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- The principal tool of analysis in the Simple Keynesian Model of Income Determination model is the 'aggregate demand'. The focus of this model is only the goods market and the influence of the money market on the goods market. The model is build assuming that prices do not change at all and that firms are willing to sell any amount of output at the given level of prices (the aggregate supply curve is perfectly elastic). Aggregate demand is the total amount of goods demanded in the economy and is equal to the sum of consumption spending (C), investment spending (I), government purchases (G), and net exports (NX).
AD = C + I + G + NX
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Equilibrium level of output is that level of output at which the total desired spending on goods and services (desired aggregate demand) is equal to the actual level of output (Y).
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The concept of multiplier is a very useful one. The multiplier tells what the increase in the level of equilibrium income would be for a unit increase in autonomous spending. Multiplier is given by the ratio of increase in equilibrium income to increase in autonomous spending The value of the multiplier is the reciprocal of the marginal propensity to save, assuming all other components of aggregate demand 1, G and NX are constant and independent of the level of income. The larger the marginal propensity to consume, the lower is the marginal propensity to save, and thus larger is the value of the multiplier. Multiplier, cc = 1/MPS
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Taxes play an important role in determination of disposable income. When tax is considered the value of the multiplier is equal to 141 b (1 — 0], where, b is the marginal propensity to consume and t is the rate of tax. Thus, a cut in the tax rate would, therefore, increase the value of multiplier.
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The value of multiplier in the above case is determined assuming that the other components of aggregate demand, I, G and NX are constant and independent of the level of income. But,in real scenario. the imports are dependent of the level of the income. Mathematically,imports (M) = M(Y) m- Y, where m is the marginal propensity to import Thus, the value of multiplier is equal to
1/[1 — b (1-t) + m]