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Income and Expenditure - Introduction

This chapter will consider the macroeconomic mechanisms that govern the flows of income and expenditure within an economy. It will first look at the key concept of the circular flow of income, which introduces many of the factors the govern national income in an economy. This then leads to discussion of the determinants of national income, also called aggregate demand. The Keynesian calculation for aggregate demand, C+I+G+(X-M), is presented and explained. This is accompanied by an explanation of the Keynesian Cross diagram which shows how aggregate demand and national output achieve equilibrium and form real GDP.

To support the understanding of the macroeconomic models the underlying assumptions are explored.  This includes critique of the theories relating to rational decision making from consumers regarding their incomes. The random-walk hypothesis of income is compared to the permanent income hypothesis in order to identify the differences in assumptions of consumer behaviour. As an extension of the discussion of market mechanisms for demand, the IS/LM graph is also included.

Learning outcomes

To be able to:

  1. Understand the circular flow of money through the economy
  2. Outline the determinants of national income
  3. Understand Intertemporal choice
  4. Recognise the consumption functions: Random Walk Hypothesis and Permanent Income Hypothesis
  5. Understand the IS/LM

Begin the Lecture