National Income Accounting, Equilibrium Income, and Keynesian Gaps

National income accounting requires a careful examination of the relationship between income, consumption, and savings to determine economic stability.
In the provided data set, at an income level of $900$ , the following values are observed:
- Consumption ( $C$ ): $820$
- Savings ( $S$ ): Calculated as income minus consumption ( $Y - C$ ). In this case, $900 - 820 = 80$ .
Marginal Propensity to Consume ( $MPC$ ):
- At the income level of $900$ , the $MPC$ is calculated at $0.6$ .
- The $MPC$ is represented by the coefficient " $b$ " in the consumption function formula ( $C = a + bY$ ).
- Consistency check: If the $MPC$ used to calculate consumption levels does not match the $MPC$ derived from those consumption levels during analysis, a mathematical error has occurred.
Average Propensity to Consume ( $APC$ ):
- Formula: $APC = \frac{\text{Consumption}}{\text{Income}}$
- For an income of $900$ and consumption of $820$ , the $APC = \frac{820}{900} = 0.91$ .
Average Propensity to Save ( $APS$ ):
- Formula: $APS = \frac{\text{Savings}}{\text{Income}}$
- For an income of $900$ and savings of $80$ , the $APS = \frac{80}{900} = 0.09$ .
Fundamental Identities in Accounting:
- The sum of marginal propensities must equal one: $MPC + MPS = 1$ .
- The sum of average propensities must equal one: $APC + APS = 1$ .

Impact of Rising Income on $APC$ and $APS$ :
- As income increases, the Average Propensity to Consume ( $APC$ ) typically drops. Even if an individual spends high absolute amounts of money (e.g., more than a billionaire like Bill Gates), their average spending relative to total income decreases as they get wealthier.
- Conversely, as income increases, the Average Propensity to Save ( $APS$ ) must rise.
Political and Economic Implications of $APS$ :
- The observation that the wealthy have a higher $APS$ forms the foundation for conservative economic arguments regarding tax breaks for the rich.
- The logic is that providing the wealthy with more money leads to higher average levels of savings.
The Importance of Savings:
- Savings are critical for the banking system and the circular flow of the economy.
- Without savings, there is no pool of funds available for businesses to borrow and invest. Therefore, savings are a prerequisite for investment: $\text{Savings} \rightarrow \text{Investment}$ .

Definition: Equilibrium income ( $Y$ ) is defined as the income level at which the economy is stable and "comes to rest."
Aggregate Demand ( $AD$ ):
- In a model with two primary players (consumers and producers), total demand is the sum of what these players want.
- Consumer demand is measured by Consumption ( $C$ ).
- Producer demand is measured by Investment ( $I$ ).
- Total Demand = $C + I$ .
Aggregate Supply ( $AS$ ):
- Total supply is represented by National Income ( $Y$ ).
- This identification is based on the circular flow diagram, which establishes that the total value of goods and services produced equals the total income created.
Equilibrium Condition:
- Equilibrium occurs where total supply equals total demand: $Y = C + I$ .
- Based on the data chart, when national income is $1100$ , the sum of $C + I$ is also $1100$ . Therefore, the equilibrium income level for this economy is $1100$ .

Axes:
- The horizontal axis ( $X$ -axis) represents Disposable Income ( $Y_d$ ).
- The vertical axis ( $Y$ -axis) represents Consumption ( $C$ ) and Total Demand ( $C + I$ ).
The Consumption Line ( $C$ ):
- The consumption line does not start at the origin (zero) because of autonomous consumption ( $a$ ).
- Autonomous consumption is the level of spending when income is zero ( $Y = 0$ ). In the example, $a = 280$ .
- From the intercept of $280$ , the line slopes upward based on the $MPC$ .
The Investment Line ( $I$ ):
- Investment is assumed to be constant across all income levels. In this example, $I = 160$ .
The Total Demand Line ( $C + I$ ):
- This line represents the vertical summation of consumption and investment.
- When income is zero, the $C + I$ intercept is the sum of autonomous consumption ( $280$ ) and investment ( $160$ ), which equals $440$ .
The 45-Degree Line:
- This line represents all points where the value on the horizontal axis equals the value on the vertical axis (e.g., $5$ units over, $5$ units up).
- In economics, it represents all possible points where total supply ( $Y$ ) equals total demand ( $C + I$ ).
Graphical Equilibrium:
- The equilibrium income level is found exactly where the $C + I$ line intersects the 45-degree line.
- In the provided example, this intersection occurs at an income level of $1100$ .

Potential GDP:
- This is the maximum Level of GDP a country can achieve without triggering a recession or causing high inflation.
- It is graphically represented as being on the Production Possibilities Curve ( $PPC$ ).
Comparison of Equilibrium Income and Potential GDP:
- Keynes focused on comparing the level where the economy naturally "comes to rest" (equilibrium) against the "Potential GDP."
Deflationary (Recessionary) Gap:
- Occurs when Potential GDP is greater than Equilibrium Income (\text{Potential GDP} > Y^*).
- This indicates the economy has settled at a point below its full potential, placing it "under" the Production Possibilities Curve and resulting in a recession.
Inflationary Gap:
- Occurs when Potential GDP is less than Equilibrium Income (\text{Potential GDP} < Y^*).
- In this scenario, demand is significantly higher than supply, which causes price levels to rise rapidly (inflation).
The Keynesian Revolution and Government Intervention:
- Keynes argued that if the economy stabilizes (reaches equilibrium) at a point other than Potential GDP, government intervention may be necessary to move the economy toward its potential and close the resulting gaps.