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Model Of National Income Determination

 Model of National Income Determination


In this chapter, we are going to discuss a general Keynesian model of national income ascertainment in an industrialist financial system. To abridge the study, it has been divided into three kinds such as two sector model, three sector model and a four sector model. First two sectors are related to a closed economy in which there is no foreign trade and the four sector model is related with an open economy.

Two Sector Model

A two sector model of revenue ascertainment of a fiscal system comprises only of domestic and business sectors.


The earnings ascertainment in a closed economy depends on the following postulations:

  1. It is a two sector economy where only consumption and investment spending take place. Therefore, the total productivity of the financial system is the total of consumption and investment spending.
  1. Investment is associated to net investment after subtracting depreciation.
  1. It is a closed financial system where there are no overseas transactions.
  1. There are no corporate industries in the financial system so that there are no corporate undistributed proceeds.
  1. There are no commercial taxes, no earning taxes and no social security taxes so that disposable personal earnings parities NNP.
  1. There are no transfer payments in the two sector model.
  1. There is no statute.
  1. The investment is self-governed.
  1. The financial system is at less than full employment level of productivity.
  1. The level of price remains invariable upto the limit of whole employment.
  1. The money wage rate is invariable.
  1. There is a constant function of consumption.
  1. The interest rate is fixed.
  1. The study is associated to short term.


Given these postulations, the equilibrium level of national income can be ascertained by the equality of aggregate demand and aggregate supply or by the equality of saving and investment. Aggregate demand is the summation of consumption expenditure on newly produced consumer goods by households and on their services C and investment expenditure on newly produced capital goods and inventories by businessmen (I).

It is represented as the following:

                                                Y         =          C + I

Disposable Personal Income   Yd       =          C + S

But                                          Y         =          Yd

Therefore,                             C + I    =          C + S

Or                                          I           =          S

Where Y = national income, Yd = disposable income, C = Consumption, S = saving and I = Investment.

In the above identities, C + I relate to consumption and investment expenditures which depict aggregate demand of an economy. C is the consumption function points the association between income and consumption outlay. I is the investment demand which is self governing. When investment demand (I) is added to consumption function (C), the aggregate demand function becomes C + I.

C + S point is related to the aggregate supply of a financial system. That is the reason why the consumer goods and services are produced from total consumption outlay and aggregate savings are invested in the production of capital goods.

In a financial system, the symmetry level of national income is ascertained by the parity of aggregate demand and aggregate supply (C + I = C + S) or by the equality of saving and investment (S = I).

Three Sector Model

A three sector model of income ascertainment comprises of a two sector model and the government sector. The government increases aggregate demand by spending on goods and services and by collecting taxes.

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