İKTİSADA GİRİŞ II

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.

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.

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.

When the households decide to increase their savings without a change in income level, interesting contradiction called as saving paradox will arise. To understand this situation, we need to answer the question “What if households want to save more today in order to prepare for the difficult days in the future?” For instance, if planned savings of households increase, let’s say 400 TL at every level of income, the total leakages curve (S1 + T + IM) in Figure 3.4 shifts upward to S2 + T + IM position. Planning to increase savings also means planning less consumption at the same time. As a result of the decrease in consumption, aggregate expenditure, i.e., aggregate demand, will decrease. In this case, the decrease in aggregate expenditures leads to an increase in stocks. This increase in stocks will lead to production level of firms and income level to decrease.

Before the increase in savings, the level of equilibrium income was 5,000 TL, expressed by the point D1 where injections line intersects leakages line. Increase in savings shifted equilibrium point to D2 and the new level of equilibrium income is 4,000 TL. As you see, 400 TL increase in savings regarding their beginning values has resulted in a decrease of 1,000 TL in equilibrium income level. When Table 3.2 is considered, the original level of savings was 1,200 TL when equilibrium level of income was 5,000 TL. In the new equilibrium level of income at 4,000 TL, households again save the same amount (1,200 TL) with the beginning value. According to this result, households planning to save more and consume less now, but save the same amount. This is a paradox indicating that increasing saving reduces consumption and, therefore, income; however, at this new income level savings are at the same level. When you consider the fact that savings are used to finance investments in the country, this result contradicts the widespread belief that savings are beneficial for the economy.

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 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. Here, the determinant of the size of the Equilibrium in the Economy effect is marginal propensity to consume. As you remember, the marginal propensity to consume gives us how consumption rises when income rises. For example, the primary effect of 1 unit increase in autonomous expenditure would be to increase production and income by 1 unit. If the marginal propensity to consume is large, this increase in income leads to a large increase in consumption. In this case the multiplier effect will also be large. If the marginal propensity to consume is small, this increase will lead to a low change in consumption. In this case, the multiplier effect will be small. Based on this value, we find that 100 TL increase in the initial expenditure level leads to an increase of 2.5 times in GDP, that is, an increase of 250 TL (2.5 x 100). If you remember our discussions on leakages and injections above, the rest of the income increase after separating leakages is devoted to domestically produced goods and services, and the ratio of this amount to income increases is measured by marginal propensity to consume (MPC). Therefore, we can also calculate the multiplier by writing the same formula in terms of MPC as:

Here we also get the same multiplier value when we write 0.60 instead of MPC:

Regarding the multiplier, whichever formula above we use, we reach the following conclusion: The larger the leakages (in other terms, the lower the marginal propensity to consume), the smaller the value of the multiplier will be. The smaller value of multiplier means that the income generating effect of the same amount initial expenditure increase will also be small. For example, when the marginal propensity to save (MPS) is 0.35 and the marginal propensity to import (MPI) is 0.15, the multiplier will be 2:

In this case, the expanding effect of the increase in spending on the economy will be smaller because a smaller portion of the income generated at each stage will be spent. If the multiplier is 2, the income increase effect on the economy will be 200 TL (2 x 100).

The multiplier is a coefficient that can give us to 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. Here, the determinant of the size of the Equilibrium in the Economy effect is marginal propensity to consume. As you remember, the marginal propensity to consume gives us how consumption rises when income rises. For example, the primary effect of 1 unit increase in autonomous expenditure would be to increase production and income by 1 unit. If the marginal propensity to consume is large, this increase in income leads to a large increase in consumption. In this case the multiplier effect will also be large. If the marginal propensity to consume is small, this increase will lead to a low change in consumption. In this case, the multiplier effect will be small. Based on this value, we find that 100 TL increase in the initial expenditure level leads to an increase of 2.5 times in GDP, that is, an increase of 250 TL (2.5 x 100). If you remember our discussions on leakages and injections above, the rest of the income increase after separating leakages is devoted to domestically produced goods and services, and the ratio of this amount to income increases is measured by marginal propensity to consume (MPC). Therefore, we can also calculate the multiplier by writing the same formula in terms of MPC as:

Here we also get the same multiplier value when we write 0.60 instead of MPC:

Regarding the multiplier, whichever formula above we use, we reach the following conclusion: The larger the leakages (in other terms, the lower the marginal propensity to consume), the smaller the value of the multiplier will be. The smaller value of multiplier means that the income generating effect of the same amount initial expenditure increase will also be small. For example, when the marginal propensity to save (MPS) is 0.35 and the marginal propensity to import (MPI) is 0.15, the multiplier will be 2:

In this case, the expanding effect of the increase in spending on the economy will be smaller because a smaller portion of the income generated at each stage will be spent. If the multiplier is 2, the income increase effect on the economy will be 200 TL (2 x 100).