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NATIONAL INCOME
RECAP!
Gross Domestic Product (GDP) is the most
comprehensive measure of the overall performance of an
economy or the nations total output of goods and services.
GDP using Expenditures Approach:
GDP = C + I + G + NX
Where:
C Consumption expenditures
I Investment expenditures
G Government expenditures
NX
Net exports of a nation during the year
INTRODUCTION
CONSUMPTION, INCOME AND SAVING
Consumption
- is usually the largest single component of GDP
Disposable Income
- is the amount of money that households have available
for spending and saving afterincome taxeshave been
accounted for.
Example:
Personal income
9,275
Less: Personal taxes ($9,275 * 12.5%)
(1,160)
Disposable Personal Income
8,115
Less: Personal Outlays (C + Int.)
(7,815)
Personal Savings (amt.)
300
CONSUMPTION FUNCTION
This function shows the relationship between the level of
consumption expenditures and the level of disposable
income.
C = a + b (Y)
Where:
C = Consumer Spending
a = Autonomous Consumption
b = Marginal Propensity to Consume
Y = Disposable Income
This suggests consumption is primarily determined by the
level of disposable income.
If income is low, people will have to spend a high
proportion of their income. If income is high, people will
have the luxury to save.
Illustration:
C
Savings
28,000
26,000
Break-even point
24,000
22,000
Consumption
20,000
18,000
45
20,000
28,000 30,000
DETERMINANTS OF CONSUMPTION
1. Consumer Disposable Income
C = a + b (Y)
2. Permanent Income and the Life-Cycle Model of
Consumption
Permanent Income is the income after removing
temporary or transient influences due to the weather
or windfall gains or losses.
Permanent-income theory states that consumption
responds primarily to permanent income.
Life-cycle hypothesis assumes that people save in order
to smooth their consumption over their life-time.
3. Wealth and Other Influences
Wealth effect higher wealth
consumption.
leads
to
higher
INVESTMENT FUNCTION
Investments two (2) important role in Macroeconomics:
Affects short-run output through its impact on
aggregate demand.
Affects long-run output growth through the impact of
capital formation on potential output and aggregate
supply.
Capital or real investments refer to additions to the
stock of productive assets or capital goods like computers
or trucks.
Financial investments refer to buying shares, stocks,
bonds and securities which already exist in stock market.
Why do people invest?
They expect a profit.
Revenues > Costs
Autonomous Investment
- is independent of the level of income and is thus
income inelastic.
- is affected by factors like innovations, inventions,
growth of population and labor force, researches, social
and legal institutions, weather changes, war, revolution,
etc.
- regarded as public investment.
1,000
G
F
800
E
600
D
400
C
200
B
0
-200
Savings
GOVERNMENT
FUNCTION
GOVERNMENT CONSUMPTIONS
EXPENDITURES AND GROSS
INVESTMENT
In
EXCLUSION OF TRANSFER
PAYMENTS
Government transfer payments are government
payment to individuals that are not made in
exchange for goods and services supplied..
these payments meet important social purposes but,
since they are not purchases of current goods or
services they are omitted from GDP
One peculiar government transfer payment is the
interest on the government debt. Interest is treated
as a payment for debt incurred to pay for past wars
or government programs and is not considered to be
purchase of a current good or service. Government
interest payments are considered transfers and are
therefore ommited from GDP..
TAXES
Wherever the dollars came from, the statistician
computes the governmental component of GDP as
the actual cost to the government of the goods and
services.
While it is fine to ignore taxes I the flow of product
approach, however we must account for taxes in
the earnings or COST APPROACH to GDP.
NET EXPORTS
Exports-Imports= Net Exports
The Phil. GDP represents all goods and
services within the boundaries of the Philippines.
Production differs from sale in the Philippines in
two aspects:
Some of our production (agricultural piroducts)
is bought by foreigners and shipped abroad and
these items constitute our EXPORTS
Some of what we consume is produced abroad
and shipped to the Philippines and these items
constitute our IMPORTS
EXAMPLE:
Suppose that Philippines produces 100 bushels of
corn and 7 bushels are imported. Of these, 87
bushels are consumed (C), 10 go for government
purchases to feed the army (G) ang 6 go into
domestic investment as increases in inventories (I).
In addition, 4 bushels are exported.
Net exports= -3.
GDP= 87 (C) + 10 (G) + 6 (I) -3 (NE)
AUTONOMOUS EXPENDITURE
AUTONOMOUS GOVERNMENT
PURCHASES
-Government purchases by the government
sector that do not depend on income or production
(especially national income or gross domestic
product). That is, changes in income do not
generate changes in government purchases.
-are government purchases by thegovernment
sectorthat are unrelated to and unaffected by the
level of income or production.
1
AUTONOMOUS: AN EQUATION
One way to provide an illustration of autonomous
government purchases (and the relation to induced
government purchases) is with a general linear
government purchases equation, such as the one
presented here:
G = g + hY
where: G is government purchases, Y is income
(or aggregate production), g is the intercept, and
h is the slope.
INDUCED GOVERNMENT
PURCHASES,
-government purchases that are based on the level
income or production
An Autonomous Intercept: The intercept of the
government purchases equation (g) measures the
amount of government purchases undertaken if
income is zero. If income is zero, then
government purchases is $g. The intercept is
generally assumed and empirically documented
to be positive (0 <g).
Marginal
Propensit
y to
Consume
MPC =
Consumptio
n
Expenditur
e
MPC
Net
Saving
A 24000
24200
800/1000= 0.8
-200
200/1000=0.
2
B 25000
25000
800/1000= 0.8
200/1000=0.
2
C 26000
25800
800/1000=0.8
200
200/1000=0.
2
D 27000
26600
800/1000=0.8
400
200/1000=0.
2
E 28000
27400
800/1000=0.8
600
200/1000=0.
2
F 29000
28200
800/1000=0.8
800
200/1000=0.
2
G 30000
29000
800/1000=0.8
1000
200/1000=0.
Disposabl
e Income
MPS
KEY POINTS:
The MPC is always less than 1.
If a consumer receives a dollar of income,
consumer will spend some of it and save the
rest.
The fraction that the consumer spends is
determined by the MPC
The fraction of income that the consumer
saves is determined by the marginal
propensity to save (MPS)
The sum of the MPC and MPS is always 1
MARGINAL PROPERTY TO
CONSUME AS GEOMETRICAL SLOPE
MARGINAL PROPENSITY TO
SAVE
It is defined as the fraction of an extra dollar of
disposable income that goes to extra saving.
It indicates the change in saving resulting from
a change in income. In fact, if the MPC and
MPS are calculated based on after-tax
disposable income, then the two marginals
sum to one:
MPC + MPS = 1.
MPS =
DEFINITION OF
TERMS::
Consumption Function- relates the level of
consumption to the level of disposable income
Saving Function- relates saving to disposable ;
what is saved equals what is not consumed,
saving and consumption schedules are mirror
images
The Multiplier
WHAT IS A MULTIPLIER?
A
INVESTMENT
The value of an investment multiplier is a
function of several factors , including the
marginal propensity to save (MPS) and
marginal propensity to consume (MPC) of the
people whose payment for labor constitutes the
investments expenditure.
EXAMPLE:
If the marginal propensity to consume of a project's
workers is 0.75, then 75% of the workers' income is
spent on goods and services that produce income for
another individual or business, and 25% of their
income is withdrawn from circulation by means of
savings, taxation or expenditures on foreign goods
and services. This same project has an investment
multiplier of 4, which means that for every $1 spent
on investment, another $4 of income is generated.
The investment multiplier is calculated as 1/(1MPC), or 1/(1-0.75), in the example.
TAX MULTIPLIER
EXAMPLE:
Simple Tax Multiplier = MPC/MPS = MPC / (1 MPC)
Where,
MPSstands for marginal propensity to save (MPS); and
MPCis marginal propensity to consume
MPS equals 1 MPC
Given the same value of marginal propensity to consume,
simple tax multiplier will be lower than the spending
multiplier. This is because in the first round of increase
in government expenditures, consumption increases by
100%, while in case of a decrease in taxes of the same
amount, consumption increase by a factor of MPC.
Increasing
government
expenditures
and
investment is more effective than decreasing
taxes in increasing the GDP because it requires
lower increase in budget deficit. The target
increase in GDP of $40 billion can be achieved by
increasing
government
expenditures
and
investment by $10 billion. $13.3B of tax reduction
would be needed if the country decides to achieve
the target growth in GDP by decreasing taxes.
This is because spending multiplier is higher
than the tax multiplier. Relevant calculations are
shown below.
GOVERNMENT EXPENDITUES