The Keynesian Theory of Determination of National Income.pptx

The keynesian theory of determination

1. The Keynesian Theory of Determination of National Income Understanding the foundational concepts of national income determination is the first step in mastering macroeconomics. MADE BY: AARUSHI GUPTA COURSE :B.COM

2. The Two-Sector Economy: Households & Businesses The two-sector model is the simplest representation of a closed economy, excluding government spending (G) and foreign trade (X-M). Households (C) Businesses (I) Businesses produce goods and services, and they make investments, shown as I. Households provide land, labor, and capital. They earn income and spend it mostly on consumption — that’s represented by C So the total spending in this model is: AE=C+I which means Aggregate Expenditure equals Consumption plus Investment.

3. Aggregate Expenditure and National Income Keynesian equilibrium focuses on Aggregate Expenditure (AE) as the driver of national income (Y). 1 Total Spending Defined Aggregate Expenditure (AE) is the total planned spending in the economy, which in this model is the sum of Consumption and Investment. The Consumption Function Consumption (C) is directly related to disposable income (Y\_d). The functional form is: Autonomous Consumption (a) Even if people have zero income, they still spend a little — that’s called autonomous consumption. Marginal Propensity to Consume (b) when income rises, people spend more — the rate at which they do so is called the marginal propensity to consume.

4. Equilibrium and the Keynesian Cross Equilibrium in the economy occurs when the total quantity of goods and services produced (National Income, Y) equals the total planned spending (Aggregate Expenditure, AE). The Keynesian Cross visually represents this equilibrium at the intersection of the AE line and the 45° line (where AE = Y). Disequilibrium 1: AE > Y If aggregate expenditure exceeds income, there is unplanned inventory depletion. Businesses must increase output and income to reach equilibrium. Disequilibrium 2: AE < Y If aggregate expenditure is less than income, there is unplanned inventory accumulation. Businesses must cut production, causing income to fall back to equilibrium. The Multiplier Effect : The multiplier demonstrates how an initial change in autonomous spending (like investment) leads to a larger final change in national income.

5. TO SUM UP National income is determined by aggregate demand, Equilibrium happens when planned spending equals total output, And small changes in investment can have big effects on income through the multiplier.