Economics and National Income

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Answers to End-of-Chapter Questions in Chapter 17

1.An economy is currently in equilibrium. The following figures refer to elements in its national income accounts. | |£ billions |
|Consumption (total) |60 |
|Investment |5 |
|Government expenditure |8 |
|Imports |10 |
|Exports |7 |

(a)What is the current equilibrium level of national income? (b)What is the level of injections?
(c)What is the level of withdrawals?
(d)Assuming that tax revenues are £7 billion, how much is the level of saving? (e)If national income now rose to £80 billion and, as a result, the consumption of domestically produced goods rose to £58 billion, what is the mpcd? (f)What is the value of the multiplier?

(g)Given an initial level of national income of £80 billion, now assume that spending on exports rises by £4 billion, spending on investment rises by £1 billion, whilst government expenditure falls by £2 billion. By how much will national income change? (h)Given this new level of national income, assume that full employment is achieved at a national income of £100. Is there an inflationary or a deflationary gap? (i)What is the size of this gap?

(a)In equilibrium, income (Y) = expenditure (E)
E= C + I + G + X – M
= £60bn + £5bn + £8bn + £7bn – £10bn
= £70bn

(b)J= I + G + X
= £5bn + £8bn + £7bn
= £20bn

(c)In equilibrium, W = J. As this economy is in equilibrium, withdrawals will equal current injections. W= £20bn

(d)W= S + T + M
= S + £7bn + £10bn
(S = £20 – £7bn – £10bn
= £3bn

(e)Cd= C – M = £50bn
mpcd = (Cd/(Y = (£58bn – £50bn) / (£80bn – £70bn) = £8bn/£10bn
= 0.8 or 4/5

(f)Multiplier = 1 / (1 – mpcd)
= 1 / 1/5
= 5
(g)Injections have risen by £4bn + £1bn – £2bn = £3bn ( national income will rise by 5 times this amount
= increase of £15bn

(h)New national income = £80bn + £15bn = £95bn
With full-employment national income at £100bn, there is a deflationary gap.

(i)With a multiplier of 5, injections would need to increase by £1bn to make up the £5bn shortfall in national income. Thus the deflationary gap is £1bn.

2.What is the relationship between the mpc, the mpcd and the mpw? The mpc is the proportion of a rise in national income that consumers spend (including the consumption of imports, and measured at prices that include taxes on goods, such as VAT, and the effects of any subsidies on goods). mpc = (C/(Y.

The mpcd is the proportion of a rise in national income that accrues to domestic firms from consumption (and thus excludes those parts of consumption that go on imports, and is measured in prices that firms actually receive: i.e. after the payment of taxes on goods and the receipt of any subsidies on goods). mpcd = (Cd/(Y.

The mpw is the proportion of a rise in income that is withdrawn from the circular flow of income: i.e. the proportion that does not accrue to domestic firms. mpw = 1 – mpcd

3.Why will the short-run consumption function be different from the long-run consumption function? If people have a rise in their incomes, they may take a time to adjust their spending patterns. Thus in the short run they may only increase their consumption slightly, but over the longer term they may alter their living style to match their income: they may buy a house rather than rent, or buy a bigger house; they may choose to run a car or, if they already have one, a bigger...
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