Equilibrium level of national income and government expenditure

Equilibrium take of subject income and goernment expenditureIn an open miserliness, the billhook flow stick of study income consists of five sectors as shown in strain 1 below. realize 1 Circular Flow of National Income in a five Sector ModelThe figure above illust lays the five sector circular flow set, which can be described as a model based on income flows from one sector of the economic system to another in a circular flow motion, which explains the train of national income.The main sectors of the economy include households and firms. In the two sector model consisting only of households and firms, the economy is evermore at residual. That is Income (Y) is always equal to consumption (C). However, the economy cannot be limited only to these two sectors. The effects of banks, political relation and international portion out must be taken into consideration. These three sectors bring about withdrawals and injections. The monetary sector mobilises savings (S) from h ouseholds and makes investments (I) to firms. The government sector collects taxes (T) from households and makes expenditure (G) on firms. Finally, in the balance of payments sector, part of household income is spent on imports (M) while somewhat revenue is received as exports (X).Since the two sector model always takingss to sense of equilibrium, any distortion in equilibrium get out turn out from the partake of the other three sectors. From the figure above, the national income is devoted byY = C +S+T+M (I+G+X)For equilibrium to be achieved, keep down leakages must be equal to total injections. That is, S+T+M = I+G+X. therefore, the equilibrium level of national income is scarcely given byY=C.The Keynesian cross model shows how consumption is determined. Under normal conditions, households exit consume all goods and go produced. In this end, consumption impart be exactly equal to income. This is represented by the 45 degree line in figure 2 below. Keynes celebrated that the affinity between consumption and income could not be perfect as the one depicted by the 45 degree line. He state that not everybody in the economy earns income but everybody consumes. Therefore, in that location is a received amount of consumption that does not depend on income and a sure amount that depends on income. From the foregoing, Keynes suggested the following consumption prevail (Mankiw, 2009 497)Where = constant is be as the consumption that does not depend on income c is the monger of the consumption function referred to as the marginal proneness to consume. The marginal propensity to consume lies between 0 and 1. This indicates that consumption annexs as income adds but the rate of ontogeny in consumption is not as much as the rate of ex be in income (Mankiw, 2009 496).Figure 2 The Keynesian swing out450Consumption (C)National income (Y)Y*According to the Keynesian cross model, the equilibrium level of national income Y* is achieved at the point where the consumption function intersects the 45-degree line. At this point, all income that is earned is consumed. This is also the point where the desired level of spending is equal to the national income (Suranovic, 2005). mix penury (AD) is the total or compound expenditure of final goods and function in an economy over a given period of time say one pecuniary year. The amass demand is represented depending on whether it is a closed or open economy. For an open economy, the gist demand is given byY = AD = C+I+G+X-MFor a closed economy, the aggregate demand is given byY = AD = C+I+GIn the closed economy case, X-M is considered to be zero since there are neither imports nor exports.The aggregate demand curve is downward sloping. It shows the relationship between the quantity of real GDP demanded and the price level (Parkin, 2009 324). The AD curve is as shown in the figure below.Figure 3 pile up Demand (AD) CurveADPrice take aim (P)National income (Y) aggregate supply (AS ) refers to the aggregate or total supply of final goods and services or real GDP in an economy over a given period of time. The national income or real GDP is given byY = GDP = C+I+G+X-M. inappropriate the AD curve, the AS curve is upward sloping. It shows the relationship between aggregate supply of final goods and services and price levels. This is represented in figure 4 below.ASPrice Level (P)National income (Y)Figure 4 Aggregate Supply (AS) CurveFigure 5 Aggregate Demand-Aggregate Supply poser (Macroeconomic Equilibrium)ASPrice Level (P)National income (Y)Y*P*ADMacroeconomic equilibrium is defined as a situation where aggregate demand and aggregate supply are equal without any style for change (Chiang and Wainwright, 2005 30). At this point a given price level ensures that the final goods and services demand is exactly equal to the final goods and services supplied. As shown in figure 5 above, this price level is referred to as the equilibrium price level (P*) and the real GDP or national income at this price level is the equilibrium level of national income (Y*). At this level of national income, the aggregate supply curve intersects the aggregate demand curve.Multiplier effect caused by an Increase in Government uptakeFrom the circular flow model above, a multiplier effect from government expenditure will lead to an addition in government expenditure. Firms will enlarge investment in capital goods, employment will increase, and compensation will increase. The increase in wages will lead to an increase in consumption, savings and taxes. Both imports and exports will also increase.In the long-run, the total amount of leakages will exactly equal the total amount of injections. There will be an overall increase in national income and the equilibrium level of national income will be higher than before.Using the Keynesian Cross, an increase in government expenditure will result to an increase in national income through increases in wages, consumption, savings, investment, imports and exports.450Consumption (C)National income (Y)Y*Y1*As income rises, the average propensity to consume (APC) which measures slope of the line from the outset to the consumption function will decrease (Mankiw, 2007 497). This will lead to an increase in the equilibrium level of national income from Y1*.ASPrice Level (P)National income (Y)Y*P*ADAD1AS2In the AD/AS model, an increase in government expenditure will result to an increase in aggregate demand. An increase in aggregate demand will motivate firms to increase investment. Employment will increase leading to an increase in wages. Savings will increase as well as taxes. In addition imports and exports will rise. The overall effect will be an increase in aggregate supply and aggregate demand. This will result to a rightward shift in the aggregate demand and supply curves as shown in figure 6 below.Consumer ConfidenceIf consumer assurance is high, people tend to consume more of current income. In t he circular flow model, the multiplier effect will be higher if consumer confidence is high. That is the respond to an increase in government spending will be higher than the case would be if consumer confidence is low. Households will consume more of their current levels of income as they anticipate an increase in future income. In like manner, firms will increase investment, employment will increase, and savings will reduce. Moreover, taxes will increase as well as imports and exports.In the Keynesian cross model, consumer confidence will lead to an increase in the marginal propensity to consume. commonwealth will be willing to consume more of their current incomes as they anticipate increases in future incomes.In terms of the AS/AD framework, a higher consumer confidence will lead to a square increase in aggregate demand. This will in turn result to higher rates of investment spending, taxes, imports and exports. The overall impact will be a rightward shift in the AS and AD cur ves to establish a new equilibrium level of national income.