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Pearson Education Materials

Workshop 8: Determination of National Income and the role of Fiscal Policy

1.  
   1. If a household earns £200 a week and spends £150 each week on domestically produced goods and services, how much does it withdraw from the circular flow?
      
      

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   2. What forms will these withdrawals take?
      
      

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   3. Assume that total household incomes rise from £500bn to £550bn. Assume that this results in the consumption of domestically produced goods and services rising from £450bn to £490bn. What is the mpc_d?
      
      

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   4. Assuming that mpc_d remains constant, what will the level of consumption of domestically produced goods and services be if national income now rises to £700bn?
      
      

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   5. If total UK consumption of domestically produced goods and services is £490bn and injections into the circular flow of income are £80bn, what will be the level of aggregate expenditure (E)?
      
      

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   6. Given your answer to e., and assuming that total household incomes are currently £550bn, what will happen to household income? Rise / Fall / Stay the same
   7. What is the formula for the marginal propensity to withdraw? ΔY/ΔW; ΔW/ΔJ; ΔW/ΔY; ΔJ/ΔW
   8. What are the answers to the following? (Use a number or another term as appropriate.)
      1. Y - W =
         
         

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      2. mpcd + mpw =
         
         

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      3. 1 - mpc_d =
         
         

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2.  
   1. Assuming that injections are constant at all levels of national income at £20 billion, complete the following table.
      
      

      Income (Y) (£bn)	40	80	120	160	200	240	280
      Consumption (Cd) (£bn)	40	70	100	130	160	190	220
      Injections (J) (£bn)
      Withdrawals (W) (£bn)
      Aggregate expenditure (E) (£bn)

      
      
   2. Calculate the marginal propensity to consume domestically produced goods (mpc_d).
   3. On the diagram below, label the line shown and then plot Cd, J and aggregate expenditure (E) against national income (Y).
      
      
   4. What will be the equilibrium level of income (where E = Y)?
      
      

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   5. What are withdrawals and injections at this level of income?
      
      

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   6. Plot the withdrawals line on the diagram.
      
      

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   You should now be able to see that there are two ways of finding the equilibrium level of national income.
   
   
3. In a closed economy (i.e. one that does not engage in foreign trade), spending on consumer goods is related to national income by the following schedule:
   
   

   Y (£bn)	0	20	40	60	80	100	120	140	160	180
   Cd (£bn)	4	20	36	52	68	84	100	116	132	148
   J (£bn)
   E (£bn)

   
   If firms are investing at a rate of £8bn per year and the government is spending £12bn per year:
   
   1. Fill in the figures in the table for total injections (J) and aggregate expenditure (E).
   2. What is the equilibrium level of national income?
      
      

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   3. What is the mpc_d?
      
      

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   4. What is the value of the expenditure multiplier?
      
      

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   5. Suppose that full employment yields a national income of £140bn per annum, by how much must government expenditure be changed to reach full-employment income?
      
      

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   6. Does the initial equilibrium situation represent an inflationary or a deflationary gap, and what is the size of this gap?
      
      

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4. Examine the following diagram:
   
   
   Identify the correct letters for each of the following (circle the correct answer):
   
   
   1. Equilibrium national income (i) Oa (ii) Ob (iii) Od (iv) Of
   2. Injections at income Oa (i) aq (ii) ah (iii) hq (iv) qa-hq
   3. Withdrawals at income Of (i) tf (ii) nt (iii) mt (iv) mn
   4. mpc_d (i) ur/su (ii) su/ur (iii) mt/tl (iv) tr/tv
   5. The amount that withdrawals rise when national income rises from Od to Of (i) tn (ii) nm (iii) tm (iv) ln (v) lm
   6. mpw (i) tn/df (ii) nm/df (iii) df/tn (iv) df/nm
   7. The multiplier (i) tn/df (ii) nm/df (iii) df/tn (iv) df/nm