The price level is assumed to be constant until the economy reaches its full-employment or Natural Real GDP level.
Second assumption in the simple Keynesian model?
there is NO foreign sector. In other words, the model represents a closed economy, not an open economy. It follows, then that total spending in the economy is the sum of consumption, investment, and government purchases
Third assmption in the simple Keynesian model?
The monetary side of the economy is excluded
Keynes 3 basic points about consumption:
Consumption depends on disposable income (income minus taxes)
Consumption and disposable income move in the same direction.
When disposable income changes, consumption changes by less.
Consumption Function
C = C0 + (MPC)(Yd)
C symbolizes:
consumption
Yd
disposable income
(MPC)
marginal propensity to consume: the ratio of the change in consumption to the change in disposable income
CHANGE IN CONSUMPTION
MPC = ----------------------------------------
CHANGE IN DISPOSABLE INCOME
C0
autonomous consumption
Changes NOT as disposable income changes, but rather due to facors other than disposable income
C0 = ___________ consumption
MPC(Yd) = ____________ consumption
autonomous consumption
induced consumption
What is savings? (S)
Saving = disposable income - consumption
SAVING equation
S = Yd - [C0 - (MPC)(Yd)]
marginal propensity to save (MPS)
is the ratio of the change in saving to the change in disposable income
CHANGE IN SAVING
MPS = -------------------------------------------
CHANGE IN DISPOSABLE INCOME
What two factor can disposable income can change?
consumption
saving
C + S = Yd
MPC + MPS =
1
MPC + MPS = 1
1 - MPC = MPS
1 - MPS = MPC
According to Keynes, if C0 RISES BY $40 billion, what will total spending rise by??
MORE than $40 billion
A - J
A buys $40 of goods from B -->
B has $40 additional income -->
depending on MPC, lets say (.8)
B increases consumption by $32 -->
C has 32$ of additional income -->
and so on
The process of an initial rise in autonomous consumption leads to a rise in consumption for one person, generating additional income for another person, and leading to additional consumption spending by that person
multiplier process
equation to find the total of the MULTIPLIER
(additional spending generated)
1
multiplier (m) = -------------------
1 - MPC
(m) * original consumption ($40) = $200 increase in total spending
Change in total spending equation?
Change in total spending = Multiplier x Change in autonomous spending
A change in autonomous spending leads to a _______ change in total spending
A) Greater
B) Smaller
C) Equal
D) None of the above
A) Greater
in the simple Keynesian model, the change in total spending is _______ the change in Real GDP
A. equal to
How long does the multiplier take to have an effect in the real world?
process takes many months
What must take place for the multiplier to increase Real GDP?
idle resources must exist at each spending round, idle resources must be available to be brought into production.
in the simple Keynes model, what three variables can shift the AD curve?
(C, I, G)
(((no NX because it is a closed economy)))
Note: change in C0 will change (C)
What does the AD shift look like with $40 autonomous consumption and a multiplier of 5??
In the simple Keynesian model, the price level is assumed to be ________ until it reaches its full employment or Natural Real GDP
A) constant
The AS curve in the simple Keynesian model
price level stay the same until Real GDP is reached
after that any AD shift, increases the price level
Why did Keynes believe that even if interest rates dropped, it wouldn't always cause businesses to invest more?
because business might have a pessimistic expectation of future sales so strong that they don't invest more at the lower interest rate.
in terms of AD and AS, the essence of the simple Keynesian model can be summarized in five statements
1. the price level is constant until Natural Real GDP is reached
2. The AD curve shifts if there are changes in C, I , or G.
3. According the Keynes, the economy could be in equilibrium and in a recessionary gap, too. In other words, the economy can be at point A in Exhibit 7.
4. The private sector may not be able to get the economy out of a recessionary gap. In other words, the private sector (households and businesses) may not be able to increase C or I enough to get the AD curve to intersect the AS curve at point B
5. The government may have a management role to play in the economy. According to Keynes, government may have to raise aggregate demand enough to stimulate the economy to move it out of the recessionary gap and to its Natural Real GDP level.
Total expenditures are the sum of 3 parts:
consumpton
investment
government purchases
The TE curve is _______ sloping.
A. upward
The TE curve shifts if there is a change in:
C, I, or G
There are 3 possible states of economy in the TE - TP framework
(total expenditures - total production)
TE < TP
TE > TP
TE = TP
How can businesses produce $10 trillion worth of goods and services, but the economy buys $10.5 trillion?
businesses sell goods that they hold in inventory
When businesses have overproduced and have more than the optimum inventory they:
cut back on the quantity of goods they produced, causing Real GDP to fall
ultimately TP will equal TE
if businesses have underproduced they will:
increase the quantity of goods they produce, causing Real GDP to rise
ultimately TP will equal TE
TE-TP framework
Qe, TE = TP
According to Keynes, can the economy be in equilibrium and in a recessionary gap?
YES
In terms of TE and TP, the essence of the simple Keynesian model can be summed up in five statements
1. the price level is constant until Natural Real GDP is reached.
2. The TE curve shifts if there are changes in C, I, or G.
3. According to Keynes, the economy could be in equilibrium and in a recessionary gap, too.
4. the private sector may not be able to get the economy out of a recessionary gap In other words, the private sector (households and businesses) may not be able to increase C or I
5. The government may have a management role to play in the economy. According to Keynes government may have to raise TE enough to stimulate the economy to move it out of the recessionary gap and to its Natural Real GDP level.
