This document discusses the Keynesian two-sector model of income determination. It consists of only household and firm sectors in a closed economy with no government or foreign trade. The model shows how consumption, savings, and investment determine equilibrium income. Consumption is defined as a function of disposable income. Equilibrium income is found using the consumption function equation and shown graphically using aggregate demand and supply. Income is determined by autonomous consumption and investment multiplied by the multiplier.
This document discusses the Keynesian two-sector model of income determination. It consists of only household and firm sectors in a closed economy with no government or foreign trade. The model shows how consumption, savings, and investment determine equilibrium income. Consumption is defined as a function of disposable income. Equilibrium income is found using the consumption function equation and shown graphically using aggregate demand and supply. Income is determined by autonomous consumption and investment multiplied by the multiplier.
This document discusses the Keynesian two-sector model of income determination. It consists of only household and firm sectors in a closed economy with no government or foreign trade. The model shows how consumption, savings, and investment determine equilibrium income. Consumption is defined as a function of disposable income. Equilibrium income is found using the consumption function equation and shown graphically using aggregate demand and supply. Income is determined by autonomous consumption and investment multiplied by the multiplier.
This document discusses the Keynesian two-sector model of income determination. It consists of only household and firm sectors in a closed economy with no government or foreign trade. The model shows how consumption, savings, and investment determine equilibrium income. Consumption is defined as a function of disposable income. Equilibrium income is found using the consumption function equation and shown graphically using aggregate demand and supply. Income is determined by autonomous consumption and investment multiplied by the multiplier.
: BACHELOR OF COMMERCE (SPECIAL) DEGREE COURSE TITLE : ECONOMICS FOR ENTERPRISES COURSE CODE : COM 11032 COURSE STATUS : COMPULSORY KEYNESIAN THEORY OF INCOME DETERMINATION TWO HAND-OUT TITLE : SECTOR MODEL ECONOMY LECTURER R.UMANAKENAN, DEPARTMENT OF COMMERCE
Learning Objectives: define income and output determination Explain two sector model economy differentiate consumption function and consumption equation illustrate income determination of two sector model economy by formula interpret income determination of two sector model economy by graph
Introduction This hypothetical economy provides a simple and very convenient starting point to understanding the Keynesian theory of income determination.
Two Sector model Economy
It consists of only house hold and firm sectors. It represents a closed economy in which there is no government and no foreign s trade.
Assumptions 1. there are only two sectors house hold and firm 2. there is no government sector 3. the total household income equals to disposable income either spend it or save it 4. it is a closed economy no foreign sector 5. in the business sector, there is no corporate savings or retained earnings 6. all prices including factor prices remain constant. 7. the supply of capital and technology are given
Consumption Function The consumption function refers to functional relationship between total consumption and gross national income.
C = f (Y) Where, C: - consumption Y: - income
Note: Y means disposable income.
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Consumption Function Equation
Linear consumption function has two parts
1. Amount of consumption expenditure which is independent of the level of
income autonomous consumption
2. Amount of consumption which is depends on the level of income.
Note: autonomous consumption to be financed out of past savings. That is
consumption at zero level of income.
C = Ca + bYd
Where: C: aggregate consumption Ca: autonomous consumption b: marginal propensity to consume Yd: disposable income
Note: Keynes consumption function is the short run consumption function, which is function of income. Here the factors other than income are assumed to be constant in the short run.
Income and Output Determination
The equilibrium national income is determined aggregate demand equals the aggregate supply of income.
Aggregate demand = Aggregate supply
C+I=C+S
Formal Model of Income Determination
C + I = C + S (1) I = S (C is common to both)
According to the equation (1), at the equilibrium
Y=C+I But C = Ca + bY + IO
Therefore, Y = Ca + bY + IO Y bY = Ca + IO Y (1 b) = Ca + IO
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Ca Io Y= 1 b
1 Y= (Ca I ) 1 b
Note: 1. Io is autonomous because it doesnt depend on income.
1 2. Y = (Ca I ) 1 b
It reveals that autonomous consumption and investment (Ca + I)
generate so much aggregate demand which is equal to income.
It reveals equilibrium level of income can be obtained by
multiplying the elements of autonomous expenditure by the vale of multiplier.
It reveals equilibrium level of income is higher when greater the
marginal propensity to consume and autonomous investment.
Determination of Equilibrium Level of Consumption
C = Ca + bY (1)
1 Y= (Ca I ) (2) 1 b
By substitute, (2) in (1)
1 C = Ca + b (Ca + Io) (1 b)
b C = Ca + (Ca + Io) (1 b)
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Graphical Presentation of Income Determination
1. Aggregate Demand and Supply Approach
Equilibrium level of income is determined by the intersection of aggregate demand and aggregate supply curves.
2. Saving Investment approach
The determination of equilibrium level of income can be explained through the saving investment approach.
References:
1. Raj Kumar and Kuldip Gupta, Managerial Economics; Revised Edition, 2006; UDH Publishers & Distributors (Pvt) Ltd, New Delhi. 2. H.L.Ahuja; Macro Economics: Theory & Practice., 10 Th Edition (2004). S.Chand & Company, NewDelhi. 3. D.N.Dwivedi., Macro Economics: Theory & Practice.,3rd Edition (2012).,Tata McGraw Hill, NewDelhi.
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