Question

INSTRUCTIONS: DEFINE THE FOLLOWING TERMS AND CONCEPTS IN A CLEAR, CONCISE, AND EXPLICIT WAY. DEMONSTRATE THE RELATIONS BETWEEN THEM!

a)Equilibrium condition in the goods market & the multiplier;

b)IS relation & paradox of saving;

Answer 1

a) Equilibrium condition in the goods market & the multiplier;

Goods or output market is in equilibrium when aggregate expenditure (Sum of consumption, government and investment expenditure) is same as aggregate income (Y) and planned investment is same as planned savings.

Y = C + I + G

I = S

MULTIPLIER = 1/ (1 - MPC)

MPC is marginal propensity to consume that varies between 0 and 1. It is the tendency of consumption by people which is higher in poor people as compared to rich. Multiplier is the ratio of change in Y due to change in factors like G, C or I.

b) Saving and Investment both are upward sloping linear curves plotted between Savings, Investment on Y-axis and income on X-axis. I - S intersect at the equilibirum level of national income.

Paradox of savings states that when you tend to save more, you end up saving less. When you increase in savings, you decrease investment and thus, increase in national income slows down. The decrease in income leads to decrease in savings. This is paradox of thrift or savings.