İKTİSADA GİRİŞ II

Economic agents obtain the goods and services they demand by paying the cost, that is, by spending. If we rewrite our aggregate expenditure function for an open economy, we get:
AE = C + I + G + NX

The answer is B.

Leakages are used to denote reductions in autonomous components of aggregate expenditures. It is possible to mention three types of leakages from the income-expenditure flow: savings, taxes and imports for an open economy.

The answer is D.

In order to achieve equilibrium in the economy, the leakages from income expenditure flow must
be balanced by additions (i.e., injections) to this flow. There are three types of injections for income expenditure model developed so far: investments, government expenditures, and exports for an open economy.

The answer is C.

Saving Paradox is the reduction in the consumption expenditures and, therefore, income because of rising savings. Increasing savings in the economy will cause total spending and income to decrease as long as it does not turn into investments.  In most of the developing countries, households have low level of saving. The answer is C.

Full Employment Level of Income is the level of income that will be attained in the economy if all the factors of production participate most effectively in production. Underemployment Equilibrium Level is the level of equilibrium income in which some of the production factors are idle. The equilibrium level of the economy, we have revealed the differences between Classical and Keynesian theory in the explanations.

The answer is D.

Deflationary Gap Is the expenditure gap when the economy is in equilibrium below the full employment level of income.

The answer is E.

We can analyze the effect of the increase in government spending of 250 TL by using the
multiplier coefficient on the level of equilibrium GDP.  

The marginal propensity to save (MPS) is 0.25 and the marginal propensity to import (MPI) is 0.25, the multiplier will be 2: Multiplier = 1/(0.25 + 0.25) = 2

ΔGDP = 2 * 250 = 500

In the equilibrium approach of the Classical model, thanks to the smooth operation of the market mechanism, the economy is in constant balance, that is, at full employment. The classical model explains the continuous realization of employment in the economy, based on Say’s Law, which states that “every supply creates its own demand”. According to this law, a certain amount of income is generated as a result of the production of goods and services.

The Keynesian theory argues that the economy is not always be at full employment equilibrium because flexible prices and wages are not always valid. According to this opinion, there are many factors that prevent wages and prices from being flexible. For this reason, markets are moving away from a fully competitive structure. In some sectors, the existence of firms that do not want to reduce prices may be the case

Equilibrium GDP Level is the level at which planned aggregate expenditures are equal to GDP.

Leakages are used to denote reductions in autonomous components of aggregate expenditures. It is possible to mention three types of leakages from the income-expenditure flow: savings, taxes, and imports for an open economy. Let’s shortly review these concepts. Leakages are the factors that cause autonomous components of aggregate expenditures to reduce.  Because saving is defined as an unspent part of income, households will spend less to increase their savings. Another leakage arising from the income-expenditure flow is taxes. Taxes lead to compulsory reductions in consumption expenditures.  The savings realized by the households are the source of funds that can be borrowed by the financial system and used for financing investment expenditures of firms.

Injections are additions to income-expenditure flow.

Saving Paradox is the reduction in the consumption expenditures and, therefore, income because of rising savings.

The multiplier is a coefficient that can give us to the opportunity to calculate how much income will change when there is a shift in aggregate expenditures, stemming from the change in autonomous expenditures. The multiplier value is always greater than 1. The reason for this is that the change in autonomous expenditure leads to an additional change in consumption expenditures

Full Employment Level of Income is the level of income that will be attained in the economy if all the factors of production participate most effectively in production.

Deflationary gap is the expenditure gap when the economy is in equilibrium below the full employment level of income.

The inflationary gap is the excess of expenditures when the economy is in equilibrium above the full employment level of income.

Equilibrium in Classical Model

In the equilibrium approach of the Classical model, thanks to the smooth operation of the market mechanism, the economy is in constant balance, that is, at full employment. The classical model explains the continuous realization of employment in the economy, based on Say’s Law, which states that “every supply creates its own demand”. According to this law, a certain amount of income is generated as a result of the production of goods and services. This income is used again to buy goods and services. Firms purchase or lease the resources required in the production process. They pay their owners in the form of fees, interest, rents, and profits. The amount that the producers pay to the owners of the production factors has to be equal to the value of the goods and services produced. Here, the production factor consumes all the income that the owners have gained and everything produced is sold. Thus, according to Say’s Law, every supply creates its own demand. It is not the case that the aggregate expenditures are insufficient in terms of full employment level. In some economies, when there is supply surplus or excess demand in some markets, the price mechanism is engaged and the market returns to the equilibrium level again. Therefore, the economy is in constant equilibrium.

Equilibrium in Classical Model

When households decide to save a portion of their income, how will the necessary expenditure to be made ensure the complete purchase of the economy’s production? The Classics’ answer to this question is that savings of the production factors are invested by the firms. Such a reduction in expenditure resulting from savings will be offset by investments. What is important here is how the savings will be equal to investments. According to Classical economists, interest rate is the key variable to provide this equality. This interest rate, which is determined on the loanable funds market, will change so as to ensure that the funds provided as a result of savings are equal to the funds requested for investments. End of this process, equilibrium interest rate rises in the market and the amount invested will be equal to the amount saved.

Equilibrium in Keynesian Model

The views of the classical model which guarantee full employment equilibrium were began to be questioned as a result of the long-term economic stagnation and the associated high unemployment during Great Depression that occurred in the 1930s. In order to solve this problem, British economist John Maynard Keynes argued that the economic equilibrium, as put forward by Classical economists, does not mean that the level of full employment income is provided at the same time. According to Keynes, equilibrium income can be achieved at the level of underemployment or overemployment. What is important here is the level of aggregate demand. Since it is difficult to change the production capacity that determines aggregate supply in the short term, the level of income depends on aggregate demand or aggregate expenditures. In other words, firms give their production decisions according to the expected aggregate expenditure or aggregate demand level. If the economic units plan to spend more, the sales expectations of the companies will increase and they will make more production. As it is seen, Keynes links the deviations from full employment to the inadequacy of aggregate expenditures in the economy. Accordingly, full employment in the economy can be achieved by an adequate level of aggregate expenditure. Then, Keynesian theory criticizes the views expressed by Classics on investment as a function of the interest rate and on wage-price elasticity. The Keynesian theory argue that the economy is not always be at full employment equilibrium because flexible prices and wages are not always valid. According to this opinion, there are many factors that prevent wages and prices from being flexible. For this reason, markets are moving away from fully competitive structure. In some sectors the existence of firms that do not want to reduce prices may be the case. Prices in these sectors can remain at the same level for a long time instead of falling when there is a fall in demand or expenditure. Because of the existence of strong labor unions and long-term wage contracts, the same is also true in labor markets. According to Keynesian model, one reason why equilibrium income is not always at full employment level is that investment and saving equality cannot always be provided as Classics argue. The reason for this is that the economic units that save and invest in the economy are generally different from each other. These economic units give savings and investment decisions for different reasons. For example, when savings for households occur as accumulation for future days, firms’ investment decisions are directed at expanding facilities or purchasing new capital goods to increase their profitability. In this case, it may not happen that savings at an income level that close to full employment equal investments. Savings can also lead to an increase in the amount of money held, rather than being used for financing investments. In this case, savings-investment equality will not be provided again.