EC6012 Homework 2

Why must the vertical columns equal zero?

'Everything comes from somewhere and everything goes somewhere'. Simply put, the outgoings must equal in incomes in this model. In the case of households, the difference between the outgoings of consumption and taxes paid and the income of wages must equal the cash held. The vertical column therefore sums to zero.
In the case of production, the model assumes that no cash is held by industry so the money received from sales and government input must equal wages paid. "Balancing the books" in effect.
Similiarly, the change in the amount of money in the economy must be equal to the difference between government expenditure and receipts.


Why must the horizontal columns equal zero?

In this model whatever is demanded(services, taxes and labour) is supplied. In other words, an equality exists between sales and purchases.In the table we can see a corresponding supply element for every demand element. eg. Cd = Cs

Row Explanations

Consumption

In this model disposable income is given by the wages earned by households minus taxes.
Yd = W.Ns – Ts.
The tax rate on income is t and Td = tWNs.

The consumption function describes the rate at which households consume. In each period, households’ have disposable income and a stock of wealth held from the previous period. In any period consumption is determined by multiplying alpha one by disposable income and adding the product of alpha two and the stock of wealth accumulated from the past. Alpha one is the propensity to consume from current income and alpha two the propensity to consume from past wealth.

Government Expenditure

The government purchases goods and services from firms in the economy with money. Governments fund this spending by taxing its citizen’s wages. The sale of government services is given by Gs and Gd represents the purchase of government services.

Output

Output is the total production of goods and services in the economy. Output is equivalent to national income. National income is given by the identity Y = Cs + Gs. It can also be written as
Y = W.Nd.

Factor Income

Factor income is calculated by multiplying wages by the number of workers. It represents the income received for supplying labour in the production of goods and services. Households earn W.Ns. The factor income paid by the producers represents a liability on their part and is equal to –W.Nd. Factor income paid by producers is equal to that received by households and thus +W.Ns – W.Nd = 0 in the behavioural transactions matrix.

Taxes
Taxes paid by individuals equals taxes received by the government. These taxes received by the government fund government expenditure. Taxes are calculated based on a percentage of the individuals wage decided by the government. So taxes are a percentage of WB*N where N is the number of workers. Wages themselves arise from sales of the individual's work.
Td = θ * W* N


Changes in Money

The change in money held by the household, ΔHS must equal the difference between their outgoings(consumption and taxes) and their income(wages). An increase in the change in money would denote an increase in excess money above their outlays and so indicate a move towards savings and in this model an assumption of investment in financial assets issued by the government.

(Godley&Lavoie, Monetary Economics Chapter 3)