National Income Determination

The determination of the relationships between production, incomes, and spending.

Definition of Terms:
 Demand Estimation- Attempt to estimate demand more correctly for the benefit both of
the producers who can make more profit by estimating demand correctly and the
consumers who would be provided with the goods that they want and demand.

 The Consumption Function- “Propensity to consume”; Schedule that relates

consumption to disposable income

 Marginal Propensity to Consume (b) –indicates the percentage of each additional peso
of disposable income that will be consumed
o The value of the marginal propensity to consume is less than unity or one

 Zero Disposal Income(a)- this value will be positive and is plotted above zero
o Even at zero disposal income, consumption takes place
 The Savings Function – savings is the difference between consumption and income
 Marginal Propensity to Consume (MPC) - expresses the change in the level of
consumption (∆𝐶) that occurs as a consequence of a change in income (∆𝑌)
o Ratio ∆𝑪⁄∆𝒀
o MPC- slope of the consumption function

 Marginal Propensity to Save (MPS) – expresses the ratio of the changes in the level of
savings (∆𝑆) that occurs as a consequences of a change in income (∆𝑌)
o Ratio ∆𝑺⁄∆𝒀
o MPS- slope of the saving function

 Investment – the decision made by firms to spend on capital goods.

 This decision to commit funds for capital goods is assumed to be
independent of the level of income.
 The most volatile of the major components of aggregate expenditures.

 The level of National Income – determined by the consumption function and the level of
planned investment which can be expressed as Y = C + I.
 The level of total spending in the economy by household firms at various levels of
income is determine by adding the value of Investment to Consumption.

Lozano D., Valencia C.

 THE CONSUMPTION FUNCTION THE SAVINGS FUNCTION

C= a + by S=y–c
C= Consumption S = Savings
a = Zero Disposal Income c = Consumption
b = Marginal Propensity to Consume y = Income
y = Income

*At what point would consumption be equal to income?

Given: a = 50
b = .75
C = 50 + .75y

The point where CONSUMPTION=INCOME (break-even point) can be represented as:

C=Y
c = a + by

if c = 50 + .75y
y = 50 + .75y
y - .75y = 50
. 25y = 50
50
y = .25
y = 200

*How much would consumption be at other income levels?

Examples:

y = 200

if y =100 if y = 400
c=? s=y-c c=? s=y-c
c = a + by s = 100 - 125 c = a + by s = 400 - 350
= 50 + .75 (100) s = -25 = 50 + .75 (400) s = 50
= 50 + 75 = 50 + 300
c = 125 c = 350

Lozano D., Valencia C.

 Schedule of Income, Consumption

Income (Y) Consumption (C) Savings (S)

100 125 (25)
200 200 0
300 275 25
400 350 50
500 425 75
600 500 100

Consumption Savings Y=C+S

600
550 C = C (y)
500
450
400
350
300
250
200 S=Y-C
150
100
50
Income
50 100 150 200 250 300 350 400 450 500 550 600
-50
The Consumption and Saving Function

Lozano D., Valencia C.

 THE MPC THE MPS
∆𝐶 ∆𝑆
MPC = MPS =
∆𝑌 ∆𝑌

EXAMPLES: MPC

When income increases from 100–200, consumption rises from 125-200.

∆𝐶 200−125 75
MPC = = = = .75
∆𝑌 200−100 100

If income rises from 200–300, consumption rises from 200-275.

∆𝐶 275−200 75
MPC = ∆𝑌 = 300−200 = 100 = .75

EXAMPLES: MPS

When income increases from 300–400, consumption rises from 25-50.

∆𝑆 50−25 25
MPS = ∆𝑌 = 400−300 = 100 = .25

When income rises from 400–500, consumption rises from 50-75.

∆𝑆 75−50 25
MPS = ∆𝑌 = 500−400 = 100 = .25

When one put MPC AND MPS

MPC + MPS = .75 + .25
MPC + MPS = 1.00

Note: MPC – usually value LESS THAN 1

MPS – value is ALWAYS 1 MINUS the MPC

Lozano D., Valencia C.

 Average and Marginal Propensity Consumption
(Same process under Saving/APS/MPS)

Income (Y) Consumption (C) APC MPC

100 125

200 75
200 200 = 1.00 = .75
200 100

275 75
300 275 = 0.91 = .75
300 100

350 75
400 350 = 0.87 = .75
400 100

425 75
500 425 = 0.85 = .75
500 100

500 75
600 500 = 0.83 = .75
600 100

Level of National Income

Equilibrium Income Simplifying the equations, we
Y=C+I have:
GIVEN: a = 50
Y= Income y = 50 + .75 + 50
b = .75
C = Consumption y - .75 = 50 + 50
I = 50
I = Investment 25y = 100
100
y = c + I, c = a + by = .25
y = a + by + I y = 400

Lozano D., Valencia C.

 The Schedule of Income, Consumption, and Savings

Income Consumption Savings Investment C+I

100 125 (25) 50 175

200 200 0 50 250
300 275 25 50 300
400 350 50 50 400
500 425 75 50 475
600 500 100 50 600

Graphical Presentation

Y=C+S
C
C+I
600
550 C
500
450
400
350 |
300 |
250 |
200 | S
150 | |
100 | |
50 | | I
| | Y
50 100 150 200 250 300 350 400 450 500 550 600
-50

Income = Consumption + Investment

Lozano D., Valencia C.

 The Multiplier – the number of times money has changed hands and generate income.
 It depends very much on the marginal propensity to consume (MPC).
 MPC and Multiplier has a DIRECT relationship
(If the MPC is high, the multiplier is also high; if the MPC is low, the multiplier is
also low)
Multiplier (K) = 1 / 1-MPC

If MPC = .75 If MPC = .80

k=? k=?
1 1 1 1
K = 1−.75 = .25 K= =
1−.80 .20

K=4 K=5

 The Government and Equilibrium Income – with the addition of the government, the
theory can now be expressed in the following equation: (Y = C + I + G)
 If we add the value of the government spending to consumption and investment
spending, we can determine the level of 3 sectors comprising our model; the
household, he investors, and the government

 Full Employment Equilibrium – an ideal objective because at the level of income, there
is no available and useful resource that is wasted.

 Inflationary Gap – HIGHER than Government spending constant amount

 Lead to pressures for higher prices

 Deflationary Gap – LOWER than Government spending constant amount

 Lead to less income produce in the economy

Lozano D., Valencia C.

 Schedule of Income and Total Saving

Y C I G C+I+G

100 125 50 25 200

200 200 50 25 275
300 275 50 25 350
400 350 50 25 425
500 425 50 25 500

The amount of Government Spending:

Income generated (Yg) = G x K

100 = G x 4
100
G= 4
G = 25

 Fiscal Policy – is when the government uses its powers to influence total spending either
directly by changing its purchases of goods and services or indirectly by altering the
disposable incomes of persons through changes in the level of taxation or transfer
outlays.
 During periods of deflation or recession, economic policy dictates deficit budget
 Deficit Budget - means that the government can or should spend
more than what it collects through its taxes

 Tax Cut – taxes imposed on persons and on businesses are cut.

- If this happens, persons would have greater disposable incomes
and corporations would retain higher incomes.

 During Inflationary Periods, economic policy dictates a surplus or balanced

budget
 Surplus Budget – means the government should spend less than its
budget

Lozano D., Valencia C.