INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Polytechnic University of the Philippines

College of Social Sciences and Development
Department of Economics

INSTRUCTIONAL MATERIAL
FOR ECON 30023
MACROECONOMICS

CHAPTER 3

COMPILED BY

NORIE L. MANIEGO
AILEEN L. CAMBA
 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Course Overview

This course, Macroeconomics, will provide an overview of macroeconomic issues: the

determination of income and output, employment, interest rates, and inflation. Monetary and fiscal policies
are discussed including public and international economic issues. It introduces basic models of
macroeconomics and illustrates principles based on the experience of the Philippines and other economies.

This, Instructional Material, is divided into eight (8) parts. The first two (2) chapters focus on the
basic concepts about economics and the overview of macroeconomics. National income and output will be
discussed in Chapter 3 while monetary and fiscal policies will be discussed in Chapter 4 and Chapter 5,
respectively. The last three (3) chapters will focus on the theories of growth and development;
unemployment and inflation and international trade, exchange rate and balance of payments.

Course Outcomes

At the end of this course, students are expected to;

1. Employ the tools of economic thinking in explaining macroeconomic phenomena and in evaluating
the relative effectiveness of fiscal and monetary policies;
2. Discuss the relevance of economic analysis to real-world economic problems;
3. Apply enduring macroeconomic principles in their personal lives to contribute in making this world
a better place for them, their families, and their communities.

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

CHAPTER 3
NATIONAL INCOME AND OUTPUT

Learning Outcomes: At the end of this chapter students are expected to:

1. Discuss the components to compute the National Income

2. Identify the different cycles in business and how it can be addressed through
government policies
3. Discuss the different components/ approaches in solving the national income
4. Explain the consumption and savings functions
5. Discuss the investment and the factors affecting it
6. Use the concept of multipliers to determine the economy’s output

1.1. National Income Accounting

In national income accounting, it is important to understand the transactions between the

different economic agents. This focuses on the measurement of indicators of aggregate output or
income.

GROSS DOMESTIC PRODUCT

GDP is defined as the market value of all final goods and services produced domestically in a single
year and the single most important measure of macroeconomic performance. The word domestic means
within the country, hence, productions within the Philippine jurisdiction are included in estimating GDP.

The market value (MV) is derived by taking the product of its per unit price and the quantities that were
produced.

MV = Pi  Qi

In order to calculate GDP, we simply take the sum of the market values of all final goods and services that
were produced during the period.

GDP only measures current production and does not include production in the other periods.

Transfer payments are excluded because no current production takes place in return for the payment.

Final Goods and Services versus Intermediate Goods and Services

• Final goods and services are goods and services that have been purchased for final use or goods
and services that will not be resold or used in production within the year.
• Intermediate goods and services, which are used in the production of final goods and services,
are not included in estimating GDP because expenditures on intermediate goods and services are
included in the market value of expenditures made on final goods and services. Including
expenditures on both intermediate and final goods and services would lead to double counting and
an exaggeration of the true market value of GDP.

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

A related measure of the economy's total output product is gross national product (GNP), which
is the market value of all final goods and services produced by a nation in a single year.

GDP or GNI

• GDP includes only goods and services produced by a nation's own citizens and firms. Goods and
services produced outside a nation's boundaries by the nation's own citizens and firms are included
in GNP but are excluded from GDP.
• Goods and services produced within a nation's boundaries by foreign citizens and firms are
excluded from GNP but are included in GDP.

GNP = GDP + Net Factor Income from Abroad

Net Factor Income from Abroad or Net Primary Income measures the difference
between the earnings of the Philippine residents in other countries and foreign residents in the
Philippines. It represents the earnings from labor services and ownership of asset.

For example, Ms. Kris Aquino has business in Singapore and since she is residing in the Philippines,
any profits from her business in Singapore will be remitted in the Philippines. The remittances from
Singapore is not part of the GDP of the Philippines but Philippine’s GNP.

These remittances from the rest of the world to the Philippines are part of inflows while foreign
investors in the Philippines also remit their profits to their mother country, which becomes a part of the
Philippines’ outflows or payment. The difference between outflows and inflows is the NFIA.

Three Approaches in Estimating GDP

1. Expenditure Approach. The expenditure approach adds up the market value of all domestic
expenditures made on final goods and services in a single year. Final goods and services are
goods and services that have been purchased for final use or goods and services that will not be
resold or used in production within the year. Intermediate goods and services, which are used in
the production of final goods and services, are not included in the expenditure approach to GDP
because expenditures on intermediate goods and services are included in the market value of
expenditures made on final goods and services. Including expenditures on both intermediate and
final goods and services would lead to double counting and an exaggeration of the true market
value of GDP.

Total expenditure on final goods and services is broken down into four large expenditure
categories, according to the type of good or service purchased. The sum total of these four
expenditure categories equals GDP. These four expenditure categories are

a. Personal Consumption expenditures: This is spending by households on goods and services

which comprise the largest share of total expenditure. Goods include household spending on
durable goods appliances and automobiles, and nondurable goods, such as food and clothing.
Services include intangible items such as manicure, haircuts, and legal advice.
b. Government expenditures: Government expenditures on consumption and investment goods
and services are treated as a separate category in the expenditure approach to GDP. Examples
of government expenditures include the hiring of civil servants and military personnel and the
construction of roads and public buildings. Social security, welfare, and other transfer

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

payments are not included in government expenditures. Recipients of transfer payments do

not provide any current goods or services in exchange for these payments. Hence, government
expenditures on transfer payments do not involve the purchase of any new goods or services
and are therefore excluded from the GDP.
c. Net exports: Exports are goods and services produced domestically but sold to foreigners,
while imports are goods and services produced by foreigners but sold domestically. In the
expenditure approach to GDP, expenditures on exports are added to total expenditures, while
expenditures on imports are subtracted from total expenditures. Alternatively, one can calculate
net exports, which are defined as expenditures on exports minus expenditures on imports, and
add the value of net exports to the nation's total expenditures.

2. Income Approach. The income approach to measuring GDP adds up all the income earned by
households and firms in a single year. The rationale behind the income approach is that total
expenditures on final goods and services are eventually received by households and firms in the
form of wage, profit, rent, and interest income. Therefore, by adding together wage, profit, rent,
and interest income, one should obtain the same value of GDP as is obtained using the expenditure
approach.
3. Industrial-Origin/Value Added Approach. The difference between the sale price and the
production cost of a product is the value added per unit. Summing value added per unit over all
units sold is total value added.

GDP is broken down into Agriculture, Fishery and Forestry, Industry, and Service Sectors.
The Agriculture, Fishery and Forestry sector represents value added of three sub-sectors.
Agriculture captures value added from the production of agricultural crops such as rice, corn, etc.,
ornamental plants and livestock. Fishery includes commercial and municipal fishing, aquaculture
and the harvesting of marine products. Forestry represents activities such as logging and gathering
of forestry products.

The Industry sector represents value added of firms engaged in mining, quarrying,
manufacturing, construction and utilities.

The Services sector is made up of the following sub-sectors: transportation, communication

and storage, trade, finance, ownership of dwellings and real estate, private services, and
government services.

Nominal GDP, Real GDP, and Price Level

Nominal GDP is GDP evaluated at current market prices. Therefore, nominal GDP will include all
of the changes in market prices that have occurred during the current year due to inflation or deflation.
Inflation is defined as a rise in the overall price level, and deflation is defined as a fall in the overall price
level. In order to abstract from changes in the overall price level, another measure of GDP called real GDP
is often used. Real GDP is GDP evaluated at the market prices of some base year. For example, if the
year 2000 were chosen as the base year, then real GDP for 2005 is calculated by taking the quantities of
all goods and services purchased in 2005 and multiplying them by their 2000 prices.

Other Concepts in National Income Accounting

There are two types of expenditures, however, that are included in the expenditure approach to
GDP measurement but do not provide households or firms with any form of income: depreciation

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expenditures and indirect business taxes. Depreciation expenditures, made to replace existing but
deteriorated investment goods, do increase the incomes of those providing the replacement goods, but
they also decrease the profit incomes of those purchasing the replacement goods. The result is that
aggregate income remains unchanged. Indirect business taxes consist of sales taxes and other excise
taxes that firms collect but are not regarded as a part of firms' incomes. Consequently, indirect business
taxes are not included in the income approach to GDP measurement but are included in the expenditure
approach.

In order to finetune value for a more accurate accounting of the economy’s final product,
depreciation expenditures are deducted from GNP.

(1) Net National Product (NNP)=GNP-Depreciation

(2) National Income (NI) =Net National Product-Indirect Business Taxes (IBT)
National income is the income earned by the different sectors in the economy-households,
business, and government sector-after deducting indirect business taxes.
(3) Personal Disposable Income (PI)=NI-(UCP+CT+GI) +TP
Where: NI=national income, UCP=undistributed corporate profits, CT=corporate tax, TP=transfer
payments
Personal disposable income is the individual’s income that is available for consumption and
savings.
(4) PI=Personal Consumption (C) + Personal Savings (S)

Growth rate of GDP. What is interesting is the annual growth rate, or year-to-year percentage change,
in the value of GDP. To calculate the percentage change in a statistic, such as GDP, one needs to know
the value of the statistic at two dates in time. Suppose that the value of GDP last year was GDPL and the
value of GDP in the current year is GDPC. Then, the percentage change, or growth rate, of GDP is given
 GDPC − GDPL 
by   x100%
 GDPL 

A positive growth rate of GDP implies that the economy is expanding, while a negative growth rate of GDP
implies that the economy is contracting. An expanding economy is said to be in a boom/peak, while a
contracting economy is said to be in a recession/contraction.

3.2. Business Cycle Pattern

The four parts of a business cycle are contraction/recession, expansion, peak/boom, and trough.
The red line, which presents a hypothetical tracking of real GDP, is used to illustrate the alternative parts
of a business cycle. Long-run trend is the straight, blue line. The long-run trend represents the production
capacity of the economy and full employment.

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1. Contraction- A period of decline in which economic activity decreases for at least six months
is termed a contraction. Contractions, are also termed recessions. During the recession
economic output declines, therefore unemployment is rising and inflation is declining.
2. Trough- The end of a contraction and transition to an expansion is designated a trough.
During the trough economic output is at its lowest, therefore, unemployment is at its highest
and inflation at its lowest.
3. Expansion- A period of growth in which economic activity tends to increase from month to
month and year to year is termed an expansion. The early part of an expansion is often
termed a recovery. During recovery economic output increases, therefore, unemployment
is declining and inflation is rising.
4. Peak- The end of an expansion and the transition to a contraction is designated a peak.
During the peak of the business cycle economic activity (output) is at its highest, therefore
unemployment is very low, but inflation is high.

The primary causes of the changes in output reflected in the business cycle are changes in spending. This
could be changes in consumer spending (C), government spending (G), business spending on new capital
(I), or purchases by foreigners (Xn).

3.3. Stabilization Policies

Government policies designed to reduce unemployment and/or inflation.

There are two major types of stabilization policies:

1. demand-management policies
2. supply-side policies

Demand-Management Policies

Policies designed to shift the AD curve in order to reduce unemployment or to reduce

inflation. Some of the determinants of aggregate demand can be manipulated by the government
to achieve these goals.

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There are two types of demand-management policies depending upon who conducts the policy:

1. fiscal policy is undertaken by the President and Congress, and

2. monetary policy is undertaken by the Bangko Sentral ng Pilipinas (monetary authority)

FISCAL POLICY

There are two types of fiscal policy:

1. expansionary fiscal policy

2. contractionary fiscal policy

Fiscal Policy and the Crowding-Out Effect

Crowding out occurs when an increase in government spending results in less spending by the
private sector. This occurs when the government borrows more when interest rates are low to finance its
expenditures, thus pushing interests upward. Business firms that wanted to borrow at the lower interest
rates, no longer borrow when the interest rates went up, thus business spending falls.

Expansionary Fiscal Policy

Problem: Recession/Unemployment

Expansionary Fiscal Policy

Increase in domestic interest rate Investments Decline

Increase Demand for Domestic

Currency

Domestic Currency Appreciates

Net Exports Decline

Aggregate Expenditures Decreases

partially offsetting the expansionary
fiscal policy

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

The goal of expansionary fiscal policy is to reduce unemployment; therefore, the tools would be an increase
in government spending and/or a decrease in taxes. This would shift the AD curve to the right increasing
real GDP and decreasing unemployment, but it may also cause some inflation.

Contractionary Fiscal Policy

Problem: Inflation

Contractionary Fiscal Policy

Decrease in domestic interest rate Investments

increase
Decrease Demand for Domestic
Currency

Domestic Currency Depreciates

Net Exports Increase

Aggregate Expenditures Increase

partially offsetting the contractionary
fiscal policy

The goal of contractionary fiscal policy is to reduce inflation; therefore, the tools would be a decrease in
government spending and/or an increase in taxes. This would shift the AD curve to the left decreasing
inflation, but it may also cause some unemployment.

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Monetary Policy for Recession and Inflation

A. Easy Monetary Policy

Problem: Recession

Central Bank buys bond, lowers reserve

requirement or lowers discount rate

Excess Reserves Increase

Money supply increases

Interest rate declines

Investment spending increases

Aggregate Demand Increases

Real GDP rises

The goal of an easy monetary policy is to reduce unemployment during a recessionary period.
Therefore, the tool would be an increase in the money supply. To increase money supply, the Central Bank
will take some combination of the following actions; buy government securities from banks and the public,
lower the reserve requirement and lower the discount rate. The outcome would be an increase in excess
reserves and thus, an increase in money supply. An increase in money supply will lower interest rate,
increasing investment, aggregate demand and real GDP. This would shift the AD curve to the right
decreasing unemployment, but it may also cause some inflation.

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B. Tight Monetary Policy

Problem: Inflation

Central Bank sells bond, increase reserve

requirement or increase discount rate

Excess Reserves decrease

Money supply Decreases

Interest rate rise

Investment spending decreases

Aggregate Demand decreases

Real GDP falls

The goal of a tight monetary policy is to reduce inflation. Therefore, the tool would be a decrease
in the money supply. Central Bank will sell government securities to the banks and the public, increase the
reserve requirement or increase the discount rate in order to decrease the supply of money. Banks will
then realize that their reserves are below than those required by the Central Bank. The Central Bank needs
to reduce their checkable deposits by refraining from issuing new loans, thus, lowering the supply of money.
The decrease in money supply will result to an increase in interest rate. The higher the interest rate will
discourage investment, lowering aggregate demand and restraining inflation. This would shift the AD curve
to the left decreasing inflation, but it may also cause some unemployment.

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Monetary Policy and the Net Export Effect

A. Easy Monetary Policy

Problem: Recession

Easy Monetary Policy

Decrease Demand for

Domestic Currency/Increase
demand for Foreign Currency

Domestic Currency
Depreciates/Foreign Currency
Appreciates

Net Exports
Increase/Aggregate Demand

The adoption of an easy monetary policy during recession has an effect on the level of exports and
imports in an economy. When the Central Bank uses an easy monetary policy, the demand for domestic
currency will decrease because of the decline in the level of interest rate. The decrease in interest rate will
discourage foreign investors to invest in the country, thus, resulting to a decrease in the demand for
domestic currency but an increase in the demand for foreign currency because domestic investors will
bring their investments to other countries that offer a higher interest rate. The decline in the demand for
domestic currency leads to the depreciation of the domestic currency which makes the domestic products
attractive to other countries, therefore, the level of exports and aggregate demand will increase.

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

B. Tight Monetary Policy

Problem: Inflation

Tight Monetary Policy

Increase Demand for

Domestic Currency/Decrease
demand for Foreign Currency
(Dollar)
Domestic Currency
Appreciates/Foreign Currency
Depreciates

Net Exports
Decrease/Aggregated Demand
Decreases

A tight monetary policy results to an increase in the interest rate which encourages capital inflows.
Investors see that investing in a country that offers a higher interest rate is profitable. This results to an
increase in the demand for domestic currency which in turn leads to the appreciation of the domestic
currency. The effect of the appreciation of the domestic currency is an increase in the level of
imports/decrease in exports.

"Supply-Side Economics"

Supply-Side economic policy occurs when the government tries to increase aggregate supply. This
will reduce both unemployment and inflation. Examples of these policies are removing regulation,
promoting competition among firms, providing incentives for firms, maintaining an efficient legal system
and encouraging technological progress.

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3.4. Aggregate Expenditure (AE) and National Income

For analytical purposes, aggregate expenditure (AE) is the sum of Consumption (C), Investment
(I), Government Expenditures (G) and Net Exports (Xn). AE represents planned spending while GDP
represents actual output. Such distinction also applies to the different expenditure components. For
instance, consumption spending in the national accounts indicates that households spend in a given period.
In contrast, consumption spending as a component of AE represents how much households want or plan
to spend. We would not be surprised to find a discrepancy between national income (Y) or the actual output
and AE. One reason for this is that firms formulate their production plans with an estimate of the quantities
that people want to buy. A mistake on their part will cause production to exceed or fall below the amounts
that people want to buy. In addition, unanticipated changes in the economic climate can induce economic
agents to alter their spending plans. Hence, if firms initially made correct production estimates, such
revisions may cause actual output to differ from AE. Discrepancies between AE and actual output are likely
to cause unintended changes in the inventory stocks of firms. When people want to buy less than what has
been produced, or AE is less than Y, firms will accumulate inventories. On the other hand, the stock of firm
inventories may decline if actual production is less than the quantities that people want to buy. In this case
firms may be forced to draw down on their existing stock of inventories in order to meet the unforeseen
demand for their products. Discrepancies between AE and Y serve as a signal for firms to adjust production.
If AE is greater than Y, firms will raise production in order to prevent their stock of inventories from falling
below the desired level. If AE is equal to Y, unintended changes in inventories are equal to zero. The stock
of inventories is equal to the desired level of output of firms; there is no reason to adjust production. The
absence of pressure to adjust production suggests that the economy is in equilibrium.

The Two-Sector Economy

This model assumes an economy with only two sectors: household and business. Therefore,
National Income (Y) is assumed to be equal to Disposable Income (Yd). Net Exports (Xn) will be zero.

Consumption, Saving, and Income

According to the Keynesian model, consumption is positively related to the level of disposable
income. Consumer spending rises with the level of income- but is normally assumed to rise less quickly
than disposable income.

Disposable Income
Disposable Income (Yd) = Gross Income - (Deductions from Direct Taxation + Benefits)
Income after taxes or net income
DI = Gross Income – Taxes

With disposable income, households can either

 Consume (spend money on goods & services)
• Save (not spend money on goods & services)

Consumption
The ability to consume is constrained by the amount of disposable income and the propensity to
save.
The consumption function is as follows:

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C = Co + b Yd where,
C= Consumer expenditure
Co = autonomous consumption. This is the level of consumption that would take place even if
income was zero. If an individual's income fell to zero some of his existing spending could be sustained by
using savings. This is known as dissaving.
b = marginal propensity to consume (mpc). This is the change in consumption divided by the change
in income. Simply, it is the percentage of each additional peso earned that will be spent. There is a positive
relationship between disposable income (Yd) and consumer spending (C). The slope of the consumption
curve gives the marginal propensity to consume. As income rises, total consumer demand rises also. A
change in the marginal propensity to consume causes a pivotal change in the consumption function. In this
case the marginal propensity to consume has fallen leading to a fall in consumption at each level of income.
A change in autonomous consumption can also shift the consumption function upwards or
downwards. This is shown below.

A Shift in the Consumption Function

Consumption
45-degree line

C2

C1

C3

Disposable Income

The diagram shows that the MPC has not changed but Co has changed. A change in factors other
than disposable income can cause the consumption curve to shift, that is, a change in the intercept of the
C function (Co). A rise in household wealth or a rise in consumer's expectations might lead to an increased
level of consumer demand at each income level (an upward shift in the consumption curve from C1 to C2).

Average propensity to consume (APC) = Total consumption divided by total income

Savings

Income that consumers earn but do not spend on consumption; part of income that is saved in some
form.
Yd = C + S

If the consumption function is C = Co + bYd

Then the savings function is given by: S = -Co + (1-b) Yd

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Income=spending
Consumer
Spending
C=Co+ (1-b)Yd
& Saving
Yd = C
(C, S) Yd > C

Co C > Yd S = -Co + (1-b) Yd

45° S=0 S>0

S<0 Disposable
income (Yd)
-C0

Average propensity to Save (APS) = Total savings divided by total income (also known as the Saving Ratio)

Formula for APC & APS

APC + APS = 1
1 – APC = APS
1 – APS = APC
APC > 1
APS < 0 or -APS: Dissaving

Formula for MPC & MPS

Marginal Propensity to Consume

o ΔC/ΔYd
o % of every extra peso earned that is spent
Marginal Propensity to Save
o ΔS/ΔYd
o % of every extra peso earned that is saved

MPC + MPS = 1
1 – MPC = MPS
1 – MPS = MPC
0 ≤ MPC ≤ 1
MPS

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Example 1. Consumption, Saving and Income

Level MPS= MPC= APC= APS=

of Change in Change in Change in
Disposable
Consumption Saving income ( saving consumption S C C S
( S ) ( C )
(C) (S)
Income Y ) Y Y Y Y
(Y)

0 200 -200 - - - - - - -
200 350 -150 200 50 150 0.25 0.75 1.75 -0.75
400 500 -100 200 50 150 0.25 0.75 1.25 -0.25
600 650 -50 200 50 150 0.25 0.75 1.08 -0.08
800 800 0 200 50 150 0.25 0.75 1.00 0.00
1000 950 50 200 50 150 0.25 0.75 0.95 0.05
1200 1100 100 200 50 150 0.25 0.75 0.92 0.08
1400 1250 150 200 50 150 0.25 0.75 0.89 0.11
1600 1400 200 200 50 150 0.25 0.75 0.88 0.12
Note that the MPS and MPC do not change as the level of income increases while the APC and
APS change as the level of income increases. The APC falls while the APS rise as the level of income
rises.

Investment Spending

It consists of spending on new buildings, machinery, plant and equipment. Investment spending is
a part of total spending or aggregate expenditures. Any increase in investment would necessarily increase
total spending or aggregate expenditures.

3 Types of Investment Spending

• Business fixed investment includes the equipment and structures that businesses buy to use in
production.
• Higher interest rates increase the cost of capital and reduce business

fixed investment.
• Improvements in technology and in tax policies such as the corporate income tax and
investment tax credit will shift the business fixed investment function.
• Residential investment includes new housing that people buy to live in and that landlords buy to
rent out.

1) An increase in the interest rate increases the cost of borrowing for home

buyers and reduces residential housing investment.

2) An increase in population increases the demand for residential housing investment.

3) During a boom in the business cycle, higher income raises the demand for housing and
increases residential investment.

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• Inventory investment includes those goods that businesses put aside in storage, including
materials and supplies, work in progress, and finished goods that have not been sold for the current
year.

Aggregate Expenditure (AE) and Equilibrium in the Two-Sector Economy

Since the economy is composed of households and firms only aggregate expenditure (AE) is equal
to the sum of consumption (C) and investment (I). That is

AE = C + I or Y = C + I

Saving and Investment

Formula for Saving:

S = Y – C. S stands for saving, Y for disposable and national income as well and C for
consumption.
Formula for Investment:

I = Y – C, where I stands for investment, Y for income and C for consumption.

Equation for Saving and Investment:

S = Y - C ...................(i)

I = Y - C ....................(ii)

Taking, Y - C which is common from both equations (i) and (ii). So we have:

S=I

Saving = Investment

"Saving is equal to investment at the equilibrium level of income".

Y = C + I .................. (i)

Income (Y) is also equal to consumption plus saving.

Y = C + S ................ (ii)

From equations (i) and (ii), we have:

C+I=C+S

C will cancel from both sides of the equation, so:

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I=S

Investment = Saving

The basic idea of explaining equality between saving and investment is that it is brought about
by changes in income. When people save more than what the investors think it worthwhile to invest, the
demand for consumer and producer goods falls down. When the goods produced are not profitably sold,
the entrepreneurs curtail production of goods and the national income falls. If investment is more than
saving, the national income rises. The process of changes is income, saving and investment continues till
saving and investment are in equilibrium. The saving and investment equality is explained with the help of
the schedule shown below:

Example 2. Consumption, Investment and the Equilibrium Level of Income

Change in AE=Y Income

Level of Consumption Saving Investment consumption( Movements
Or
Income(Y) (C) (S) (I)
C ) C+I = Y
0 200 -200 100 - 300
200 350 -150 100 150 450
400 500 -100 100 150 600
Expansion
600 650 -50 100 150 750
800 800 0 100 150 900
1000 950 50 100 150 1050
1200 1100 100 100 150 1200 Equilibrium
1400 1250 150 100 150 1350
1600 1400 200 100 150 1500 Contraction
1800 1550 250 100 150 1650

As seen from the table, the level of investment has not changed with the level of income unlike
consumption and saving. Investment, then, is autonomous (I0) of the level of income.

In the schedule, it is shown that as long as investment is higher than saving, the income level
continues to rise. When income is P1200, saving and investment are equal to P100 each. After this
equilibrium point, saving exceeds investment, income contracts until equilibrium is reached at an income
level of P1200.

Algebraic Computation of the Equilibrium level of income

C = C O + bYd , I = I O , Y = Yd

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Y =C+I
Y = C O + bYd + I O
Y − bYd = C O + I O
Y (1 − b) = C O + I O
CO + I O
Y=
1− b
Example 3. Let consumption function equals C=200+0.75Yd, and investment I=100.

200 + 100
Y=
1 − 0.75
Y = 1200

The Effects of a Change in Investment and the Multiplier (m)

A change in investment leads to a change in aggregate expenditure; this results to a change in the
equilibrium level of income. Let us say that investment (I) increases to 150:

Example 3. C, Change in I and the Equilibrium Level of Income

Investment
Level of Consumption Saving Investment
AE=Y I2 = I1 + ∆I AE=Y
Income(Y) (C) (S) (I1)
(I)
0 200 -200 100 300 150 350
200 350 -150 100 450 150 500
400 500 -100 100 600 150 650
600 650 -50 100 750 150 800
800 800 0 100 900 150 950
1000 950 50 100 1050 150 1100
1200 1100 100 100 1200 150 1250
1400 1250 150 100 1350 150 1400
1600 1400 200 100 1500 150 1550
1800 1550 250 100 1650 150 1700

Why is the increase in the equilibrium level of income greater than the increase in investment? To address
this question, it is important to discuss the concept of the multiplier.

The multiplier measures the change in the level of income as a result of a one-peso change in the
sum of autonomous components of aggregate expenditure. In the present analysis, the change in the level
Y
of income ( Y ) is due to a change in investment spending (∆I) m = =200/50=4. This implies that the
I
multiplier is 4. This means that a one-peso increase in investment leads to a four-peso increase in the
equilibrium level of income.

Algebraic Computation of the Multiplier

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Y =C+I
Y = C O + bYd + I O
CO + I O
Y=
1− b
I
Y =
1− b
Y 1
= or m = _ 1__
I 1 − b 1-b

Example 4. Let consumption function equals C=200+0.75Yd, and investment increased from I=100 to
I=150.

Y 1
=
50 1 − 0.75 or

Y
=4
50
Y = 200
∆Y = m · ∆I

= 4 · 50

=2

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

When an autonomous component of aggregate demand changes, equilibrium output (Y) will change. The
change in output will be even larger than the initial change in aggregate demand. For example, if the
marginal propensity to consume (MPC) is 0.75 and autonomous investment increases by P50, equilibrium
output will ultimately change by P200, not 50. The simple output multiplier assumes that there are no
proportional taxes; all expenditures are for domestically produced goods and services, and the price level
is fixed.

TABLE 1
Initial Change Change in Change in
Round in Investment Output Consumption
1 P100 P100.00 P75.00
2 0 P75.00 P56.25
3 0 P56.25 P42.19
4 0 P42.19 P31.64
5 0 P31.64 P23.73
6 0 P23.73 P17.80
7 0 P17.80 P13.35
8 0 P13.35 P10.01
9 0 P10.01 P7.51
10 to inf. 0 P30.03 P22.52
Total P100 P400 P300.00
Let us work through an example of the multiplier process using Table 1. Suppose the MPC is 0.75. PUP
decides to build a new building worth P100 million. Construction workers earn P100 million in income, and
they spend 75 percent--or P75 million--dining out, going to the movies, shopping, and buying new
appliances. The increased spending of P75 million becomes income to the owners and employees of the
restaurants, movie theatres, shopping malls, and appliance dealers. In turn, these people spend 75 percent
of the new P75 million, or P56.25 million, on other goods and services. The P56.25 million becomes income
to others in the community, and the process continues. Table 1 shows the impact of the multiplier through
various rounds. When all the effects are summed up, output will increase by P400 million because the
value of the output multiplier is equal to 1/(1-0.75) = 4. Remember that the initial increase in aggregate
demand for the new building was just P100 million. I0 unit,

_∆Y_ = __1__
∆I 1-b

∆Y_ = ___1___
100 1 – 0.75

∆Y = 400

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Equilibrium in the Three-Sector Economy

In the presence of the government, consumption and saving are affected because of the income
taxes which were imposed by the government sector. Households have no control over income taxes, thus,
the disposable income of households (Yd) becomes income (Y) less income taxes (Tx). In the three-sector
economy, income is allocated to consumption (C), saving (S) and income taxes (Tx).
In reality, income taxes tend to increase with the level of income. In other words, households that received
higher income pay more taxes. In such a case, income taxes also affect the extent to which changes in
income affect consumption. An increase in income has a smaller effect on consumption if a portion of the
increase in income goes to taxes. Let’s say, that a 20% tax is imposed on their income. A 100-peso increase
in income leads to a 20-peso increase in income taxes. This implies an 80-peso increase in disposable
income. Multiplied by the marginal propensity to consume (MPC) of 50%, this suggests an increase in
consumption of 40 pesos.
Aggregate expenditure (AE) is equal to the sum of consumption, investment, and government
expenditures, (Y=C+I+G). It also suggests that, other variables held constant, an increase in government
expenditures lead to an increase in aggregate expenditures.
Graphical Illustration of the three-sector equilibrium

C, I, G S, I, G

C+I+G S

C+ I
C1 +I0 G0
S1 I+G
C0 +I0
S0 I

0
Y0 Y1 Income

Y0 Y1 Income
(a) (b)

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

The addition of government spending, ceteris paribus, increases the equilibrium level of income in the
figure above from Y0 to Y1. The saving investment approach in figure b shows that the deficit caused by
government spending must be financed by an increase in private saving of S1-S0.

C, I, G

C+I+G S, Tx, I, G
C+I+G-Tx
S+Tx
C1 +I0 +G0
C2+ I0+ (G0-Tx0) S
I0 +G0 I+G

0
Y2 Y1 Income

Y2 Y1 Income
(a) (b)

An increase in taxes, ceteris paribus, lowers the level of income. In figure a, the introduction of taxes,
lowers aggregate spending since the government is receiving revenue that it is not spending. In figure b,
taxes that are not spent are a part of government saving and can be added to private saving.

Example 5. Income and Aggregate Expenditure

Let’s say income taxes (Tx) = 100 regardless of the level of income. In other words, we have an
economy with lump-sum taxes. Since equilibrium requires the equality between income and aggregate
expenditure, the table below suggests that the equilibrium level of income is equal to 1,300 pesos.
Level of Tax YD Consumption Investment Government Saving S+Tx I+G Income
Income(Y) (Tx) (C) (I) (G) AE=C+I+G (S) Movements
100 100 0 200 100 100 400 -200 -100 200
200 100 100 275 100 100 475 -175 -75 200
400 100 300 425 100 100 625 -125 -25 200
600 100 500 575 100 100 775 -75 25 200 Expansion
800 100 700 725 100 100 925 -25 75 200
1000 100 900 875 100 100 1075 25 125 200
1200 100 1100 1025 100 100 1225 75 175 200
1300 100 1200 1100 100 100 1300 100 200 200 Equilibrium
1400 100 1300 1175 100 100 1375 125 225 200
1600 100 1500 1325 100 100 1525 175 275 200
1800 100 1700 1475 100 100 1675 225 325 200 Contraction
2000 100 1900 1625 100 100 1825 275 375 200
2200 100 2100 1775 100 100 1975 325 425 200

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If income (Y) or the level of output is less than aggregate expenditures, firms are experiencing unexpected
reductions in their inventory of stocks. Therefore, the firms will expand production to reach equilibrium level.
However, if income (Y) or the level of output is greater than aggregate expenditures inventory of goods will
pile up so firms will cut their production.
The table shows that at the equilibrium level of income, the sum of investment and government
expenditures are equal to the sum of saving and income taxes. Investment and government expenditures
are considered as inflows in the income stream while saving and income taxes are considered as outflows
or leakages. For a given level of income, higher saving or income taxes reduce aggregate expenditures.
Hence, an increase in S+Tx tends to pull down the equilibrium level of income. On the other hand, higher
I+G tends to raise aggregate expenditures.

Algebraic Computation of Equilibrium Level of Income in the Three-Sector Economy

C = CO + bYd , I = I O , Yd = Y − Tx , G = GO

Y =C + I +G
Y = CO + b(Y − Tx) + I O + GO
CO − bTx O + I O + GO
Y=
1− b
Example 5. Let consumption function equals C=200+0.75Yd, investment I=100, government expenditure
G=100, tax (Tx)=100.

200 − 0.75(100) + 100 + 100

Y=
1 − 0.75
Y = 1300
Example 6. What happens to the equilibrium level of income if government expenditures increased by 25?

The equilibrium level of income will increase by 100, i.e. from 1300 to 1400.

Algebraic Computation of the Multiplier for Government Expenditures

Y =C + I +G
Y = C O + b(Y − Tx) + I O + G0
C O − bTx + I O + GO
Y=
1− b
G
Y =
1− b
Y 1
=
G 1 − b

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Algebraic Computation of the Tax Multiplier

Y =C + I +G
Y = C O + b(Y − Tx) + I O + G0
C O − bTx + I O + GO
Y=
1− b
− bTx
Y =
1− b
Y −b
=
Tx 1 − b
When the government imposes taxes, the multiplier works in reverse because now money is leaving the
circular flow. If there is a tax-CUT, then the multiplier is positive, because there is now more money in the
circular flow.

Balanced Budget Multiplier

An equal increase in government taxes and spending raises the equilibrium level of income
while a decrease lowers it. The effect of equal changes in government spending and taxes
is called the balanced budget multiplier.
G − bTx
Y =
1− b
Assuming a balanced budget where G = Tx
G − bG
Y =
1− b
G (1 − b)
Y =
1− b
Y = G
Y
=1, the multiplier for equal changes in G and Tx
G
The balanced budget multiplier always = 1

The Four-Sector Economy

Trade is an important aspect of a nation’s economy. Trading occurs between and among countries
because not one sovereign state in the world can supply all of its needs for products and services. With
regards to raw materials, labor force and other resources needed for production, every nation is inadequate
in at least one. Because of this condition, nations around the world continue to trade and exchange goods
and services among themselves. Let us now look at an open economy that incorporates exports (X) and
imports (M). For this part, our concern would be on the net exports. Net exports are measured by
subtracting the expenditures on imports from the expenditures on exports. Exports are goods and services
produced domestically but sold to the foreign market. Imports, on the other hand, are goods and services
produced by foreigners but sold domestically. When exports exceed imports there is a balance of trade
surplus. In contrast, when a nation’s imports exceed exports, the country is said to have a balance of trade
deficit.

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Trade surplus and trade deficit play an important part in the economic growth of a nation. A balance
of trade surplus contributes to a nation’s productivity. As demand for a country’s exported goods increases
in the world market, firms would need to cope with the demand by increasing their production. Increased
production can also lead to a higher employment rate as demand for labor increases. In addition, as exports
grow, national income also increases because money from foreign buyers would enter the country’s
economy which could be used for further growth and development.

A balance of trade deficit represents loss for a nation because this indicates that more money has
left the country than has entered to it through trade. Too much dependence on imported goods can have
negative effects on the economy. When imports exceed exports, it means that the aggregate demand for
locally made goods in the international market has decreased. Also, in the local market, imported goods
are usually lower priced than the local products. Because of this situation, local firms may find it difficult to
compete with imported goods. This can contribute to a rise in the unemployment rate as local firms decide
to lower production cost by reducing the number of workers.

Equilibrium in the Four-Sector Economy- Introduction of the Foreign Sector

Level of Tax YD Consumption Investment Government Exports Imports Saving S+Tx+M I+G+X
Income(Y) (Tx) (C) (I) (G) (X) (M) (S)
100 100 0 200 100 100 50 25 -200 -75 250
200 100 100 275 100 100 50 25 -175 -50 250
400 100 300 425 100 100 50 25 -125 0 250
600 100 500 575 100 100 50 25 -75 50 250
800 100 700 725 100 100 50 25 -25 100 250
1000 100 900 875 100 100 50 25 25 150 250
1200 100 1100 1025 100 100 50 25 75 200 250
1300 100 1200 1100 100 100 50 25 100 225 250
1400 100 1300 1175 100 100 50 25 125 250 250
1600 100 1500 1325 100 100 50 25 175 300 250
1800 100 1700 1475 100 100 50 25 225 350 250
2000 100 1900 1625 100 100 50 25 275 400 250
2200 100 2100 1775 100 100 50 25 325 450 250

Table shows that the equilibrium level of income is 1400. Since there is a positive net exports, the
level of income rises from the original level of 1300. In equilibrium, aggregate demand (C+I+G+X-M) is
equal to income. Also, outflows (S+Tx+M) equal inflows (I+G+X).

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Graphical Illustration of the four-sector equilibrium where imports (M) and exports (X) are
autonomous variables

C, I, G, X S, I, G,X

C+I+G+X S

C+ I+G
C1 +I0 +G0+X0

C0 +I0+G0 I+G+X
I+G

0
Y0 Y1 Income

Y0 Y1 Income

(b) (b)

The addition of exports in the model, ceteris paribus, increases the equilibrium level of income in
figures a and b from Y0 to Y1.
C, I, G,M S, Tx, I, G

C+I+G
C+I+G-M
S+Tx+M
C1 +I0 G0
C2+ I0+ G0-M0 S+Tx
I+G

0
Y2 Y1 Income

Y2 Y1 Income
(b) (b)

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

The addition of imports in the model, ceteris paribus, decreases the equilibrium level of income in
figures a and b from Y1 to Y2.

Algebraic Computation of Equilibrium Level of Income in the Four-Sector Economy

Let us assume that exports and imports are autonomous variables

C = CO + bYd , I = I O , Yd = Y − Tx , G = GO , X=XO, M=MO

Y =C + I +G+ X −M
Y = CO + b(Y − Tx) + I O + GO + X O − M O
CO − bTx O + I O + GO + X O − M O
Y=
1− b
Example 7. Let consumption function equals C=200+0.75Yd, investment I=100, government expenditure
G=100, tax (Tx)=100, X=50, M=25

200 − 0.75(100) + 100 + 100 + 50 − 25

Y=
1 − 0.75
Y = 1400
Algebraic Computation of the Multiplier for Exports

Y =C + I +G+ X −M
Y = C O + b(Y − Tx) + I O + G0 + X O − M O
C O − bTx + I O + GO + X O − M O
Y=
1− b
X
Y =
1− b
Y 1
=
X 1 − b

An Import Function and the Expenditure Multiplier

As income increases, consumption of domestic and foreign goods rises. In addition, the need for
imported materials is directly related to production levels. Thus, we assume that imports are positively
related to income M= M0+mY, where M0 is autonomous imports and m is the marginal propensity to import.
Exports, by assumption, remain an exogenous variable.
Let us assume that exports are autonomous variable while imports are dependent on the level of income.
C = CO + bYd , I = I O , Yd = Y − Tx , G = GO , X=XO, M=M0+mY
Y = C + I + G + X − (M 0 + mY )
Y = C O + b(Y − Tx) + I O + GO + X O − M O − mY
C O − bTx O + I O + GO + X O − M O
Y=
1− b + m
For autonomous changes in C, I, G, X, the expenditure multiplier is

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

1 1
multiplier = or m =
1− b + m 1− b + m
For autonomous changes in M, the expenditure multiplier is
−1 −1
multiplier = or m =
1− b + m 1− b + m
For autonomous changes in Tx, the tax multiplier is
−b −b
multiplier = or mtx =
1− b + m 1− b + m
3.5. Injections and Leakages
Injections into the income-expenditures stream equal the leakages from the income stream. For an
open economy, saving, importing and paying taxes are all uses of income that subtract from potential
consumption but exports, government purchases and investments are injections into the income-
expenditure stream.
Exports
Expenditures

Investments

Consumption Expenditure
Goods and Services Banks

Households Firms

Land, Labor, Capital, Entrepreneur

Wage, Rent, Interest, Profit Governme
nt

Foreigne
rs
Saving

Taxes

Imports

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Households do not usually spend all of their incomes on goods and services. A part is saved and
paid to the government in the form of taxes. Another part of household’s expenditure is paid out to foreign
firms for imported goods and services. All these—savings, taxes, and imports do not remain in the circular
flow. They are leakages and therefore, constitute outflows or withdrawals from the circular flow. The same
is also true for the firm. It saves, pays taxes, and imports economic resources if need be.
Conversely, part of the savings goes to financial institutions, like banks, which lend out funds to
users, both the firms and the households, who send the money back into the circular flow when they buy
economic resources or goods and services. Taxes which are received as income by the government are
spent on maintaining government services. Exports also retrieve funds from the circular flow through the
receipts from the sales of the products to the rest of the world.

3.6. Inflationary and Recessionary Gaps

The full employment level of income or output (Yf) represents the level of income when the
resources in the economy are fully utilized. In other words, the economy is operating at full capacity.

Inflationary Gap
Recessionary Gap
AE1
AE0 AE0

AE1

Full
employment
(Y
Full employment

450 450

1300 1500 1500 1600

0 Yf Yf

Recessionary gap exists when aggregate expenditures are less than the full employment level.
Resources in the economy are not fully utilized. The figure above shows that a 50-peso recessionary gap
causes a 200-peso negative GDP gap, assuming a multiplier equal to four, thus, 4 (-50) = 200.

Inflationary gap is a condition when the equilibrium level of income is beyond the full employment,
that is, aggregate expenditures are greater than the full employment level of income. Since the economy
cannot produce beyond the full employment, an inflationary gap exerts pressure on the general price level.
In other words, it causes inflation. The figure shows a 25-peso inflationary gap, thus, 4(25)=100 The gap
can be eliminated if aggregate expenditures fall such that the full employment level of income(Y=1500)
becomes the economy’s equilibrium level of income. This requires a downward shift in the aggregate
expenditures schedule from AE1 to AE0. The autonomous component of aggregate expenditures must fall
to bring about the downward shift to AE.

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

EXERCISES AND ASSESSMENT

1. Multiple Choice: Encircle the letter of the best answer.

1. If the government lowers taxes and spending by P10, then with an MPC of 0.90 the income level will fall
by
a. P9 b.P80 c. P10 d. P20
2. The tax multiplier is
a. greater than the government expenditure multiplier
b. equal to the government expenditure multiplier
c. less than the government expenditure multiplier
d. equal to investment expenditure multiplier
3. If there is an increase in taxes and government spending, then
a. the S+Tx schedule shifts upward and I+G schedule shifts upward
b. the S+Tx schedule shifts downward and I+G schedule shifts downward
c. the S+Tx schedule shifts downward and I+G schedule shifts upward
d. the S+Tx schedule shifts upward and I+G schedule shifts downward
4. If there is an equal increase in taxes and government spending,
a. C+I+G is shifting upward
b. C+I+G is shifting downward
c. C+I+G does not shift
d. C+I+G either shift upward or downward
5. Given a 3-sector (C+I+G) model, equilibrium income occurs where
a. I+S=Tx+G b. I+G=S+Tx c. I+Tx=S+G d. S=I+Tx+G
6. A contractionary fiscal policy is a policy that:
a. reduces aggregate demand by decreasing government purchases.
b. reduces aggregate demand by decreasing money supply.
c. reduces aggregate demand by decreasing interest rates.
d. reduces aggregate demand by decreasing taxes.

7. If the MPC is 0.8 and the government spending decreases by P50 million, then equilibrium GDP will
decrease by:
a. P40 million b. P50 million c. P200 million d. P250 million

8. Suppose the economy is experiencing a recessionary gap. To move equilibrium aggregate output closer
to the level of potential output, the best fiscal policy option is to:
a. decrease government purchases b. decrease taxes
c. decrease government transfers d. increase real interest rates

9. Fiscal policy involves:

a. changes in interest rates
b. changes in government spending.
c. changes in the quantity of money.
d. changes in the quantity of money and interest rates.

10. In the basic equation of national income accounting, the government directly controls _____ and
influences ______.
a. G ; C and I b. T ; G and C
c. C ; X and M d. I ; G and T

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

11. Automatic stabilizers are government spending and taxation rules that:
a. cause fiscal policy to be expansionary when the economy contracts.
b. cause fiscal policy to be contractionary when the economy contracts.
c. cause fiscal policy to be neutral when the economy contracts.
d. cause fiscal policy to be ineffective when the economy contracts.

12. If the increase in exports exceeds the increase in imports, ceteris paribus, the level of income will
a. fall b. rise c. stay the same d. either rise or fall

13. An autonomous increase in exports will result in

a. an equal increase in imports if imports are a function of income
b. imports increasing more than exports if imports are a function of income
c. imports increasing less than exports if imports are a function of income
d. none of the above.

14. If imports increase, ceteris paribus,

a. the domestic spending schedule shifts upward
b. the domestic spending schedule shifts downward
c. there is a movement along the domestic spending schedule
d. there is no change in domestic spending

15. If exports equal imports and the import function reads M=M0+mY, a tax cut will
a. increase imports
b. decrease imports
c. have no effect on the level of imports
d. cause the income level to fall

16. Suppose the economy is currently operating at an output level of P4,000 billion. Assume furthermore
that potential output is P5,000 billion and the marginal propensity to consume is 0.75. Which of the
following would be required to close this recessionary gap?
a. A P25 billion increase in government spending.
b. A P25 billion increase in taxes.
c. A P250 billion increase in government spending.
d. A P1,000 billion increase in government spending.
e. A P500 billion increase in transfer payments.

17. The marginal propensity to consume is equal to:

a. the proportion of consumer spending as a function of disposable income
b. the change in saving divided by the change in disposable income
c. one
d. the change in saving divided by the change in consumer spending
e. the change in consumer spending divided by the change in disposable income
18. If the MPS = .1, then the value of the multiplier equals:
a. 1 b. 5 c. 9 d. 10 e. 100

19. If the multiplier equals 4, then the marginal propensity to save must be equal to:
a. 1/4 b. 1/2 c. 3/4 d. 1/3 e. 1/5

20. If the marginal propensity to save is 0.3, the size of the multiplier is:

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

a. 3.3 b. 2.3 c. 1.3 d. 0.7 e. 10

21. The marginal propensity to save is:
a. savings divided by aggregate income
b. the fraction of an additional peso of disposable income that is saved
c. 1+MPC
d. 1/MPC
e. Equal to 1
22. Suppose investment spending increases by P50 billion, and as a result the equilibrium income
increases by P200 billion. The multiplier is:
a. 8 b. 10 c. 4 d. ¼ e. 3
23. Suppose investment spending increases by P50 billion, and as a result the equilibrium income increases
by P200 billion. The value of the MPC is:
a. 0.8 b. 0.4 c. 0.75 d. 4 e. 0.5
24. If the size of MPS is decreasing, it will:
a. make the multiplier smaller
b. make the multiplier larger
c. not affect the value of the multiplier
d. increase the interest rate
e. cause the MPC to also decrease
25. You have been trying to develop a linear equation that describes the local household consumption
function as a function of disposable income. You have finished the project and the consumption function is:
C = 100 + .75(Yd). Your job is to explain this result to your supervisor. According to this consumption
function, what is the marginal propensity to consume?
a. 100 b. 0.75 c. 4 d. 0.25 e. 0.5

26. You have been trying to develop a linear equation that describes the local household consumption
function as a function of disposable income. You have finished the project and the consumption function is:
C = 100 + .75(Yd). Your job is to explain this result to your supervisor. According to this consumption
function, how much consumption spending would occur if a household had a disposable income of P1000?
a. P750 b. P4000 c. P850 d. P350 e. P7600
27. Suppose the marginal propensity to consume changes from 0.75 to 0.90. How will this affect the
consumption function?
a. The slope will get steeper
b. Autonomous consumption will increase
c. The function will exhibit a parallel shift upward
d. The slope will get steeper and autonomous consumption will increase
e. The function will exhibit a parallel shift downward
28. Consider a simple economy: MPC = 0.75, income =P400 billion and aggregate consumption spending=
P400 billion. The autonomous consumption is:
a. 0 b. P100 billion c. P300 billion d. P200 billion e. P400 billion
29. A fall in the market interest rate makes any investment project:
a. less profitable if the funds were borrowed and more profitable if it came from retained earnings
b. less profitable, regardless of whether the funds were borrowed or came from retained earnings
c. more profitable, more profitable, regardless of whether the funds were borrowed or came from
retained earnings.
d. more profitable only if the funds were borrowed
e. more profitable if the funds come from retained earnings than if the funds are borrowed.
30. If planned investment spending is P2 trillion and inventories decrease by P0.5 trillion then, actual
investment spending is:
a. P2.5 trillion b. 1.5 trillion c. P2 trillion d. P3 trillion e. -P1.5 trilli

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 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

Fill-in Questions and Identification

Injections in the income-expenditures stream equal the leakages from the income stream.
For an open-economy, 1.__________, 2__________, 3_________ are all uses of income that
subtract from potential consumption but 4_________, 5__________ and 6___________ are
injections into the income-expenditures stream.

Identification
__________7. Exists when the equilibrium domestic output is greater than the full-employment
real domestic output.
__________8. An economy that does not interact with economies in the world.
__________9. A variable is said to be ___ when it is determined outside the model and assumed
to be independent of income.
__________10. A negative budget surplus or an excess of expenditure over revenue.

3. Assuming marginal propensity to consume is constant, complete the table below.

Y C S I AE=Y
0 -50 50
100 130 50
200 50
300 50
400 50
500 50
600 50
700 50
800 50
900 50
1000 50
Consider an economy that is described by the equations derived from the table in #1.

a. find the equilibrium level of income

b. find the value of the multiplier
c. calculate the effects of a 500-peso decrease in investment.

4. The fundamental equations in an economy are given as:

Consumption Function C = 200 + 0.8Yd
Investment I = 300
Tax T = 120
Government Expenditure G = 200
Exports X = 100
Imports M = 50

Find the following.

a. The equilibrium level of income
b. The net exports

5. Write a reflection paper on the performance of the Philippine economy during the 1st and
2nd quarter of 2020. Enumerate 4 possible measures to address the issue/s.

34
 INSTRUCTIONAL MATERIAL FOR ECON 30023 MACROECONOMICS

COURSE GRADING SYSTEM

Class Standing (portfolio/e-portfolio, projects, case analysis,

quizzes, summative test (long or unit test) 70%

Midterm / Final Examinations 30%

100%

Midterm Grade + Final Term Grade = FINAL GRADE

REFERENCES

Books
Dornbusch, Rudiger, Fischer, Stanley & Startz, Richard (2010), Macroeconomics, 11th ed.,
McGraw-Hill/Irwin

McConnel, Campbell and Brue, Stanley (2014), Macroeconomics: Principles, Problems and
Policies, 20th ed. McGraw Hill

Sexton, Robert L.(2012), Exploration of Macroeconomics, 6th ed., Cengage Learning Asia Pte
Ltd, 1st Phil. Reprint.

Websites

www.bsp.gov.ph
www.un.org
www.neda.gov.ph
https://faculty.washington.edu/danby/notes/notes12.html
https://www.sparknotes.com/economics/macro/aggregatedemand/section2/
www.slideshare.net demand-and-supply analysis
https://www.economicsdiscussion.net/money/top-5-theories-of-demand-for-money

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