PROGRAMME: BACHELOR OF COMMERCE
UNIT NAME: INTRODUCTION TO MACROECONOMICS
UNIT INSTRUCTOR: THOMAS MAHUNDA
UNIT CODE: HBC 2211
ACADEMIC YEAR: 2012/13
* MROKI, Evans
Determination of National Income by the Equality of Saving and Investment Method:
Definition and Explanation:
This approach is based on the Keynesian definitions of saving and investment. According to Keynes, the level of national income, in the short run, is determined at a point where planned or intended saving is equal to planned or intended investment. Saving as defined by Keynes is that part of income which is not spent on consumption (S = Y - C). On the other hand, investment is the expenditure on goods and services not meant for consumption. (I = Y - C).
According to Keynes, if at any time, the intended saving is less than intended investment, it implies that people are spending more on consumption. The rise in consumption will reduce the stock of goods in the market. This will give incentive to entrepreneurs to increase output. Likewise, if at any time intended saving is greater than intended investment, this would mean that people are spending lesser volume of money on consumption. As a result of this, the inventories of goods will pile up. This will induce entrepreneurs to reduce output. The result of this will be that national income would decrease. The national income will be in equilibrium only when intended saving is equal to intended investment.
Example and Diagram/Curve:
The determination of national income is now explained with the help of saving and investment curve below:
In the above figure, income is measured on OX axis and saving and investment on OY axis. SS is the saving curve which shows intended saying at different levels of income. The investment curve is drawn parallel to the X axis which shows that investment does not change.
The entrepreneurs intend to invest $50 only irrespective of the amount of income. Saving (SS) and investment curves (ll) intersect each other at point M. If the conditions stated above remain the same, the size of equilibrium level of income is $250.
Under the assumed conditions if there is inequality between saving and investment or disequilibrium, the forces will operate in the economy and restore the equilibrium position. Let us suppose that the income has increased from the equilibrium level OL to ON ($300). At this level of income, desired saving is greater than the desired investment. When intended saving exceeds planned or intended investment, the businessmen will not be able to dispose off all their current output. They will slow down their productive activities. This will result in reducing the number of workers employed in factories and a decrease in the income. This process will go on until due to a decrease in income, people's saving is reduced to the level of investment ($50). The equilibrium income is $250.
In the same way, income cannot remain below this equilibrium level of $250. If at any time, income falls below the equilibrium level, then it means that people are investing more than they are willing to save I > S. They will increase productive activities as they are making high profits. The number of workers employed in the factories will increase. This will result in an increase in income and higher saving. This rise in national income will go on up to a point where saving and investment are just in balance and that will be the equilibrium level. At this point, income will have the tendency of neither to rise nor to fall. It will be in a state of rest. It is, thus, clear that national income is determined at a point where the intended investment is equal to intended saving.
Determination of Equilibrium Level of National Income According to Aggregate Demand and Aggregate Supply Method:...