Question

Describe the process of national income determination and demonstrate for an economy with government, income tax, but a closed economy (no exports or imports).

Answer 1

According to keynes , two amjor factors determine the national income

Aggregate supply and aggregate demand

aggregate supply is given by both consumer and producer goods supplied at one point of time

aggregte income/ output= saving + consumption

then we look at the aggregate demand

it is the actual expenditure or demand for consumer and producer goods.

it is given by aggregate demand = consumption + investment

so in a cl;osed economy with no government we have

saving = investment

National income is determined as specified by Keynes in 3 models

2 sector model

3 sector model and

4 sector model

since we need to look at the model with government and without foreign trade we look at the 3 sector model.

the 3 sector model consists of  households businesses, and government .

so we have Y= C+I+G

ie aggregate output Y must be equal to aggregate demand.

also since it is a closed economy we have S=I

ie S+T=I+G ...........so if T=0 , we have S=I+G

we have Y or aggregate output and supply as the 45 degree line from the orgin (positively related )

also the C+I+G is not from origin since it has a part of C where even at 0 income we still have some consumption . the consumption cant be 0 at 0 level of income. so a part of consumption is autonomous and rest depends on income.

equilibrium (income) is reached when the aggregate supply is same as aggregate demand