CH6B: National income and emplyment determination - Coggle Diagram
CH6B: National income and emplyment determination
is the total value of final goods and services firms in an economy that would like to produce at a different general price level
short run AS curve
in the short run, AS curve slope upward:
as the price level rises, firms have a greater incentive to supply more
rise in output will lead to an increase in MC, producing extra units will be more expensive as shortage and bottlenecks in the factors of production.
long run AS curve
in the long run, the economy reaches full employment
all resources are fully utilised.
not possible to increase output any further
reach productive capacity / full employment level of output
vertical, perfectly price inelastic, not influenced by the price level
at very low levels of aggregate output, the AS is flat.
sufficient excess capacity for output to increase without any increase in price (MC is not changing)
(1) horizontal segment known as Keynesian range
excess capacity, unused capacity and significant unemployment
(2) positively sloped segment known as the intermediate-range
some spare capacity, but others do not.
economy moves toward maximum capacity.
price level will rise
(3) vertical: classical range
no excess capacity, full employment, using its technology to the fullest
the only thing that can happen is for the price to rise. output cannot increase beyond.
factors that only shift the SRAS curve
1. changes in input prices or costs of production
the price of inputs will affect the SRAS if they do not reflect permanent changes in supplies of some factors of production
e.g. increase in wage - increase in the cost of labour - increase COP - SRAS curve shift leftwards
however, LRAS will not shift because the supply of labour is the same as before, potential output is not changed
2. short term supply shock
unantipated but temporary shift in the SRAS curve
cuase significant but temporary inrease or drop in AS.
e.g. bumper harvests and natural disaster
factors that shift BOTH
1. capital stock
change in the stock of capital will alter the number of goods and services the economy can produce, ignoring the problems such as machines wearing out...
investment in capital improves quality and quantity of capital stock, increase SRAS due to lower COP arising from high efficiency, and LRAS due to improved productivity and increased productive capacity
2. labour force
an increase in the working population can lower the COP of labour and tend to depress wages and increases the SRAS.
the expanded labour force also inrease productive capacity and increase LRAS.
3. changes in productivity of factors or production
increase in skills of the workforce
improvement in technology e.g. using better equipment and machinery
better organisation of the factors of production
--- so more output can be produced with the same amount of resources, increase LRAS
--- At the same time, COP is reduced as the same amount of input is divided by a larger output, SRAS also increase
4. long term destruction or loss of factors of production
e.g. natural disasters/wars such as major earthquakes.
lead to loss of lives and destruction of physical capital
fall in productive capacity, LRAS shift leftwards
equilibrium real national income and general price level
the economy is in equilibrium in the short run when AD=SRAS
this is the equilibrium point as at any other price level firms in the economy would see their stocks of goods rise or fall in an unplanned way.
if when AD exceeds AS firms would see their stocks of goods run down quickly, they would raise output to restore their stocks and in raising production, they would demand more factors of production, thus driving up the price level to the equilibrium.
the shift in AD will increase in real income, increase the general price level, or both
equilibrium: output produced is purchased by the various sectors and thus there is no surplus.
the various sectors obtain the output they want to purchase, thus, there is no shortage
hence there is no need for production plans to change so no tendency for national income to change
however, a change in AD usually leads to a larger than proportionate change in (nominal) NY due to multiplier principle
factors determine magnitude of change in national income
△Y = k (△AD)
the size of multiplier which in turn depend on the size and the number of leakages
k=1/MPW or 1/(1-MPC) or 1/(MPS+MPT+MPM)
-hence its size is dependent on MPS, MPT and MPM
lifestyle and consumption patterns (materialistic or not)
expectations (e.g. if think there will be a recession ppl will be more cautious about spending)
income level (as income increases, ppl will not continue to increase consumption as their needs are met. C does not increase in proportion to income, lower multiplier)
MPT. change in taxation due to change in income. An increase in tax rate means higher tax leakage with an increase in income, a lower multiplier
MPM. change in import spending due to change in income. depends on a country's reliance on imports
state of the economy (position on the AS) real national income may not increase by a full multiplier effect if the economy is nearing full employment as there is an increase in the general price level. it will only increase by full multiplier only when there is the existence of substantial spare capacity in the economy
does not measure the actual increase in real output (due to higehr price)
does not consider the impact of ROI. national income increases, demand of money increase, interest rate increase, investment decrease, smaller increase in NY (crowding-out effect )
size of k is limited by the leakage. eonomy with high saving and high dependence of imports, MPS and MPM would tend to be high, smaller multiplier effect
shows an autonomous increase will lead to multiple increases in GDP. given the value of k, policymakers can predict how much output can be increased if aggregate spending is increasing by a certain amount
paradox of thrift
the more frugal and thrifty the economy is, the lower will be the level of national income and total employment
paradoxical as the way in which the household should behave if it wished to raise its wealth and its future ability to consume is directly opposite to that of the nation
save more, consumption reduced, increase in the stock of firms, firms will cut back production and employment fall, output and income fall, lower equilibrium is reached. nation gets poorer
the size of initial change in AD