Income, Employment & Cycles

NODE 01

Aggregate Activity

• Macroeconomics studies the economy in aggregate.
• Output ↔ Income ↔ Expenditure.
• Connects directly with Realm 09.

NODE 02

Aggregate Demand (AD)

• Planned expenditure on domestic final goods.
• AD = C + I + G + (X − M).
• At different overall price levels.

NODE 03

Consumption (C)

• Household expenditure on goods and services.
• Influenced by disposable income, wealth, confidence.
• C = C̄ + cYd (Autonomous + Induced).

NODE 04

Saving (S)

• Income not spent on consumption.
• S = Yd − C.
• Income = Consumption + Saving.

NODE 05

Marginal Propensity to Consume

→

• Change in C resulting from change in Income.
• MPC = ΔC / ΔYd.
• E.g., Income ↑ ₹1000, C ↑ ₹800 → MPC = 0.8.

NODE 06

Marginal Propensity to Save

→

• MPS = ΔS / ΔYd.
• In simplest two-sector model: MPC + MPS = 1.
• If MPC = 0.8, then MPS = 0.2.

NODE 07

Autonomous Consumption

• Consumption that occurs even when Income = 0.
• Financed through past savings or borrowing.
• The y-intercept of the consumption function.

NODE 08

Investment (I)

• Expenditure that adds to productive capacity/inventories.
• Influenced by profitability, interest rates.
• Driven heavily by business confidence.

NODE 09

Aggregate Supply (AS)

• Amount of output firms are willing/able to produce.
• At different overall price levels.
• In simple models, AS = level of output/income (Y).

NODE 10

Equilibrium Income

• Occurs where Planned Expenditure = Output (AE = Y).
• If AE > Y: inventories fall → production increases.
• If AE < Y: inventories rise → production decreases.

NODE 11

Aggregate Expenditure

AE =C+I+G

• Planned spending in the economy.
• 2-sector: AE = C + I.
• 4-sector: AE = C + I + G + (X − M).

NODE 12

Underemployment Equilibrium

• Equilibrium can occur BELOW full-employment output.
• Critical Keynesian idea.
• Economy can be stable but still have high unemployment.

NODE 13

Full Employment

• Does NOT mean literally zero unemployment.
• Frictional & structural unemployment still exist.
• Using labour resources at a sustainable high level.

NODE 14

Involuntary Unemployment

• People willing and able to work, but cannot find jobs.
• Important in Keynesian analysis of insufficient AD.

NODE 15

Effective Demand

→

• AD level corresponding to equilibrium output/employment.
• AD → Firm expectations → Prod → Employment.
• Weak demand = weak employment.

NODE 16

The Multiplier (k)

• Eventual change in income from an initial change in expenditure.
• k = 1 / (1 − MPC) OR k = 1 / MPS.

NODE 17

Multiplier Example

→ k=5 →

• Suppose MPC = 0.8. Then k = 1/(1-0.8) = 5.
• If autonomous investment rises by ₹100cr...
• Eventual income effect could be ₹500cr.

NODE 18

Why the Multiplier Works

• Initial spending becomes someone's income.
• They spend a portion (Consumption).
• Becomes someone else's income, repeated infinitely.
• Rounds become progressively smaller.

NODE 19

Multiplier & MPC

MPC↑

MPC↓

• Higher MPC = Larger Multiplier.
• Lower MPC = Smaller Multiplier.
• Higher MPC means more consumption in each round.

NODE 20

Gov Exp Multiplier

→ k →

• Gov expenditure increase produces multiplied income increase.
• Connects Fiscal Policy (Realm 08) with AD.

NODE 21

Tax Multiplier

→ k →

• Change in taxation influences disposable income.
• Standard simple tax multiplier is negative.
• kT = −MPC / (1 − MPC).

NODE 22

Fiscal Policy & AD

vs

• Expansionary: G ↑ or Tax ↓ → AD ↑.
• Contractionary: G ↓ or Tax ↑ → AD ↓.
• Reduces inflationary pressure.

NODE 23

Output Gap

• Compares actual output with potential output.
• Negative gap: Actual < Potential (Unemployment).
• Positive gap: Actual > Potential (Inflation pressure).

NODE 24

Recession

↓

• Substantial decline in economic activity.
• Falling production, rising unemployment.
• Weak investment & consumer spending.

NODE 25

Expansion

↑

• Period of rising economic activity.
• Output, employment, income, investment ↑.

NODE 26

Business Cycle

• Fluctuations in activity around long-term growth path.
• Expansion → Peak → Contraction → Trough → Recovery.

NODE 27

Expansion Characteristics

GDP

EMP

INC

INV

• GDP ↑, Employment ↑, Income ↑.
• Investment ↑, Consumer confidence ↑.
• Demand for labour generally increases.

NODE 28

Peak

• High point in cycle before slowing.
• Capacity constraints hit.
• Inflationary pressures become important.

NODE 29

Contraction

GDP

INV

EMP

CNF

• Production growth weakens / falls.
• Investment declines.
• Unemployment may increase.
• Confidence weakens.

NODE 30

Trough

• Lowest point of the cycle before recovery.
• Minimum activity within that cycle.

NODE 31

Recovery

• Economic activity begins to strengthen.
• Demand ↑ → Prod ↑ → Emp ↑ → Inc ↑ → Cons ↑.

NODE 32

Automatic Stabilisers

• Fiscal system moderates fluctuations automatically.
• Downturns: Income ↓ → Taxes ↓, Transfers ↑.
• Supports disposable income and AD.

NODE 33

Inflationary Gap

• AD pushes output beyond sustainable full capacity.
• Excess demand creates upward pressure on prices.
• Connects to Realm 11.

NODE 34

Recessionary Gap

• AD is insufficient to sustain full-employment output.
• Output below potential → Unemployment / Spare capacity.

NODE 35

Stagflation

+

• Weak/stagnant economic growth + High inflation.
• Often includes high unemployment.
• Inflation & Unemployment do not always move oppositely.

NODE 36

Demand-Pull Inflation

>>

• AD grows faster than economy's capacity to produce.
• AD ↑ strongly → Pressure on prices ↑.

NODE 37

Cost-Push Shocks

<<

• Supply-side disruptions (oil shock, input costs).
• Cost ↑ → AS worsens → Prices ↑ and Output ↓.
• Helps explain stagflation.

NODE 38

Shocks to Business Cycle

⚡

• Demand Shocks: Changes in C, I, G, NX.
• Supply Shocks: Energy prices, disasters, productivity.
• Financial Shocks: Credit, asset prices, banking stability.

NODE 39

Confidence

vs

• Expectations matter.
• Consumer confidence ↓ = Consumption may ↓.
• Business confidence ↓ = Investment may ↓.
• Expectations → Spending → AD → Output.

NODE 40

Expectations

• Decisions based on future income, prices, rates.
• Expectations can amplify economic cycles.

NODE 41

Inventory Adjustment

• Important adjustment mechanism.
• Sell less → inventories ↑ → production cut.
• Demand rises → inventories ↓ → production increases.
• Central to short-run income determination.

NODE 42

Employment

• People engaged in economic activity.
• Affects income, consumption, poverty, AD.

NODE 43

Unemployment

• People without employment, available and seeking work.
• Forms: Frictional, Structural, Cyclical, Seasonal.

NODE 44

Okun's Law (Concept)

GDPU%

• Downturns coincide with rising unemployment.
• Empirical relationship between Output and Unemployment.

NODE 45

Cycle Indicators

• Economists monitor GDP, industrial prod, retail sales.
• Employment, confidence, inflation, credit growth.
• Helps identify changing economic conditions.

NODE 46

Leading, Coin, Lagging

• Leading: Change BEFORE broader economy.
• Coincident: Move WITH current activity.
• Lagging: Adjust AFTER broader changes.

NODE 47

Stabilisation Policy

• Attempting to reduce excessive fluctuations.
• Channels: Fiscal, Monetary, Fin Regulation, Auto Stabs.
• Bridges Realm 08 and Realm 11.

NODE 48

Monetary Policy Conn

→

• Weak activity: Monetary easing → Credit → Invest → AD.
• Excess inflation: Monetary tightening → Reduces demand.

NODE 49

Multiplier-Accelerator

MLT ACC

• Demand ↑ → Output ↑ → Investment ↑ → Income ↑.
• Amplifies economic fluctuations.

NODE 50

Cycle Limitations

?

• Cycles don't follow perfectly predictable patterns.
• Differ in duration, depth, causes, recovery speed.

NODE 51

Growth vs Cycle

• Growth: Long-term increase in productive capacity (Trend).
• Cycle: Short/medium fluctuation around trend.
• Both occur simultaneously.

NODE 52

Master AD-Income Chain

• Autonomous Spending → AD → Firm Sales.
• Prod → Emp → Income → Cons → Further Demand.
• Multiplier → Equilibrium Output.

NODE 53

Master Bus-Cycle Chain

• Shock/Demand Change → AD/Output/Emp changes.
• Income/Cons/Invest changes → Further AD change.
• Expansion / Contraction.

NODE 54

Formula Bank

k = 1 / MPS

• Y = C + I + G + (X − M)
• Yd = C + S
• MPC = ΔC / ΔYd | MPS = ΔS / ΔYd
• k = 1 / (1 − MPC) = 1 / MPS
• Tax Multiplier = −MPC / (1 − MPC)