3 sector model managerial Economics .pdf

3 sector model explaination of Economics

1. National Income Determination
Three-Sector National Income Model
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2. Three-Sector Model
◦Output-Expenditure Approach: Equilibrium
National Income Ye
◦Injection-Withdrawal Approach: Equilibrium
National Income Ye
Fiscal Policy
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3. With the introduction of the government
sector (i.e. together with households C, firms
I), aggregate expenditure E consists of one
more component, government expenditure G.
E = C + I + G
Still, the equilibrium condition is
Planned Y = Planned E
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4. Government expenditure is made up of two
parts
◦Government expenditure on current production, G
◦Transfer payments, Q
Government also collects tax revenues, T
Government budget may be defined as
◦T-(G + Q)
When positive, there is a government surplus
When negative, there is a government deficit
When zero, there is a balanced budget
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5. Assumptions about the Government
component of AE
◦Government expenditure on current production is
assumed constant, G= G*
◦Transfer payments are also an autonomous
expenditure flow, Q= Q*
Additional assumptions
◦All transfer payments are made to households
◦All taxes are direct taxes on personal and company
incomes
◦Tax rate is levied at a flat rate, T= tY where 0<t<1
i.e. taxes are a constant proportion of national income
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6. In the 2-sector model, all national income
was paid out to households
◦Households decided to consume or save amounts
◦National income, Y= disposable income, Yd
Introduction of taxes and transfer payments
drives a wedge between national income and
disposable income
◦Yd= Y-T + Q
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7. We continue to assume C= cYd
◦Households spend a fraction of disposable income
and save the rest
Given that Yd= Y-T+Q,
C= c(Y-T+Q)
=cY–cT+ cQ, but T= tY
=cY–ctY+ cQ
= c(1 –t) Y + cQ
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8. Aggregate expenditure has three components
◦E= C + I + G
At the equilibrium,
◦E = Y
Derive the aggregate expenditure function
assuming the following
◦Yd= Y –T + Q
◦G= G*
◦Q= Q*
◦T= tY
◦I= I*
◦C= cYd
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9. E= C + I + G
= cYd+ I* + G*
= c( Y –T+ Q*) + I* + G*
= c(Y –tY+ Q*) + I* + G*
At equilibrium, Y= E
Y = c(1-t) Y+ cQ* + I* + G*
Y-c(1 –t) Y= cQ* + I* + G*
Y[1 –c(1 –t)] = cQ* + I* + G*
Y = 1/ [1 –c(1 –t)] (cQ* + I* + G*)
Expenditure depends on two main terms
◦The sum of the three autonomous flows: Q*, I*, G*
◦Behaviouralpatterns of consumption, c, and taxation, t
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10. 10

11. What is the effect of changes in autonomous
expenditure flows and the tax rate, t, on
national income?
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12. An increase in G or
I shifts the AE curve
upwards
Increase in national
income
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13. An increase in transfer payments will also
increase national income
◦How?
However, an extra Ghc1 spent on final
government expenditure, G, increases
national income by more than Ghc1 spent on
transfer payment, Q.
◦Why?
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14. A cut in tax rates
implies that a larger
proportion of each
Ghc1 reaches
households as
disposable income
Therefore, the
propensity to
consume increases
AE becomes steeper
Increase in national
income
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15. How large is the change in national income
from a given change in autonomous
expenditure?
To determine this, we need to solve the
following algebraically:
◦Ye/I
◦Ye/G
◦Ye/Q
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16. Recall from the income expenditure approach
◦Equilibrium national income is given by
Y = 1/ [1 –c(1 –t)] (cQ* + I* + G*)
◦Solution?
◦Ye/I
◦Ye/G
◦Ye/Q
What do you notice about the change in income
from a change in investment, I*, or government
expenditure, G*?
What do you notice about the value of the
transfer payments multiplier, Q*?
◦Is it larger or smaller? Why?
◦Under what conditions are al three multipliers equal?
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17. In a 3-sector model, national income is either
consumed, saved or taxed by the government
Y = C + S + T
Given E = C + I + G
In equilibrium, Y = E
C + S + T = C + I + G
S + T = I + G , but G= G + Q (Q= cQ)
S + T = I + G + cQ
i.e. withdrawals = injections
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18. Graphical Approach
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19. Graphical Approach
◦An increase in any component of aggregate
expenditure shifts the injections curve upwards
And vice versa
◦A fall in the tax rate increases the amount of
disposable income, and the propensity for
increased consumption
This is illustrated by a flatter (i.e. smaller value of t)
withdrawals curve, leading to increased equilibrium
national income
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20. An algebraic approach
◦We define savings, S= s(Y-T)
◦i.e. the part of national income that is saved
◦Other assumptions
T= tY
Q= Q*
I= I*
G= G*
◦At the equilibrium, Withdrawals = Injections
◦Withdrawals = s(1-t)Y + tY= Y[s(1-t) + t]
◦Injections = I* + G* + cQ*
◦At the equilibrium,
◦Y =1/ [s(1-t) + t] x (I* + G* + cQ*)
Is this the same equilibrium as obtained under the income-expenditure
approach?
Derive the multipliers for investment and government expenditures, and
transfer payments.
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21. Y = Multiplier* G*
There are several problems with this method
of analysis, i.e., Y may be less
◦Sources of financing G*
◦Effects on private investment I*
◦Productivity of government projects
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22. Sources of financing G’
Increasing Tax
◦will exert a contractionary effect on the economy
Increasing Money Supply
◦will generate an inflationary pressure
Prices assumed constant
Increasing Debt/ Private sector borrowing
◦will increase the demand for loanable fund as well as
interest rate affect private investment
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23. Effects on Private Investment I’
Private investment may be crowded out when
government increases its expenditure
◦It is questionable that the government can really
produce something which is desired by the
consumers
Besides, government investment projects are
usually less productive than private investment
projects
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24. Productivity of Government Projects
Government projects may not yield a rate of
return (MEC / MEI) exceeding the market
interest rate.
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25. Using the mechanistic Keynes Theory of
National Income, explain the causes and
solutions to the Great Depression of 1929.
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26. Money and its Functions
The origin of money
Modern money and definition of monetary
aggregates
Commercial Banks and Money Creation
The Central Bank and its functions
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