EC6012 – Monday Week 5 – 12/03/07.

Group members present:

* Alex, Martina, Mark,Sinead and Jason.

* PBL - exercise & presentation was done on the Multiplier effect

First post, answers to Problem 4:

EC6012 – Problem 4

Q.1.1 Why must the Vertical Columns sum to zero?
They describe the sums of money that actually change hands and therefore represent a system of accounting identities. The change in the amount of money held in one sector must always equal the difference between receipts and payments in the other sectors.

Q.1.2 Why must the Horizontal Rows sum to zero?
The rows represent the Circular Flow of Income. Flows move in a zero sum space – i.e. ‘everything comes from somewhere and everything goes somewhere’ (Godley & Lavoie, pg. 6). Every component in the matrix must have an equivalent component elsewhere. Therefore flows must always equal zero e.g. consumption is a receipt of money by business but a payment by households.

Q.2 Write out an explanation for each row.
§ Consumption – In each period, the households consume either their disposable income or the wealth they have accumulated in previous periods or both. Consumption therefore must be some proportion alpha of the flow of disposable income and the opening stock of money.
§ Government Expenditure – The government buys services and pays for them with money (-Gd). Production companies/business sector receive this money in return for services rendered (+Gd). Thus this row will always sum to zero.
§ Output – In this case output is a positive flow (though not of cash) for the business sector as goods and services are produced within this sector thus creating a profit. For the households, Output is a negative flow as they are ultimately the ones producing the output.
§ Factor Income – The wage bill is denoted as a wage rate (W) times employment (N). The production sector supplies services to the household sector and the government and also demands a volume of employment at a wage rate which is exogenously determined. The s and d denote ‘supply’ and ‘demand’. Households earn income (+W.Ns) while the production sector pays employees (-W.Nd), thus the row also sums to zero.
§ Taxes – Households who earn income are subject to tax on their wages (-Td) while the government earns taxes as receipts from each employee (+Td). Again this row will sum to zero.
§ Change in money stock – Money (H) is a liability for the government, i.e. it is public debt or the debt of the government. On the other hand, money (H) is an asset for the household as it represents their accumulated wealth at a particular point in time. +change Hs in the Government sector is given by the difference between government receipts and expenditures in that period. Because there are no tangible assets in this matrix, additions to cash holdings constitute the saving of the households.