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In: Economics

- In your own words, explain the logic of the income-expenditure model. What determines the amount...

- In your own words, explain the logic of the income-expenditure model. What determines the amount of real GDP demanded?

Solutions

Expert Solution

Income expenditure model - This model was introduced by John Maynard Keynes. It explains about the changes in the production level of goods and services and level of spending. It says that , only that much goods and services are produ in the market which could be sold, and changes in produc as well as expenditure are tied so that economy is in stable position. The model assumes that prices , wages and rate of interest will not change and output will be decided by demand.

To understand this model clearly , we will study these points.

1) Consumption - It tells about buying level of public. This model doesnot believes much in the fact which says that response of people where there is short term income increase is different form the response in case of long term income increase or other reasons.

2) Investment expenditure - It tells about company's expenditure that they will do to make their product available in the market.It depends on their view about fluctuations in their product demands in future.

3) Output - It's the company's production of goods and services. Company may increase their output when their is increase in demand , when their spirits are high to produce more products.

4) Equilibrium - Equilibrium is achieved when consumption level , demand and income level all are equal to the output level exactly.

The amount of real GDP demanded is determined by following factors -

1) Factors affecting Demand ( spending by consumers)

2) Factors affecting Supply ( capacity to produce)

1) Factors affecting demand - Demand will be effected by increase in level of (C) consumption, (I) level of investment , (G) expenditure by government or level of exports . With increase in these factors , demand will also increase which will result in increased GDP.

a) Increase in real wages will increase the level of consumption which will increase the demand

b) Cuts in taxes will increase consumption and also increase demand.

c) Devaluation will cause increase in exports and decrease in imports which will increase the Demand .

d) With increase in government expenditure , demand will increase.

e) Fall in interest rates will also increase the demand.

2) Factors effect supply -Supply will also be effected by following factors-

a) Higher level of investment will cause increase in supply..

b) Increase in productivity of labour will also increase the supply.

c) Invention of raw materials will also increase the supply side.

d) Higher labour force will also increase supply.

e) Improvement in technology will Laos help to increase the supply.

There are some other factors will will effect the GDP in short period. They are -

1) Prices of commodities - Increase in prices of commodities with create a shock situation in the growth which will cause leftward shift in aggregate supply in short run , causing inflation and less growth.

2) Instability in politics - It will also cause negative impact on GDP.

3) Weather - Changes in the weather can also effect GDP .

So these are the factors which will determine the amount of real GDP demanded.


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