NATIONAL INCOME

DETERMINATION
Demand Estimation
 is a process that involves coming up
with an estimate of the amount
of demand for a product or service.
- a situation in which the quantity
of a good or service supplied is
more than the quantity demanded.
The Consumption Function
 Consumption function or Keynesian
consumption function, is an economic
formula representing the functional
relationship between total consumption and
gross national income.

C = a + by
 - act of using goods and services
to satisfy human wants.
 - is the minimum level of consumption or
spending that must take place even if a
consumer has no disposable income.

C = a + by
Autonomous
Consumption
 - consumption depends on income and
varies with income changes.

Induced Consumption
C = a + by b= Marginal Propensity to
Consume (MPC)

y= Disposable Income
(Income – taxes)
C = a + by Break-even point is the
point where consumption is
Given: Given: equal to income.
a = 50 a = 50
constant constant
b = .75 b = .75
y = 100 Break-even point = ? Schedule of Income and Consumption
C=? Income (Y) Consumption (C)
C = 50 + .75y
C = 50 + .75(100) 100 125
y = 50 + .75y
C = 50 + 75
y - .75y = 50
C = 125 200 200
.25y = 50
y = 200 300 275

400 350

500 425

600 500
 Income Line y=c+s
Consumption
c+1
c
700
600
Equilibrium
500 Income

400
300
Break-even
200 point

100

45°
yd Disposable Income
100 200 300 400 500 600 700
 The
Savings Function
Saving is defined as the difference
between disposable income and consumption:

S= Y-C
where S is saving
Y is income and
C is consumption
Income Consumption Savings

150 175 (25)

250 200 50

350 250 100

450 300 150

MPC AND MPS
Marginal Propensity to Consume
Marginal Propensity to Save
• The marginal propensity to consume (MPC) is
the proportion of an aggregate raise in pay
that a consumer spends on the consumption
of goods and services, as opposed to saving it.

• (MPC) is equal to ΔC / ΔY, where ΔC is

change in consumption, and ΔY is change in
income.
Income Consumption MPC

150 175

200-175 25
250 200 0.25
250-150 100

250-200 50
350 250 0.50
350-250 100

300-250 50
450 300 0.50
450-350 100
The marginal propensity to save is the proportion of an
aggregate raise in pay that a consumer spends on saving
rather than on the consumption of goods and services.

(MPS) is equal to ΔS / ΔY, where ΔS is change in

Savings, and ΔY is change in income.
Income Savings MPS

150 (25)

50-25 25
250 50 0.25
250-150 100

100-50 50
350 100 0.50
350-250 100

150-100 50
450 150 0.50
450-350 100
 Factors affecting
aggregate demand
• A change in the wage unit. Consumption is
obviously much more a function of real income
than money income. In a given state technique
and taste of social condition determining the
distribution of income, a man’s real income will rise
and fall with the amount of his command over
labor units.
• A change in difference between income and net
income. The amount of consumption depends on
net income rather than on income since it is by
definition, his net income that a man has primarily
in mind when he is deciding his scale consumption.
•Windfall changes in capital values not
allowed for calculating net income.
These are much more important in
modifying in prosperity to consume,
since they will bear no stable or regular
relationship to income.
•Changes in the rate of time discounting.
It allows for future changes in the
purchasing power of money in so far as
these are frozen.
• Changes in fiscal policy. So far as the
inducement to individual to save depends on
the future return which he expects, it clearly
depends not only on the rate of interest but
on the fiscal policy of the government.
• Changes in expectations of the relation
between the present and the future level of
income. It may affect considerably a
particular individual’s prosperity to consume,
it is likely to average out for the community as
a whole. Moreover, it is a matter about which
there is, a rule. To much uncertainty for it
exert much influence.
 The
Multiplier
 In Mathematics, the multiplier is the
number by which the multiplicand is
multiplied. In business and economics, the
multiplier behaves in the same manner. The
multiplier is the number of times money has
changed hands and generate income.
 Let us say you have a peso. You use this to buy
cigarette from a cigarette vendor. The cigarette
vendor, thus earn a peso income. The cigarette vendor,
on the other hand, uses this peso to buy cigarette
from a store. The store owner, thus, receives the peso
and earn a peso income. The store owner, in turn,
would buy cigarette from a distributor. The
distributor, thus, receives a peso income. The
distributor, in turn, would use the peso to buy
cigarettes from a cigarette factory. The factory
owner, thus, finally receive the peso. If we trace the
number of times the peso changed hands and generate
income, we will notice that it is used five times.
 The multiplier depends very much on the marginal
propensity to consume (MPC). If the marginal propensity
to consume is high, the multiplier is also high; if the MPC
is low, the multiplier is also low.

1
Multiplier (K) =
1−𝑀𝑃𝐶

If MPC = .75 If MPC = .80

K=? K=?
1 1
K=
1
=
1
K= =
1−.75 .25 1−.80 .20
K= 4 K=5
 In our example, the amount of investment was worth P50 billion,
and the marginal propensity to consume was 75%. At 75% marginal
propensity to consume, the multiplier is 4. the amount of income
generated (Yg) was, thus, P200 billion (P50 billion x 4 = P200
billion). This can be shown in the following equation:

Yg = Inc. x K
Where:
I = P50 billion
K=4
Yg = P200 billion
(P50 billion x 4)
 THE GOVERNMENT
AND
EQUILIBRIUM INCOME
(Y = C + I + G)
 With the addition of the government in our analysis,
the theory of income determination can now be expressed
in the following equation: Y = C + I + G. If we add the value
of government spending to consumption and investment
spending, we can determine the level of total spending
done by the three sectors comprising our model; the
households, the investors, and the government.
Let us assume the government spending (G) is constant
in the short run. If the government spending is constant
at P25 billion regardless of the level of income, we shall
arrive at the following table.
 Table 22
Schedule of Income and Total Saving
(in million pesos)

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

 Full employment equilibrium is an ideal objective because
at that level of income, there is no available and useful
resource wasted. Under this situation, we will not
experience any surplus of production which would pressure
producers to limit their production in the future to avoid
spoilage or storage fees. Nor would the economy experience
excess demand which would pressure prices to go up.
Let us say that full employment equilibrium in the
economy is estimated to be at P500 billion. In order to fill
up the gap, one way of doing it is government spending (G).
 How much should the government spend to generate an
income equivalent to the gap of P100 billion? We have to
remember that government spending, is an inflow in the
circular flow. The government cannot just spend P100 billion
in order to fill up a gap of P100 billion. There is the
multiplier to reckon with.
We can go back to the equation, Income Generated (Yg) =
Investment x Multiplier (K). This time since Investment and
Government Spending are inflows in the circular flow, we
can re-state the equation thus,
Yg = G x K
 At MPC of 75%, we know that multiplier is 4.
We know that gap is P100 billion. The amount
of government spending can, therefore, be
derived as:

Yg = G x K
100 = G x 4
G = 100/4
G = 25
 Thus, to fill up the amount of government spending
(G) should be P25 billion. If more than P25 billion is
spent, an inflationary gap would occur. This means
that aggregate demand (C+I+G) would exceed
equilibrium income (Y) leading to pressures for
higher prices. If less than P25 billion is spent, this
would result in a deflationary gap. This means that
aggregate demand (C+I+G) would fall short of
equilibrium income (Y) leading to less income
produced in the economy.
Fiscal Policy
• When the government uses the 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, we
have fiscal policy

• Fiscal Policy is the means by which a government

adjust its spending levels and tax rates to monitor and
influence a nation’s economy.
Although the fiscal effects of national and local
governments are enormous, such sub-national
government cannot conduct systematic fiscal policy
because they cannot run unlimited deficits. They have
to try to make ends meet or they will lose their credit
ratings, and they are, therefore, bound by a
budgetary constraint.
Theoretically, government spending is easier to handle than
investment. During periods of deflation or recession, economic
policy dictates deficit budget

deflation means reduction of the general level of prices in an

economy

deficit budget is an indicator of financial health in which

expenditures(gastos) exceed revenue(kita)
This means that the government can or should spend
more than what it collects through its taxes

Example
if the budget of the government is P100 billion,
during periods of recession the government spend more
than P100 billion.
Spending more would mean that more money would be injected
in the economy, thus, promoting more spending which can be
translated into more sales, more employment, more incomes, and
higher levels of production. During this period, tax cuts can also
be resorted to. That cuts mean that the taxes imposed on persons
and on business are cut
tax cut is the reduction in taxes. The immediate effects of a
tax cut are a decrease in the real income of the government and
an increase in the real income of those whose tax rate has been
lowered
. If this happens, person would have greater disposable
incomes and corporations would retain higher incomes.
Higher income would be translated into more inflows into
the circular flows, thus, activating the economy through
higher consumer and business spending.
During inflationary periods, economic policy dictates a
surplus or balanced budget.

inflation is the rate at which the general level of prices

for goods and services is rising and consequently, the
purchasing power of currency is falling.
Surplus budget means that the government should spend less than
its budgets. For example, if the budget of the government is P100
billion, the government should spend less than P100 billion and
retain some surplus in the budget. Spending less would mean that
the aggregate demand would become less, thus, dampening
demand for goods and services. Less demand for goods and
services. Less demand for goods and services would eventually
arrest price increase until they are lowered for reasonable levels.
During this period, tax increases can also be sorted to. Reasonable
tax increases would mean less income in the hands of consumers
and business firms. Less consumer and business demands would
mean lower aggregate demand. Less demand for goods and
services would later on be translated into lower economic activity,
thus, minimizing the “heat” from an already “overhead” economy.