Equilibrium level of national income in the keynesian cross model economics essay

A surplus of goods in the economy will induce firms to lower prices to reduce their stocks which will lead to a fall in the general price level.

equilibrium level of national income formula

When goods and services produced at a particular point of time is multiplied by the respective prices of goods and services, it provides the total value of the national output.

A shortage of goods in the economy will induce firms to raise prices to increase their profits which will lead to a rise in the general price level. Nevertheless, government expenditure on transfer payments does affect aggregate expenditure through its effect on disposable income and hence consumption expenditure.

In other words, an increase in disposable income will lead to an increase in induced consumption and vice versa. Autonomous Investment Autonomous investment refers to investment that is independent of national income and is determined by interest rates, business sentiment, business costs, capital costs, corporate income tax, technological advancements and the availability of credit.

Solve for the equilibrium level of income

Determination of National Income in Two-Sector Economy: The determination of level of national income in the two-sector economy is based on an assumption that two-sector economy is an economy where there is no intervention of the government and foreign trade. This proves that the vertical portion of the Keynesian aggregate supply curve is misaligned. Classical economics and Keynesian economics are traditional schools of thought in macroeconomics. These two methods of income determination are classified as income-expenditure approach and saving- investment approach. This is commonly known as the multiplier effect. Similarly, imports are subtracted from consumption expenditure, investment expenditure, government expenditure on goods and services and exports to derive aggregate demand. When the wealth of households increases due to an increase in bank savings, property prices or the values of financial assets, consumption expenditure will increase. He prepared three models for the determination of national income, which are shown in Figure The two-sector model of economy involves households and businesses only, while three-sector model represents households businesses, and government.

Therefore, the initial increase in aggregate demand due to the increase in aggregate expenditure as a result of the increase in autonomous expenditure will lead to increases in consumption expenditure and hence further increases in aggregate demand resulting in a larger increase in national output and hence national income.

Consumption expenditure depends to a large extent on expected future income. Many consumer durables are purchased on credit and hence an increase in the availability of credit will allow households to increase consumption expenditure.

As taxes flow from households to the government and transfer payments flow from the government to households, we can incorporate transfer payments into the circular flow model by subtracting them from taxes to derive net taxes.

Withdrawals are the factor income received by households that does not return to domestic firms as revenue. Similarly, beneath point E, the AD and AS schedules represent that the aggregate demand is more than aggregate supply. Unlike the Classical aggregate supply curve which is vertical, the Keynesian aggregate supply curve is inverse L-shaped.

Therefore, they seldom change substantially and hence do not affect consumption expenditure to a large extent. Therefore, the Keynesian aggregate supply curve is inverse L-shaped.

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