Question

7. What is the result of the spending multiplier if investment comes from savings?

8. Approximately how long is the period of the average real-estate-related business cycle?

Answer 1

7. Spending multiplier if investment comes from saving.

The simple Keynesian model of income determination it is assumed that investment expenditure is autonomously given. Let us now relax this assumption. Instead let us assume that investment expenditure like consumption expenditure also depends on the level of income. Suppose we assume that both consumption and investment function are linear. The consumption function can be written as ‘c=a+by’ and the investment function can be written as ‘I=m+ny’, where ‘m’ is the autonomous part of the function, which is independent level of income.

For equilibrium we require:

Y = c + I

• Y = a + by + m + ny
• Y – by – ny = a + m
• Y ( 1 – b – n ) = a + m
• Y = (a + m)/(1 – b – n)

This gives us the equilibrium level of income. If we denote the equilibrium level of income as :

Y₀ =(a + m)/(1 – b – n)

The equilibrium condition can also be written as the equality between intended savings and intended investment:

S(y) = I (y)

Here both the saving and investment functions are upward rising. At their intersection point the equilibrium level of income is determined.

Now the equilibrium will be stable in the walrasian sense if, d E/dy <0 where E = excess demand i.e.

E = c(y) + I(y) – y. therefore, following walrasian stability we get,

C’(y) + I(y) – 1 < 0

• C’(y) + I(y) < 1    => MPI + MPC < 1
• I’(y) < 1 – c’(y)
• MPI < MPS

The stability condition therefore requires that the sum of the MPI and MPC should be less than unity. The sum (MPI + MPC) is also known as marginal propensity to absorb. Hence the market will be stable if marginal propensity to absorb is less than unity.

From the second condition it is seen that the slope of the saving function should be greater than the investment function. This means that the savings function should cut the investment function from below.

If MPI > MPS i.e. the investment function cuts the savings function from below then the equilibrium will be unstable.

8. The period of the average real estate related business cycle is approximately 18 years.