National income equilibrium

A convenient way to understand how national income equilibrium is determined is to use the 'cross' diagram which looks at the factors which can increase and reduce the flow of income in an economy over time.

The cross diagram maps injections and withdrawals against national income, and excludes consumption from the analysis.

Injections into the flow of income in an economy include investment by firms, government spending on public and merit goods, and demand for an economy’s exports.

Because injections are not determined by current GDP, they remain constant as GDP increases. In the current time period the decision to invest by firms is assumed to have taken place in the previous time period.

Similarly, government spending decisions are taken at the time of the national budget, which will precede the current time period.

Finally, export spending is assumed to depend on overseas income, hence it is not related to the current income of the economy under consideration.

Of course, these assumptions may not hold, but are employed to simplify the 'cross' model.

Equilibrium using the cross diagram - schedule
Video on monopsony

Leakages include household savings, taxation, and import spending. These are dependent on current GDP.

Savings clearly depends (though not exclusively) on current income, as does taxation. and the level of imports.

Each withdrawal has its own 'marginal propensity' (likelihood) which indicates how the specific withdrawal changes as income changes.

Marginal propensities

marginal propensities

Hence leakages increase as GDP increases. In this example, equilibrium exists when injections equal leakages, at 'a', and Y (at $600 bn).

Equilibrium using the cross diagram
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