Macro economic equilibrium

Y = E
W = J

1. Macro economic equilibrium Unit 05

2. Prepared by ; RASHAIN PERERA 077 059 37 52 [email protected]

3. What is macro economic equilibrium? Macro economic equilibrium is determined by aggregate demand (aggregate expenditure) and aggregate supply (total output). Macro economic equilibrium could be shown in terms of a graph simply as shown below.

4. At the equilibrium AD = AS Y = E W = J Price Quantity S D

5. Y = E condition Y represents the income E represents the expenditure As explained in chapter 04, Y = E Y = C + S + T + M E = C + I + G + X

6. (Y) Aggregate income/ supply Aggregate supply is the total amount of goods and services supplied or produced by an economy in a given period of time usually a year at a given overall price level. In other words it is the total output of the economy

7. Y = C + S + T + M Consumption ; the amount that is spend on day to day activities from the disposable income is simply known as the consumption expenditure Yd. = income – direct taxes (T) + state benefits ( Tr )

8. Consumption function Consumption function shows the relationship between planned consumption and disposable income . There is a direct or positive relationship between planned consumption and disposable income. C = a + b ( Yd ) a- autonomous consumption  

9. Marginal propensity to consume This is the proportion of the extra income which is spent on consumption . In other words it is the extra spending on consumption out of the additional income. MPC = change in consumption / change in income Average propensity to consume This can be calculated by simply dividing consumption by income .

10. Factors influencing consumption or MPC other than income Distribution of income The rate of interest The availability of credit Taxation Wealth expectations

11. Y = C + S + T + M Savings ; It is the balance income part, after paying for consumption and taxes. Savings could be defined as income minus consumption S = Yd – C

12. Savings function Savings function shows the relationship between planned savings and disposable income . The savings function is the converse or opposite of consumption function . S = -a + b(Y)

13. Marginal propensity to save This is the proportion of the extra income which is saved . In other words it is the percentage change in income which will go to savings. It is equal to change in planned savings divided by change in disposable income . MPS = change in S / change in Y Average propensity to save This is the proportion of disposable income which is saved . APS = savings / income

14. The factors determining savings other than income interest rates inflation expectations

15. The relationship between MPC and MPS Consumption plus savings must equal income . Thus the change in disposable income is either consumed or saved. MPC + MPS = 100% of the change MPC + MPS = 1 1 – MPC = MPS 1 – MPS = MPC

16. The relationship between APC and APS APC + APS = 100% of the total APC + APS = 1 1 – APC = APS 1 – APS = APC

17. (E) Aggregate Exp./ Demand Aggregate demand is the sum of all planned expenditures in the economy. The aggregate demand shows the amount of goods and services in the whole economy that are demanded by all macro economic agents at any given price level.

18. E = C + I + G + X Investment ; is the addition to the capital stock . In other words it is the expenditure incurred by business firms for investments . Investment function I = I0 The planned level of investment varies inversely with the rate of interest in i.e. higher the rate of interest; lower will be the level of planned investment and vice versa The determinants of planned investment the relative price of capital and labor technological changes government policies attractiveness of the country for foreign investments

19. W = J condition W represents the Withdrawals J represents the injection W = J W = S + T + M J = I + G + X

20. (W) Withdrawals Leakages subtract from the total volume of the basic circular flow of income . That is they leak income away from the product markets . W = S + T + M

21. (J) Injections Injections add to the total volume of the basic circular flow of income . That is they inject revenue into the market J = I + G + X

22. Circular flow of income Presentation of equilibrium

23. Simple economy-2 sector Bank S I

24. Closed economy-3 sector Bank S I State S T

25. Open economy-4 sector Bank S I State S T M X

26. Equation method To present the equilibrium

27. Simple economy Y = E Y = C + I W = J S = I

28. Closed economy Y = E Y = C + I + G W = J S + T = I + G

29. Open economy Y = E Y = C + I + G + NX W = J S + T + M = I + G + X

30. Schedule method To present macro equilibrium

31. Simple economy Y C(MPC=.8) S/W I/J E 500 400 100 200 600 600 480 120 200 680 700 560 140 200 760 800 640 160 200 840 900 720 180 200 920 1000 800 200 200 1000 1100 880 220 200 1080

32. Closed economy Y C(MPC=.8) S I G E W J 500 400 100 100 40 540 100 140 600 480 120 100 40 620 120 140 700 560 140 100 40 700 140 140 800 640 160 100 40 780 160 140 900 720 180 100 40 860 180 140 1000 800 200 100 40 940 200 140 1100 880 220 100 40 1020 220 140

33. Open economy Y C(MPC=.8) S I G X M E W J 500 400 100 100 40 1000 960 600 1060 1140 600 480 120 100 40 1000 960 660 1080 1140 700 560 140 100 40 1000 960 740 1100 1140 800 640 160 100 40 1000 960 820 1120 1140 900 720 180 100 40 1000 960 900 1140 1140 1000 800 200 100 40 1000 960 980 1160 1140 1100 880 220 100 40 1000 960 1060 1180 1140

34. Graphical method To present macro equilibrium

35. Multiplier effect

36. = MPC/MPS = 1 / MPS

37. Investment rounds