National Income Equilibrium in Closed Economy

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Questions and Answers

What is the formula used to calculate national income equilibrium in a closed economy with government?

Y = a + b(Y) + G

Y = a + b(Y-T) + G (correct)

Y = C + I + G (correct)

Y = C + I + G + T

Which type of tax is independent of income changes?

Induced tax

Progressive tax

Autonomous tax (correct)

Proportionate tax

If the consumption function is given by C = 500 + 0.5(Yd), what does 'Yd' represent?

Planned investment

National income

Disposable income (correct)

Total government spending

What determines induced taxes in an economy?

They are determined by income levels Signup and view all the answers

In the given example, what is the national income equilibrium when the system includes a lump sump tax of RM10 million?

RM1350 Signup and view all the answers

At what level of national income does equilibrium occur in the AE approach?

$1100 Signup and view all the answers

What is the consumption function before tax in the three sector economy?

C = 200 + 0.75Yd Signup and view all the answers

What does the 45-degree line represent in the context of national income equilibrium?

Aggregate expenditure equals national income Signup and view all the answers

Which equation represents the consumption function after tax?

C = 175 + 0.75Y Signup and view all the answers

What is the induced consumption function after tax in the three sector economy?

C = 200 + 0.6Y Signup and view all the answers

What is represented by the equation S = Y - C in a two sectors’ economy?

Savings equals income minus consumption Signup and view all the answers

In the context of the circular flow of income, which of the following is considered a leakage?

Household savings kept in financial institutions Signup and view all the answers

Which factor do households receive as a reward for providing factors of production?

Wages and salaries Signup and view all the answers

What does the consumption function represent in economic terms?

The relationship between consumption and income Signup and view all the answers

What happens to the savings made by firms that are not distributed to shareholders?

They are used for purchasing new capital Signup and view all the answers

Which equation correctly represents the relationship between consumption (C), income (Y), and savings (S)?

Y = C + S Signup and view all the answers

In a closed economy with no government intervention, which sectors are involved?

Households and firms only Signup and view all the answers

What is the primary function of savings in the context of the circular flow of income?

To provide funds for firm investments Signup and view all the answers

What does the consumption function primarily show?

The relationship between consumption expenditure and national income Signup and view all the answers

In the linear consumption function C = a + bY, what does 'b' represent?

The slope or marginal propensity to consume Signup and view all the answers

What happens to aggregate consumption as income increases according to the consumption function?

It increases at the same rate Signup and view all the answers

What does the term 'disposable income' refer to?

Income after taxes that can be spent Signup and view all the answers

In the equation Yd = Y – T, what does 'T' represent?

Net taxes Signup and view all the answers

Which of the following describes the slope of the consumption function?

It shows the change in consumption with respect to changes in income Signup and view all the answers

What is included in the aggregate expenditure (AE)?

Consumption, investment, and government spending Signup and view all the answers

If the consumption function intercepts the C-axis at 'a', what does 'a' represent?

The minimum level of consumption regardless of income Signup and view all the answers

What is the value of Y calculated using the given equations?

1227.27 Signup and view all the answers

In the planned savings and investment table, at what output level does equilibrium occur?

900 Signup and view all the answers

What is the relationship between government spending (G) and investment (I) in the given scenario?

G equals I Signup and view all the answers

What does the aggregate expenditure function represent in this three-sector economy?

An upward shift in the consumption function Signup and view all the answers

What does the variable Yd represent in the income equations?

Disposable income Signup and view all the answers

What determines the unplanned inventory change when output exceeds consumption?

Producers overestimated demand Signup and view all the answers

At an income level of Y = 1100, what is the nature of the output adjustment indicated?

Output decreases Signup and view all the answers

Which equation best represents the aggregate expenditure (AE) in the given content?

AE = C + I + G Signup and view all the answers

What is the formula for the planned investment multiplier based on lump-sum taxes?

1 / (1 - MPC) Signup and view all the answers

How does the proportionate tax condition affect the planned investment multiplier?

It includes an additional term for marginal tax rate. Signup and view all the answers

If C = 200 + 0.75Y and I = 100, what is the equilibrium income level after a $50 million increase in investment?

1300 million Signup and view all the answers

What is the government spending multiplier based on lump-sum taxes?

1 / (1 - MPC) Signup and view all the answers

What does the standard formula for the change in equilibrium income due to government spending under lump-sum taxes look like?

∆Y = 1 / (1 - MPC) x ∆G Signup and view all the answers

What is the impact of a change in taxes on production, income, and consumption spending?

It describes a tax multiplier that is distinct from the investment and spending multipliers. Signup and view all the answers

When there is a $50 million increase in government spending with C = 200 + 0.75Y and G = 50, what is the equilibrium income level?

1500 million Signup and view all the answers

What is the correct relationship between the planned investment multiplier and the government spending multiplier under lump-sum taxes?

They are identical in structure and outcome. Signup and view all the answers

Study Notes

Principle of Economics Study Notes

There will be 20 questions covering Chapter 10.
The topics include Chapter 10: National Income Equilibrium and Aggregate Expenditure (2 and 3 Sectors Economy)
Consumption and Saving Functions
APC, APS, MPC and MPS
National Income Equilibrium – Table/numerical and Graphical Approach
Expenditure and Income Approach, Injection and Leakage Approach
Changes in National Income Equilibrium
Investment Multiplier, Government Expenditure Multiplier and Tax Multiplier.
In a closed economy, only households and firms exist, no government intervention or international trade.
Households use generated income for expenses/consumption (C) and savings (S).
Y = C + S (output equals consumption plus savings)
S = Y - C
C = Y - S
The relationship between consumption (C) and income (Y) is known as the Consumption Function.
Circular flow of income in a two-sector economy involves wages, salaries, rent, interest and profit, firm investment, firm savings, household savings, and consumption expenditure.
Firms produce goods and services using factors of production owned by households, receiving wages, salaries, rent, interest, and profit.
Households divide their income to consumption expenditure and savings in financial institutions.
Households receive interest on their savings, which firms utilize for investment.
Firms also save through undistributed profits.
Saving is an outflow (leakage), investment is an inflow (injection).
Consumption function shows the relationship between consumption expenditure and aggregate output/national income.
Keynesian consumption function links consumption to current income.
Consumption function is a straight line, where C increases at the same rate as Y.

Consumption and Saving Functions

The aggregate consumption function illustrates aggregate consumption at the different levels of aggregate income.
Higher levels of income lead to higher levels of consumption spending.
A linear consumption function is expressed as C = a + bY.
'a' represents autonomous consumption (consumption at Y=0).
'b' represents the slope of the line ie. Change in Aggregate Consumption / Change in Aggregate Income (MPC).
MPC is between 0 and 1.
MPC measures the change in consumption due to a change in income.
If MPC is small, the consumption function curve is steep.
Factors affecting consumption and changes in disposable income cause movement along curve.
Aggregate consumption increases with an increase in ‘a’, ‘Y’, or MPC.
S = – a + (1 – b) Y shows a saving function, where ‘a’ is autonomous saving and (1 – b) represents the slope (MPS).
MPS represents the marginal propensity to save (change in saving / change in income).
MPS is between 0 and 1.
Given a, MPC and Y, calculate aggregate consumption (C).
Aggregate Consumption increases with increases in autonomous consumption or income, or with increases in MPC.

MPC, MPS, APC and APS (study)

APC = total consumption/total income
MPC = change in total consumption / change in total income
APS = total saving/total income
MPS = change in saving/change in income
APC + APS = 1
MPC + MPS = 1
Tables show relationships between consumption, saving, APC, APS, MPC, and MPS.

National Income Equilibrium (Y=AE Approach)

For a closed economy, AE = C + I + G.
In equilibrium, aggregate expenditure equals aggregate output (Y = AE).
Aggregate output is the total quantity of goods and services produced.
Aggregate income is the total income received by all factors of production.

Components of Aggregate Expenditure Model

Consumption is determined by factors like disposable income, and wealth.
Consumption tends to rise with wealth, expected future income, and future price.
Interest rate has a negative relationship with consumption.
Planned investment is purchases of new buildings, equipment, and inventories.
Two types of investment: autonomous (fixed and independent of income); induced (depends on national income).
Factors influencing planned investment include interest rate, expected risk, and inventory change.
Inventory change = production – sales.
Government expenditure is the government's spending.
Net taxes are taxes paid minus transfer payments.
Taxes can be proportionate (percentage of income) or lump-sum (fixed amount).
Disposable income (Yd) = total income (Y) – taxes (T).
AE = C + I + G
In equilibrium, AE = Y.

Two-Sector Economy (Algebra Analysis)

Given S and I, calculate national income equilibrium.
S=I
Given S = -500 + 0.5Y and I = 100, solve for equilibrium Y.
Y = 1200 (using S = I approach)

Two-Sector Economy (Graphic Analysis)

The 45° line represents where Y = AE.
Equilibrium is where AE crosses the 45° line.

Three-Sector Economy (Algebra Analysis)

In a closed economy with government spending and taxes (T), AE = C + I + G.
In equilibrium, Y = C + I + G.

Three-Sector Economy (Graphic Analysis)

AE curve shifts upward when G increases.
Equilibrium occurs at the intersection of AE and TP.

The Multiplier

When autonomous expenditure changes, equilibrium expenditure and GDP also change.
Change in equilibrium expenditure is proportionally larger than the change in autonomous expenditure.
The multiplier is how much autonomous expenditure magnified the impact on the equilibrium expenditure.
The formula for the multiplier (K) is K= 1 / (1-MPC) or K= 1/MPS.
Proportionate taxes will reduce the multiplier.
Based on lump-sum taxes, the multiplier is larger.

The multiplier for government spending

Similar to the planned investment multiplier.
Using the formula 1/(1 - MPC) or 1/MPS.
Government spending multiplier formula: ΔY= 1/(1 - b)XG, (proportionate tax) : ΔY = 1/(1 – b + bT) ΔG

The multiplier for taxes

Tax multiplier is used to compute the changes in equilibrium income due to changes in taxation.
Using the formula -MPC/(1 – MPC) lump sum taxes formula.
Proportionate Taxes formula: ΔY=-b/(1 – b + bT)ΔT

Balanced-budget multiplier

The balanced budget multiplier is 1 because the change in Y is the same size as the initial change in G or T.

Equilibrium (using autonomous tax)

The equilibrium is achieved when the AE curve intersects with the S+T line.
Equilibrium occurs where the AE line crosses the TP line.

Equilibrium (using induced/proportionate taxes)

Equilibrium occurs where the AE curve intersects with the S + T line.

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Description

This quiz explores key concepts related to national income equilibrium within a closed economy that includes government factors. Test your understanding of consumption functions, taxes, and equilibrium levels in the Aggregate Expenditure approach. Ideal for economics students looking to reinforce their knowledge on macroeconomic principles.