The Components of Income Determination Under the Keynesian Model
Planned aggregate expenditure
Economically, aggregate expenditure (AE) can be described as the total expenditure on goods and services that are produced in an economy over a given period. Aggregate expenditure is composed of other expenditures including consumption (C), investments (I), government spending on goods and services (G), and net exports (X-M) (Kirsanova and Simon 238). The aggregate demand can be represented as follows AE = C + I + G + (X-M). These components of aggregate expenditure are very important in the determination of the level of income of a country.
The consumption expenditure
Consumption expenditure represents the level of household spending on goods and services produced in an economy. In the condition that the level of income is greater than consumption, savings is induced. In other words, savings is the excess of income over consumption. The consumption function represents the household spending at each level of disposable income. The Keynesian consumption function can be expressed as C = α + βYd in which α > 0 and 0 < β < 1.
This equation comprises of two components, α which is the autonomous consumption, and βYd representing induced consumption. The first parameter, α, which is the independent spending is the level of spending that is free from the non-refundable earnings. Autonomous consumption is largely determined by other factors besides disposable income including the wealth of the household, price changes, interest rates, consumer confidence in the market as well as the availability of credit facilities and income distribution. On the other hand, induced spending is that element of the overall expenditure that depends on the disposable or non-refundable earnings (Yd). In fact, as the amount of non-refundable earnings enlarges, the spending equally amplifies, yet these hardly swell in identical rates. However, as Leeper puts it, the increment in the spending rates will be lower compared to that of the total earnings.
In the above equation, β is the marginal propensity to consume (MPCYd) out of disposable income. It is the proportion of the rise in the non-refundable earnings, which is expended on total spending also written as ∆C/∆Yd. Provided the supplementary economic parameters are kept invariable, the spending intensity depends on the intensity of non-refundable earnings. At the national level, consumption depends on the gross domestic income less net taxes. Mathematically this relationship can be represented as follows C = α +β (Q – T) where α represents autonomous consumption and β the marginal propensity to consume while Q is the level of domestic income or the real GDP while T is the net taxes.
The net taxes include those taxes, which are income-dependent such as the income and profit taxes, and other taxes, which are not income dependent. Theses none income-dependent taxes are called autonomous taxes. Example of autonomous taxes includes taxes based on the value of the real estate.
Planned investments expenditure
Expenditure on planned investment can be said to be part of the firm’s savings. Goods and services sourced through this process are normally used at later date. Investments consist of fixed business investments, residential investments, and inventory investments. Investment expenditure also consists of the autonomous and induced components. Independent reserves are investment outflows that are independent of disposable income. It is largely determined by the level of interest rates among other factors including capital costs, business sentiments, and corporate tax. At each point of interest rate, the invest expenditure function is indicated.
The national income determines induced investment. In essence, the net investment is determined by the rate of change of the national income. In other words, there is a direct correlation between national income and net investment. However, in this model, investments are considered independent and thus cannot be directly related to national income. In essence, national income influences planned investments expenditure.
Government expenditure (G)
This represents the government spending on goods and services. It represents the government spending on both capital and consumer goods. A transfer payment is not included in this expenditure. Government expenditure can influence consumption and investment expenditures through direct actions such as increasing the interest rates as well as taxes. Thus, actions by the government besides its spending on goods and services have an influence on the aggregate demand. Under this model, government spending is deemed autonomous. Therefore, cannot be related to national income. In real circumstances, the level of national income influences government expenditure.
Net exports (X-M)
Exports are expenditures by foreigners on goods and services that the country produces whereas imports are expenditures by the domestic resident’s spending on goods and services produced outside the country. Exports are determined by many factors including the level of the foreign income, the general price level of the domestic goods and services, exchange rates as well as the general terms of trade. On the other hand, imports are determined by the national income, the price level of foreign products and services, exchange rates as well as the general terms of trade.