8. Determination of National Income and the role of Fiscal Policy

The Equilibrium Level of National Income The circular flow of income

The circular flow of income

The circular flow of income Cd

The circular flow of income Incomes Cd

The circular flow of income Incomes Cd W = S + T + M

The circular flow of income J = I + G + X Incomes Cd W = S + T + M

The Equilibrium Level of National Income Effect on national income of a change in injections and/or withdrawals J>W : national income rises W>J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve

Deriving equilibrium national income Cd, W, J W O Y

The Equilibrium Level of National Income Effect on national income of a change in injections and/or withdrawals J>W : national income rises W>J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve the injections curve

Deriving equilibrium national income Cd, W, J W J O Y

The Equilibrium Level of National Income Effect on national income of a change in injections and/or withdrawals J>W : national income rises W>J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve the injections curve equilibrium

Deriving equilibrium national income Cd, W, J W a J b O Y1 Y

Deriving equilibrium national income Cd, W, J W c Y2 J d O Y

Deriving equilibrium national income Cd, W, J W x J O Ye Y

The Equilibrium Level of National Income The Keynesian diagram: the income and expenditure approach the 45° line

Deriving equilibrium national income Cd, W, J Y = Cd + W W J O Y

The Equilibrium Level of National Income The Keynesian diagram: the income and expenditure approach the 45° line the expenditure curve

Deriving equilibrium national income Cd, W, J Y = Cd + W E = Cd + J Cd J W J O Y

The Equilibrium Level of National Income The Keynesian diagram: the income and expenditure approach the 45° line the expenditure curve equilibrium

Deriving equilibrium national income Cd, W, J Y = Cd + W E = Cd + J Cd e W f J O Y1 Y

Deriving equilibrium national income Cd, W, J Y = Cd + W E = Cd + J g h Cd W J O Y2 Y

Deriving equilibrium national income Cd, W, J Y = Cd + W E = Cd + J Cd z W x J O Ye Y

The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line

The multiplier: (a) a shift in injections W, J W a J1 Ye1 O Y

The multiplier: (a) a shift in injections W, J W b J2 Ye2 a J1 O Ye1 Y

The multiplier: (a) a shift in injections W, J Multiplier = DY / D J = DY / DW = c-a / b-c W b J2 J2 D J D W a J1 J1 c O Ye1 Ye2 Y DY

The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd)

The multiplier: (a) a shift in injections W, J Multiplier = DY / D J = DY / DW = c-a / b-c = 1/mpw W b J2 J2 D J D W a J1 J1 c O Ye1 Ye2 Y DY

The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd) graphical analysis: shift in the W line

The multiplier: (b) a shift in withdrawals W, J W1 a J O Ye1 Y

The multiplier: (b) a shift in withdrawals W, J W1 W2 a c J O Ye1 Ye2 Y

The multiplier: (b) a shift in withdrawals W, J Multiplier = DY / DW = c-a / a-b W1 W2 a c J DW b O Ye1 Ye2 Y DY

The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd) graphical analysis: shift in the W line The income and expenditure approach

The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd) graphical analysis: shift in the W line The income and expenditure approach graphical analysis: shift in the E line

The multiplier: (c) a shift in the expenditure curve E, W, J Y E1 Ye1 O Y

The multiplier: (c) a shift in the expenditure curve E, W, J Y E2 E1 O Ye1 Ye2 Y

The multiplier: (c) a shift in the expenditure curve E, W, J Y Multiplier = DY / D J = c-a / b-a E2 E1 c DY b D J a O Ye1 Ye2 Y

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap

The deflationary gap W, J W J O Ye Y

The deflationary gap W, J Deflationary gap W c J d O Ye YF Y

The deflationary gap W, J, E Y E O Ye YF Y

The deflationary gap W, J, E Y E a Deflationary gap b O Ye YF Y

The deflationary gap Y E W J W, J, E Y a b Deflationary gap c d O Ye YF Y

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap

The inflationary gap W, J W J O Ye Y

The inflationary gap W, J W J O YF Ye Y

The inflationary gap W, J Inflationary gap W g J h O YF Ye Y

The inflationary gap W, J, E Y E O Ye Y

The inflationary gap W, J, E Y E O Ye Y

The inflationary gap W, J, E Y E e Inflationary gap f O YF Ye Y

The inflationary gap Y E W J W, J, E Y e f Inflationary gap g h O YF

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap policy implications

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap policy implications Inflation and unemployment together

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap policy implications Inflation and unemployment together inflationary pressures before the full-employment level of income

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap policy implications Inflation and unemployment together inflationary pressures before the full-employment level of income implications for shape of AS curve

Unemployment and inflation AS1 Price level O YF Y

Unemployment and inflation AS2 AS1 Price level O YF Y

The Keynesian Analysis of Unemployment and Inflation 'Full-employment' national income 'Gap' analysis the deflationary gap the inflationary gap policy implications Inflation and unemployment together inflationary pressures before the full-employment level of income implications for shape of AS curve effect of an increase in aggregate demand

The effects of increases in aggregate demand on national output Price level O YP National output

The effects of increases in aggregate demand on national output AD4 AS AD3 AD2 Price level AD1 O Y1 Y2 Y3 Y4 YP National output

The Keynesian Analysis of Unemployment and Inflation The Phillips curve the shape of the curve

The original Phillips curve Wage inflation (%) Unemployment (%)

The Keynesian Analysis of Unemployment and Inflation The Phillips curve the shape of the curve the position of the curve

The original Phillips curve Wage inflation (%) Unemployment (%)

The Keynesian Analysis of Unemployment and Inflation The Phillips curve the shape of the curve the position of the curve policy implications of the curve

The Keynesian Analysis of Unemployment and Inflation The Phillips curve the shape of the curve the position of the curve policy implications of the curve the breakdown of the curve

The Keynesian Analysis of Unemployment and Inflation The Phillips curve the shape of the curve the position of the curve policy implications of the curve the breakdown of the curve recent relationship between inflation and unemployment

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 65 62 66 61 64 67 63 60 Unemployment (%)

Original Phillips curve Inflation (%) The breakdown of the Phillips curve? Original Phillips curve 65 62 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 74 71 73 72 70 69 65 62 68 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 76 74 77 79 71 73 78 72 70 69 65 62 68 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 71 73 82 78 72 70 85 69 84 65 62 68 83 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 90 71 73 82 78 89 72 70 91 85 69 84 65 88 62 68 83 87 66 95 92 86 61 64 67 94 63 93 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 90 71 73 82 78 89 72 70 91 85 69 84 65 88 83 62 68 98 87 66 97 95 92 86 61 64 67 94 96 63 01 00 99 93 60 Unemployment (%)

Keynesian Analysis of the Business Cycle The accelerator changes in national income and induced investment the accelerator effect the instability of investment The multiplier/accelerator interaction Fluctuations in stocks

Keynesian Analysis of the Business Cycle Determinants of the course of the business cycle why do booms and recessions persist? time lags 'bandwagon' effects why do booms and recessions end? ceilings and floors echo effects the accelerator random shocks changes in government policy

The Role of Fiscal Policy The purpose of fiscal policy correcting a fundamental disequilibrium fine tuning Deficits and surpluses central government deficits and surpluses public-sector deficits and surpluses the PSNCR the national debt

The Role of Fiscal Policy The use of fiscal policy automatic fiscal stabilisers discretionary fiscal policy

Effectiveness of Fiscal Policy Factors determining the effectiveness of fiscal policy accuracy of forecasting effect on J and W effect of changes in J and W on national income timing of the effects effects on the various macro objectives

Effectiveness of Fiscal Policy Discretionary policy problems of forecasting the magnitude of the effects effects of changes in government expenditure crowding out effects of changes in taxes size of the multiplier and accelerator effects random shocks problems of timing and time lags various time lags policy may be destabilising

Fiscal policy: stabilising or destabilising? Path (a): no intervention 3 4 Real national income 3 2 4 2 1 1 O Time

Fiscal policy: stabilising or destabilising? Path (a): no intervention Path (b): policy stabilises 3 4 Real national income 3 2 4 2 1 1 O Time

Fiscal policy: stabilising or destabilising? Path (a): no intervention Path (b): policy stabilises Path (c): policy destabilises 3 4 Real national income 3 2 4 2 1 1 O Time

Effectiveness of Fiscal Policy Side-effects of discretionary policy cost inflation welfare and distributive justice incentives A rules-based approach to fiscal policy a 'steady-as-you-go' policy the EU Stability and Growth Pact UK Labour government's 'Golden Rule'