chapter 3 keynesian theory of income and employment l.
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Chapter # 3 Keynesian Theory of Income and Employment. Chapter`s outlines. Introduction to Keynes` Theory Determination of NI in two sector economy. Two methods for determination of National Income. AD & AS method. Saving & Investment Method.

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chapter s outlines
Chapter`s outlines
  • Introduction to Keynes` Theory
  • Determination of NI in two sector economy.
  • Two methods for determination of National Income.
    • AD & AS method.
    • Saving & Investment Method.
    • Determination of NI in three sector economy. numerical examples.
introduction to keynes theory
Introduction to Keynes theory
  • In the year 1936 Lord John Maynard Keynes’ General Theory of Employment, Income and Rate of Interest was first published..
  • His followers Harrod, Domar, Kaldor, Solow etc. have ever since widened the scope of macroeconomic analysis.
introduction cont d
Introduction…….. Cont`d
  • Keynes has introduced a variety of new tools of analysis.
  • His equations of income and expenditure, consumption function, law of marginal propensity to consume (MPC), Multiplier operations, Investment Function and Marginal Efficiency Of Capital (MEC), identity between Savings and Investment, and monetary Liquidity Preference Theory of interest accompanied by speculative motive for demand for money are some of his important contributions.
introduction cont d5
Introduction…….. Cont`d
  • Keynes denied the classical belief that the free enterprise system is a self regulating one and asserted that such a system requires periodic intervention of the public authority to avoid fluctuations and instability in economic activities.
  • Besides, Keynes was building an entirely new structure of economic analysis to study and redress the problem of unemployment..
assumptions
Assumptions
  • Two sector economy i.e. consumer and producers Y= C+I
  • The consumption expenditures (C) has the following equation C= Co + cY
  • The investment expenditure (I) consist of autonomous investment
  • The saving equation is as S= -So + sY
  • The output side of NI will be as Y= C + S
two methods
Two methods
  • AD and AS Method
  • Saving and Investment Method
1 ad and as method
1 AD and AS Method

Aggregate Demand (AD) Y = C + I

  • Total demand for goods and services produced in a year
          • OR
  • Total National expenditure incurred on the final goods and services produced in a country.
aggregate supply as y c s
Aggregate Supply (AS) Y = C+S
  • In a two sector economy, “AS” consist of total output produced in the economy .
          • OR
  • “AS” is a national income which has been produced by the factor of production.
determination of equilibrium level of ni
Determination of equilibrium Level of NI

C+S

C+ I < C+S

Y

B

C+I

C+ I= C+S

.

E

C+ I > C+S

A

x

0

Y1

Y2

Y3

National income

explanation of graph
Explanation of Graph
  • In this figure the equilibrium level of NI is determined at E where C+I=C+S, and OY2 is the equilibrium level of NI.
  • The equilibrium can not take place at point OY1 because here C+I > C+S. This would lead to increase in income. Similarly at OY3, C+I < C+S which would have the effect of reducing the income of the country.
  • Thus we find that it is OY2 level of income where aggregate demand is equal to aggregate supply.
numerical explanation of ni determination in two sector economy ad as method
Numerical explanation of NI determination in two sector Economy --- AD/AS Method
  • If C= 40+0.6Y and I=I0 =80
  • Then NI Y= C+I
  • Putting the value of C & I in equation
  • Y = 40 + 0.6Y + 80
  • Y- 0.6Y = 120
  • 0.4Y =120 dividing both sides by 0.4
  • 0.4Y/0.4 = 120/0.4
  • Thus Y = 300
cont d
Cont`d
  • And we know that C= 40+0.6(Y)
  • Put the value of Y in equation, we get C = 40 + 0.6 (300)
  • C = 40 + 180
  • C = 220
  • Now Y = 300, C= 220, so S ?
  • As Y=C+S so S= 80= I0
  • Hence at Y=300 , S=I so income is determined at level Y=300
2 saving investment method
2 Saving & Investment Method
  • Saving

The part of income which is not consumed is called saving.

  • Saving depends upon income S= f(Y)

while S = -S0 + sY

  • -S0 shows –ve Y and sY shows induced saving.
cont d16
Cont`d
  • The part of the income which is spent on the purpose other than consumption is called investment.
  • According to Keynes investment is autonomous i,e. I=I0
cont d17
Cont`d

S=f(Y)

Y

I < S

I=S

I > S

.

Saving & investment

I=I0

A

E

B

0

Y1

Y2

Y3

x

National income

explanation of graph18
Explanation of graph
  • In this figure, the equilibrium level of NI is determined where I=S. Accordingly OY2 is the equilibrium level of NI. Equilibrium does not take place at OY1 because here I>S, this would result in increase in income.
  • Similarly at OY3, I<S which would result in decrease in NI.
  • So we find that OY2 is the equilibrium level of NI.
numerical explanation of ni determination in two sector economy ad as method19
Numerical explanation of NI determination in two sector Economy --- AD/AS Method
  • If S= -40+0.4Y and I=I0 =80
  • Then NI S = I
  • Putting the value of C & I in equation
  • -40 + 0.4Y = 80
  • 0.4Y = 120
  • 0.4Y =120 dividing both sides by 0.4
  • 0.4Y/0.4 = 120/0.4
  • Thus Y = 300 so S = -40 + 0.4 (300)

S = -40 + 120

  • S = 80 =I
example to be solved
Example to be solved???
  • Suppose the consumption function is given by C= 100+ 0.8Y, while I0 =50
  • What is the equilibrium level of income?
  • What is the level of saving at equilibrium level?
  • If I0 (Autonomous Investment) increases to 100 what will be the new equilibrium level of NI.
inflationary and deflationary gaps
Inflationary and Deflationary Gaps
  • Inflationary Gaps

The equilibrium level of NI may be at above full employment. This situation occurs when at the level of full employment AD is greater than AS.

inflationary gap cont d
Inflationary Gap cont`d
  • When level of investment in an economy exceeds the investment level required to full employment, the equilibrium level of NI will be above the full employment level. This gap between current investment and required investment level shows a inflationary gap.
deflationary gaps
Deflationary Gaps

The equilibrium level of NI may be at below full employment. This situation occurs when at the level of full employment AD is less than AS.

cont d24
CONT`D
  • When level of investment in an economy is below the investment level required to full employment, the equilibrium level of NI will also be below the full employment level. This gap between current investment and required investment level shows a deflationary gap.
determination of equilibrium level of ni in three sector economy26
Determination of equilibrium level of NI in three sector economy
  • Three sector economy means- consumer, producers and Government, Y= C+S+T & Y=C+I+G
  • The consumption expenditures (C) has the following equation C= Co + cYd whereas Yd= Y-T
  • The investment expenditure (I) consist of autonomous investment, I=I0
determination of equilibrium level of ni in three sector economy cont d
Determination of equilibrium level of NI in three sector economy cont`d
  • The saving equation is as S= -So + sYd

5 G =G0 , is autonomous government expenditure.

  • AD = Y = C+I+G &

AS = Y = C+S+T

cont d28
Cont`d

C+S

C+I+G

Y

B

C+I

.

E

Consumption, invest, Govt.

A

x

0

Y1

Y2

Y3

National income

numerical example
Numerical example
  • If C= 40+0.6Yd , I=80, G=20, T=10
  • Then Y=C+I+G
  • Y= 40+0.6[Y-T] + 80+20
  • Y= 40+0.6[Y -10] +80+20
  • Y= 40+0.6Y - 6 +80+ 20
  • Y -0.6 = 134
  • 0.4Y =134
  • Y = 134/0.4
  • Y = 335
cont d30
Cont`d
  • Now Putting the value of Y in C
  • Yd = Y-T
  • Yd= 335-10= 325
  • C= 40+0.6Yd
  • C= 40+0.6(325)
  • C= 40 +195
  • C= 235 Hence Y= C + I + G

335=235+80+20

335=335

example to be solved31
Example to be solved
  • If C = 100+0.75Y, G0= 20, & I0= 50
  • Find the equilibrium level of National income?
  • Prove that S=I0+G0
another example
Another Example…???
  • If C = 100+0.75Yd, (Yd =Y-T) T=20 G0= 20, & I0= 50
  • Find the equilibrium level of National income?
  • Prove that S+T=I0+G0