Skip to content
Sem 5 Prep
← Open Economy MacroIncome determination in a closed economy

Formulas for this chapter

Closed economy equilibrium

Y = C(Y) + I Equivalently S = I Shortcut: Y = autonomous spending / MPS

Any question that hands you a consumption function and an investment level. Use the shortcut to get the number fast, then verify with S = I.

Y
Equilibrium national income and production
C(Y)
Planned consumption, a function of income, class case C = 100 + 0.75Y
I
Planned investment, autonomous, class case 150
S
Desired saving, Y minus C(Y), class case S = -100 + 0.25Y

Marginal propensities

MPC = dC / dY MPS = dS / dY MPC + MPS = 1

Whenever a table or a graph gives you two levels of income and the matching consumption or saving. Both are slopes, so both are a change over a change.

MPC
Marginal propensity to consume, less than 1, class case 450/600 = 0.75
MPS
Marginal propensity to save, class case 150/600 = 0.25

Keynesian (closed economy) multiplier

k = 1 / MPS dY = k x dI Round n = MPC^(n-1) x dI

Sizing the effect of a change in investment, or working backwards from a target for income to the injection needed. The round formula is for showing the process.

k
The multiplier, class case 1/0.25 = 4
dI
The autonomous change in investment, class case 100
dY
The resulting change in equilibrium income, class case 400
Step 3 of 24
The real wordsTheory

Four assumptions, and why each matters

Every result in this half depends on these four. The deck lists them on one slide.

  1. The deficit or surplus arises in the current account. Capital flows are set aside.
  2. All prices, wages and interest rates stay constant. So nothing here works through the price mechanism.
  3. The nation is on a fixed exchange rate. So nothing works through the exchange rate either.
  4. Nations operate at less than full employment. So output can actually rise when demand rises.

Assumptions 2 and 3 are what make this a pure income story. Assumption 4 is what the absorption approach later relaxes.

← BackContinue →