The Keynesian Theory of Determination of National Income in Two Sector Model
The Keynesian theory of national income determination focuses on the role of aggregate demand in determining the level of national income in an economy. According to this theory, the level of national income is determined by the level of aggregate demand, which is composed of consumption, investment, government spending, and net exports. In a two-sector model, aggregate demand is composed of consumption and investment.
The two-sector model assumes that the economy is composed of two sectors: the household sector and the business sector. The household sector consists of individuals who consume goods and services, while the business sector consists of firms that produce goods and services.
In this model, the level of national income is determined by the level of aggregate demand, which is composed of consumption and investment. Consumption is the expenditure by households on goods and services, while investment is the expenditure by businesses on capital goods such as machinery and equipment.
According to Keynesian theory, the level of consumption is determined by disposable income. Disposable income is the income that households have left over after paying taxes and other mandatory expenses. The relationship between consumption and disposable income is called the consumption function, which can be expressed as:
C = a + bYd
Where C is consumption, a is autonomous consumption, b is the marginal propensity to consume (MPC), and Yd is disposable income.
The MPC is the proportion of additional income that is spent on consumption. For example, if the MPC is 0.8, then 80% of additional income is spent on consumption, and 20% is saved.
The level of investment is determined by the expected rate of return on capital. The expected rate of return is the return that businesses expect to earn on their investments, taking into account the cost of borrowing and the expected future income.
The equilibrium level of national income is determined by the point at which aggregate demand equals aggregate supply. Aggregate supply is the total amount of goods and services produced in the economy, which is assumed to be fixed in the short run. The equilibrium level of national income can be expressed as:
Y = C + I
Where Y is national income, C is consumption, and I is investment.
In the two-sector model, the equilibrium level of national income can be determined graphically by plotting the consumption function and the investment function on the same graph. The intersection of the two functions represents the equilibrium level of national income.
The Keynesian theory of national income determination has important policy implications. According to this theory, the government can stimulate economic growth by increasing government spending or by cutting taxes, which increases disposable income and consumption. Similarly, the government can use monetary policy to lower interest rates, which increases investment and stimulates economic growth.
The Keynesian Theory of Determination of National Income in Three Sector Model
The Keynesian theory of national income determination can also be extended to a three-sector model, which includes the government sector in addition to the household and business sectors. In this model, the level of national income is determined by the level of aggregate demand, which is composed of consumption, investment, government spending, and net exports.
The three-sector model assumes that the government sector plays an important role in the economy by providing public goods and services, redistributing income, and stabilizing the economy through fiscal policy. Government spending can be divided into two categories: current spending, which is spent on goods and services that are consumed within the current period, and capital spending, which is spent on goods and services that provide a long-term benefit to the economy.
In the three-sector model, the level of national income is determined by the level of aggregate demand, which is composed of consumption, investment, government spending, and net exports. Consumption and investment are determined by the same factors as in the two-sector model: disposable income and the expected rate of return on capital.
Government spending is determined by the government’s fiscal policy, which is influenced by its objectives and constraints. The government can increase government spending to stimulate economic growth, reduce unemployment, or address social problems such as poverty and inequality. The government can also reduce government spending to balance the budget, reduce inflation, or address other economic problems.
Net exports are the difference between exports and imports. Exports are the goods and services produced in the domestic economy and sold to other countries, while imports are the goods and services produced in other countries and sold in the domestic economy. Net exports can be positive or negative depending on the balance of trade.
In the three-sector model, the equilibrium level of national income is determined by the point at which aggregate demand equals aggregate supply. Aggregate supply is the total amount of goods and services produced in the economy, which is assumed to be fixed in the short run. The equilibrium level of national income can be expressed as:
Y = C + I + G + NX
Where Y is national income,
C is consumption,
I is investment,
G is government spending, and
NX is net exports.
The equilibrium level of national income can be determined graphically by plotting the aggregate demand curve and the aggregate supply curve on the same graph. The intersection of the two curves represents the equilibrium level of national income.
The Keynesian theory of national income determination in the three-sector model has important policy implications. According to this theory, the government can stimulate economic growth by increasing government spending, which increases aggregate demand and national income. The government can also use fiscal policy to stabilize the economy by adjusting government spending and taxation in response to changes in the business cycle.
Overall, the Keynesian theory of national income determination in the three-sector model provides a framework for understanding the role of aggregate demand in determining the level of national income in an economy. In this model, the level of national income is determined by the level of consumption, investment, government spending, and net exports, which are in turn influenced by factors such as disposable income, the expected rate of return on capital, and government fiscal policy.
The Keynesian Theory of Determination of National Income in Four Sector Model
The Keynesian theory of national income determination can also be extended to a four-sector model, which includes the international sector in addition to the household, business, and government sectors. In this model, the level of national income is determined by the level of aggregate demand, which is composed of consumption, investment, government spending, net exports, and foreign investment.
The four-sector model assumes that the international sector plays an important role in the economy by providing a source of foreign demand for domestic goods and services and by offering opportunities for foreign investment in domestic assets. Foreign investment can take the form of direct investment in businesses or financial investment in stocks, bonds, or other assets.
In the four-sector model, the level of national income is determined by the level of aggregate demand, which is composed of consumption, investment, government spending, net exports, and foreign investment. Consumption, investment, government spending, and net exports are determined by the same factors as in the three-sector model: disposable income, expected rate of return on capital, government fiscal policy, and balance of trade.
Foreign investment is determined by the expected rate of return on domestic assets and the availability of foreign funds. When the expected rate of return on domestic assets is high and foreign funds are abundant, foreign investment in domestic assets increases, which increases national income.
In the four-sector model, the equilibrium level of national income is determined by the point at which aggregate demand equals aggregate supply, which is the total amount of goods and services produced in the economy. The equilibrium level of national income can be expressed as:
Y = C + I + G + NX + FI
Where Y is national income,
C is consumption,
I is investment,
G is government spending,
NX is net exports, and
FI is foreign investment.
The equilibrium level of national income can be determined graphically by plotting the aggregate demand curve and the aggregate supply curve on the same graph. The intersection of the two curves represents the equilibrium level of national income.
The Keynesian theory of national income determination in the four-sector model has important policy implications. According to this theory, the government can stimulate economic growth by increasing government spending or reducing taxes, which increases disposable income and consumption, and hence, aggregate demand and national income. The government can also use fiscal policy to stabilize the economy by adjusting government spending and taxation in response to changes in the business cycle.
Foreign investment also plays an important role in the four-sector model. When foreign funds are abundant and the expected rate of return on domestic assets is high, foreign investment can stimulate economic growth and increase national income. However, excessive foreign investment can also lead to problems such as currency instability and loss of control over domestic assets.