each additional peso of disposable income that will be consumed Value is less than 1 Denoted as b (basic assumption: At zero disposable income, consumption takes place); for consumption function C = a + by Refers to change in the level of consumption that occurs as a consequence of a change in income (mpc= C/ Y)

Demand Estimation: Consumption Function and Savings contd

SAVING the difference

between consumption and income (S = Y C)

MARGINAL PROPENSITY

TO SAVE (mps) the slope of the saving function

Expesses the ration of the change in the level of savings ( S) that occurs as a consequence of a change in income ( Y) (mps = S/ Y)

Schedule of Income and Consumption

(in billion pesos)
Income (Y) 100 200 300 Consumption (C) 125 200 275

400
500 600

350
425 500

Source: Pagoso et al, 2002

Schedule of Income, Consumption, & Savings

(in billion pesos)
Income (Y) 100 200 300 400 500 Consumption (C) 125 200 275 350 425 Savings -25 0 25 50 75

600

500

100

Source: Pagoso et al, 2002

Schedule of Income, Consumption, & Savings

(in billion pesos)
Income (Y) 100 200 300 400 500 Consumption (C) 125 200 275 350 425 Savings -25 0 25 50 75

600

500

100

Source: Pagoso et al, 2002

Average and Marginal Propensity to Consume

(hypothetical data in million pesos)
Income (Y) Consumption (C) APC MPC

100
200 300 400 500 600

125
200 275 350 425 500 200/200 = 1 275/300=0.91 350/400=0.87 425/500=0.85 500/600=0.83 75/100=0.75 75/100=0.75 75/100=0.75 75/100=0.75 75/100=0.75

Source: Pagoso et al, 2002

The Consumption-Savings Function

700 600
Y=C+S
C=C(y)

Income/Consumptio n

500

400 300

200 100 0 0 100 200 300 400 500 600 S=Y-C

-100
100 200

Income

The fundamental psychological law... is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not as much as the increase in their income.

- John Maynard Keynes

Schedule of Income and Total Saving

(in billion pesos)
Income (Y) Consumption (C) Savings Investment C+I

100 200 300 400 500

125 200 275 350 425

-25 0 25 50 75

50 50 50 50 50

175 250 300 400 475

600

500

100

50

600

Source: Pagoso et al, 2002

Income= Consumption+Investment
Y=C+S C+ I

700 600 500 400 300

200
100 50 0 0 50 100 150 200 250 300 350 400 450 500 550 600 Y

S
I

-50

Income

Investment
Refers to the decision made by firms to spend on

capital goods Determinants: economic factors, political conditions, peace and order situation, mood of investors Components: business fixed investment, residential construction, net change in business inventories

Multiplier
The number of times money has changed hands and

generate income Multiplier K K = 1/(1-mpc) Amount of Income Generated Yg = I x K

Relevant Formulas & Symbols:

Yd = Disposable Income = Y Consumption Function: C = a + by (a= C at zero y or

the y-intercept; b=mpc or slope) mpc = C rise ------ = --------(slope of C function) Y run Savings Function: S = Y C mps = S rise ------ = --------(slope of S function) Y run mps + mpc = 1 S=Y-C

Relevant Formulas & Symbols-contd:

M or K =

--------- = ---------1 mpc mps , the multiplier

Y=IxM Yg = G x K

or

IxK

A Demo Problem

SCENARIO 1 (SIMPLE ECONOMY): GNI = C + S

Given: a = P50B
1.

b = 75%

The Consumption Function: C = 50 + 0.75 y 2. Getting the Break-even Point (C=Y):

C = a + by C=Y a + by = Y Y = a + by Y = 50 + 0.75 y (1 0.75) y = 50 Y = 50 ----- = 200, the pt where c = Y 0.25

SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75%

The Consumption Function: C = 50 + 0.75 y 3. Getting the C & S under different Ys:
If Y = 100 C=? C = 50 + 0.75 y C = 50 + 0.75 (100) = 50 + 75
= 125 S=? S = Y-C = 100 125 = -25, dissavings

If Y = 400 C=? C = 50 + 0.75 y

S=?

SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75%

The Consumption Function: C = 50 + 0.75 y 3. Getting the C & S under different Ys:
If Y = 100 C=? C = 50 + 0.75 y C = 50 + 0.75 (100) = 50 + 75
= 125 S=? S = Y-C = 100 125 = -25, dissavings

If Y = 400 C=? C = 50 + 0.75 y = 50 + 0.75 (400) = 50 + 300

= 350
S=? =Y-C = 400 - 350

= 50, + savings

SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75%

The Consumption Function: C = 50 + 0.75 y 4. Computing for MPS:
If Y S
Mps =

from 300 t0 400 from 25 to 50

S 50 25 ---- = -----------Y 400 - 300 = 25 ---100

If Y S

from 400 to 500 from 50 to 75

?

mps =

= 0.25

SCENARIO 1 (SIMPLE ECONOMY) contd: GNI = C + S Given: a = P50B b = 75%

The Consumption Function: C = 50 + 0.75 y 4. Computing for MPS:
If Y S
Mps =

from 300 t0 400 from 25 to 50

S 50 25 ---- = -----------Y 400 - 300 = 25 ---100

If Y S

from 400 to 500 from 50 to 75

S 75 50 ----- = ---------Y 500 400 = 25 ---100

mps =

= 0.25

= 0.25

SCENARIO 2 (ECONOMY w HH & investors):

Given: a = P50B
1.

(GNI = C + I) b = 75%

I = 50

Solving for equilibrium Y when there are values for C & I

Y = C + I, C = a + by Y = a + by + I Y = 50 + 0.75 y + 50 Y 0.75 y = 100 0.25 y = 100 Y = 400, the equilibrium income

Sample Problem for C & I:

1. Assume :
INCOME
50

CONSUMPTION
100

100
150 200 250 300 350 400 450 500

125
150 175 200 225 250 275 300 325

What is the equilibrium income and consumption?

Sample Problem for C & I:

Assume :
INCOME
50

CONSUMPTION
100

100
150 200 250 300 350 400 450 500

125
150 175 200 225 250 275 300 325

What is the equilibrium income and consumption? 150

Sample Problem for C & I:

2. Construct a new schedule with investment equal to 25:
INCOME
50 100 150 200

CONSUMPTI INVESTMEN ON T
100 125 150 175

C+I

250 300
350 400 450 500

200 225
250 275 300 325

What is the new equilibrium income?

Sample Problem for C & I:

2. Construct a new schedule with investment equal to 25:
INCOME
50

CONSUMPTI INVESTMEN ON T
100 25

C+I
125

100 150
200 250 300 350 400 450 500

125 150
175 200 225 250 275 300 325

25 25
25 25 25 25 25 25 25

150 175
200 225 250 275 300 325 350

What is the new equilibrium income? 200

Sample Problem for C & I:

2. Construct a new schedule with investment equal to 25:
INCOME
50 100 150 200 250 300 350 400 450 500

CONSUMPTION
100 125 150 175 200 225 250 275 300 325

INVESTMENT
25 25 25 25 25 25 25 25 25 25

C+I
125 150 175 200 225 250 275 300 325 350

What is the new equilibrium income? 200 CHECK: mpc = 0.5 , mps = 0.5, M = 1 / 0.5 = 2, Ye (new) = 150 + 50 = 200 Y = I x M = 25 x 2 = 50

Sample Problem for C & I:

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?

Sample Problem for C & I:

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?
M = 1 / mps = 1 / 0.2 = 5

a. What would be additional Income and Consumption if Investment were to increase by 7.5?

Sample Problem for C & I:

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?
M = 1 / mps = 1 / 0.2 = 5

a. What would be additional Income and Consumption if Investment were to increase by 7.5? Y = addl I x K = 7.5 x 5 = 37.5, the additional Y

S (Y-C)

I = 10
I = 17.5

50
________

40
_______

10
_______

_______
_______

Sample Problem for C & I:

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?
M = 1 / mps = 1 / 0.2 = 5

a. What would be additional Income and Consumption if Investment were to increase by 7.5? Y = addl I x K = 7.5 x 5 = 37.5, the additional Y b. What would be total Y and C as a result of the foregoing?

S (Y-C)

I = 10
I = 17.5

50
_______

40
_______

10
_______

10
_______

(1)

Sample Problem for C & I:

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?
M = 1 / mps = 1 / 0.2 = 5

a. What would be additional Income and Consumption if Investment were to increase by 7.5? Y = addl I x K = 7.5 x 5 = 37.5, the additional Y b. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37.5 = 87.5, total Y Y = C + I, C = Y I C = 87.5 17.5 = 70, total C
Y C I S (Y-C)

I = 10
I = 17.5

50

40

10
17.5

10
_______

(1)

87.5

70

(2) (50+37.5) (4)(87.5-17.5) (3)(10+7.5)

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?

M = 1 / mps = 1 / 0.2 = 5 a. What would be additional Income and Consumption if Investment were to increase by 7.5?

Sample Problem for C & I:

Y = addl I x K = 7.5 x 5 = 37.5, the additional Y

b. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37.5 = 87.5, total Y Y = C + I, C = Y I C = 87.5 17.5 = 70, total C c. Compute Additional

Savings

S (Y-C)

I = 10
I = 17.5

50

40

10
17.5

10
_______

(1)

87.5

70

(87.5-17.5) (3)(10+7.5) (2)(50+37.5) (4)

3. Assume Y = 50, C = 40, I = 10, mps = 0.2, M = ?

M = 1 / mps = 1 / 0.2 = 5 a. What would be additional Income and Consumption if Investment were to increase by 7.5?

Sample Problem for C & I:

Y = addl I x K = 7.5 x 5 = 37.5, the additional Y

b. What would be total Y and C as a result of the foregoing? Yt = Y 1 + Y = 50 + 37.5 = 87.5, total Y Y = C + I, C = Y I C = 87.5 17.5 = 70, total C c. Compute Additional

Savings S = Y C = 87.5 -70 = 17.5 S = Snew Sold = 17.5 10 = 7.5, additional S

Y C I S (Y-C)

I = 10
I = 17.5

50

40

10
17.5

10
17.5 (5)

(1)

87.5

70

(4) (2) (50+37.5) (87.5-17.5) (3)(10+7.5)

Reminder: Submission of Takehome quiz on C & I function is next meeting

SCENARIO 3 (ECONOMY w HH & investors & Government):

Given: a = P50B
1.

(GNI = C + I + G) b = 75% I = 50 Yg=100

Solving for full employment equilibrium Y when there are values for C & I & G can be computed

SCENARIO 3 (ECONOMY w HH & investors & Government):

Given: a = P50B
1.

(GNI = C + I + G) b = 75% I = 50 Yg=100

Solving for full employment equilibrium Y when there are values for C & I & G can be computed Yg = G x K, M or K = 1 / 1-mpc = 1/ 1-0.75 = 1/0.25 = 4 100 = G x 4 G = 100 / 4 = 25, the Government Spending G Y = a + by + I + G = 50 + 0.75 y + 50 + 25 = 125 + 0.75 y (y 0.75y) = 125 Y = 500, the full employment equilibrium Ye

SCENARIO 3 (ECONOMY w HH & investors & Government contd):

(GNI = C + I + G) Given: a = P50B, b = 75%, I = 50, Yg=100, G=25, Ye =500
Y,C, C+I, C+I+G

Practice Exercise (ECONOMY w HH & investors & Government):

Compute and graph. Assume that C = 50 + yd
1. Compute for the break-even point . 2. How much is equilibrium income where Y = C + I

assuming investment is P50B? 3. How much is equilibrium income where Y = C = I + G if Government Spending is P20B? 4. Graph the aforementioned equations. 5. Compute the multiplier at each of the ff mpcs given an investment of P5B: Mpc Multiplier Yg (Income Generated) 50% 45%

Government Spending
As determined from the HH,

investors, and government sectors, Y = C + I + G, G is value of government spending (Yg= G x K)

Full Employment Equilibrium

The level of income where there is no

available and useful resource that is wasted

Inflationary Gap
Occurs when aggregate demand C + I + G exceeds

equilibrium income Y

Deflationary Gap
Occurs when aggregate demand C + I + G fall short of equilibrium income Y

Schedule of Income and Total Spending (in billion pesos)

Y C I G C+I + G

100

125

50

25

200

200
300 400 500

200
275 350 425

50
50 50 50

25
25 25 25

275
350 425 500

Source: Pagoso et al, 2002

Full Employment Equilibrium

Y=C+S C+ I
C+I+G

700 600 500 400 300

200
100 50 0 0 50 100 150 200 250 300 350 400 450 500 550 600 Y

S
I

-50

Income

Fiscal Policy
When the government uses its powers to influence

total spending either directly by changingits purchases of goods and services or indirectly by altering the disposable incomes of persons to changes in the level of taxation or transfer outlays

Fiscal Policies

1) Periods of deflation
Deficit budget (government spending more than
what it collects through taxes) or tax cuts

2) Periods of inflation
Surplus budget (government spending less than its budget) or balanced budget or tax increases

Major Macroeconomic Effects of Government Expenditure and Tax Policy

The Expenditure Impact

The Financial Impact

The Supply Impact