Equilibrium Level of National Income Model

Runing head: MACROECONOMICS
Macroeconomics
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MACROECONOMICS1
Table of Contents
Question 1..................................................................................................................................2
Question A.............................................................................................................................2
Question B..............................................................................................................................3
Question C..............................................................................................................................3
Question D.............................................................................................................................4
Question 2..................................................................................................................................5
Question A.............................................................................................................................5
Question B..............................................................................................................................6
Question C..............................................................................................................................7
Question D.............................................................................................................................8
Question 3..................................................................................................................................8
Question A.............................................................................................................................8
Question B..............................................................................................................................9
Question C............................................................................................................................10
Question D...........................................................................................................................12
References................................................................................................................................14

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Question 1
Question A
In the Keynesian model, national income in the short run is determined by aggregate
effective demand. The model was initially based upon two sectors consisting household and
business only. Later the model was extended for four sectors where aggregate demand or
aggregate expenditure is the sum of consumption expenditure, investment expenditure,
government expenditure and net earnings from foreign sector (Goodwin et al. 2015).
Equilibrium level of national income in the model is determined where actual spending of the
economy matches with planned spending or aggregate demand. The equation of aggregate
expenditure in the model is given as
AE=C + I +G+ ( X−M )= AD
Figure 1: Determination of national income in Keynesian model
In the above figure, the 450 line shows actual expenditure of the economy. The
planned expenditure line is shown as the sum of consumption, investment, government
expenditure and net export. Equilibrium in the economy corresponds to the point E where

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aggregate expenditure or demand matches actual expenditure or aggregate supply. Changes in
any component of aggregate spending results in a change in aggregate demand and an
associated change in national income.
Question B
An increase in saving rate is often considered to increase capital formation to increase
causing an increase in GDP. This however is not the case always. Income of a household is
generally divided between consumption and saving. A higher saving propensity actually leads
to a decline in consumption level and income without any increase in rather decrease in
aggregate saving of the economy. The impact of increase in saving propensity explained as
thriftiness of people on equilibrium income, consumption and saving is known as paradox of
thrift. According to Keynes a higher saving rate though is welcome from view of individual
household, it is not good from aggregate perspective since it has a damaging impact on
national income (Uribe and Schmitt-Grohe 2017). The reason for a fall in GDP because of an
increase in saving rate is given as higher saving rate means a lower propensity to consume.
As households consume less, there is a smaller demand for production causing a fall in
induced investment. Because of decline in factor employment there is a fall in income
generation resulting in a smaller GDP.
Question C
A low output and high unemployment rate indicates recessionary state of the
economy. In such a situation the economy needs necessary policy stimulus from the
government. One way to boost aggregate demand and expand output and employment is to
undertake expansionary fiscal policy by increasing spending. Government expenditure being
one important component of aggregate demand, as government spending increases there is an