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DETERMINATION OF INCOME AND EMPLOYMENT - Coggle Diagram
DETERMINATION OF INCOME AND EMPLOYMENT
AGGREGATE DEMAND
-
Total demand of all the final goods and services in the entire economy.
AD = C + I
Components
Investment (I) - expenditure on investment by pvt households and enterprises
Government (G) - expenditure done by government and govt enterprises
Consumption (C) - Consumption expenditure by pvt households and enterprises
Net exports (X-M) - difference between export and import
Observations
Autonomous consumption
(a or c) - minimum positive consumption even at zero level of income.
Positive slope of consumption curve
- consumption increases with increase in income.
Autonomous investment
- parallel to X axis.
AD curve
starts above the point of origin due to
autonomous consumption
and
autonomous investment.
Positive upward slope of AD curve
- AD increases with increase in income.
AGGREGATE SUPPLY
-
Money value of final goods and services that all producers are willing to supply in an economy in a given period of time.
AS = Y = C + S
Components -
Consumption (C)
Saving (S)
CONSUMPTION FUNCTION
functional relationship between consumption and income.
C = a + bY
Observations -
Consumption curve starts above the origin
- due to autonomous consumption.
Slope of consumption curve is b
(MPC) - positive slope
when income (Y) < consumption (C)
- covered by dissavings
Break Even Point
- Y = C
Types of Propensity to consume
1. Average Propensity to consume (APC)
- ratio of consumption with income C / Y
APC > 1
when C > Y
APC = 1
when C = Y at break-even point
APC < 1
when Y > C
APC
falls with rise in income and cannot be zero or negative
2. Marginal Propensity to Consume (MPC)
- ratio of change in consumption with change in income. change in consumption / change in income
Value of
MPC
varies between 0 to 1
MPC
of poor is more than rich
MPC
falls with rise in income
SAVING FUNCTION
functional relationship between saving and income
S = -a + (1-b)Y
Observations
Saving curve starts
from -Y axis as there is negative saving
Slope of saving curve
is positive, saving increases with increase in income
Break even point
- S = 0
After break even point
saving becomes positive
Types of Propensity to save
1. AVERAGE PROPENSITY TO SAVE (APS)
- ratio of savings with income. S/Y
APS can never be 1 or more than 1
APS can be 0
when S = 0 and C = Y
APS can be negative and less than 1
when S is negative
APS rise with rise in income
2. Marginal Propensity to save (MPS)
- ratio of change in saving with change in income. Change in S / change in Y
MPS
varies from 0 to 1
Slope of saving curve is change in S.
MPS of rich is more then poor
Equilibrium Level of income employment and out
AD-AS approach
- AD = AS
IMPACT
AD > AS
; planned inventory falls, thus production will increase, income will increase.
AD < AS
; planned inventory more, thus production will fall, employment falls and income will fall.
S-I approach
- S = I
IMPACT
S > I
; inventory rises beyond desired level. reduces production, employment and income
S < I
; inventory falls below desired level. increases production, employment and income
INVESTMENT MULTIPLIER
- ratio of change in income and change investment.
K = Change in Y / Change in I; K = 1/1-MPC; K = 1 / MPS
Maximum value of K
is
Infinity
Minimum value of K
is
1
MPC increases K decreases
(inverse relation between MPC and K)
MPS increases K increases
(positive relation between MPC and K)
Disequilibrium
EXCESS DEMAND
- AD exceeds AS corresponding to full employment level of income and output
INFLATIONARY GAP
- difference/gap between actual AD and planned AD. Its impact on OUTPUT -
no change
as economy is already in full employment. ON EMPLOYMENT -
No change
- already in full employment. ON PRICE -
Price rise
FISCAL POLICY
- 1. Reduce government spending 2. Increase taxes
MONETARY POLICY
- Increase
Bank rate, repo rate, reverse repo rate, Cash reserve ratio and Statutory Liquidity ratio, margin requirements; sell Government securities
DEFICIENT DEMAND
- AD is less than AS corresponding to full employment level of income and output
DEFLATIONARY GAP
- difference/gap between actual AD and planned AD. Its impact on OUTPUT -
decrease
as unsold stock piles up. ON EMPLOYMENT -
decrease
- as production reduces. ON PRICE -
Price falls
FISCAL POLICY
- 1. Increase government spending 2. decrease taxes
MONETARY POLICY
- decrease
Bank rate, repo rate, reverse repo rate, Cash reserve ratio and Statutory Liquidity ratio, margin requirements; buy Government securities