Macro Chapter 9- Keynesian Model in Action

Why can government spending be considered an autonomous expenditure

Government spending is primarily the result of political decisions made independent of the level of national output

How can net exports be negative

When imports is more than exports

Aggregate Expenditures Function (AE)

The total spending in an economy at different levels of real GDP

Formula for Aggregate Expenditures

AE= C+I+G+ (X-M)

Result of unplanned inventory investment depletion

Businesses expand production, results in an increase in real GDP and employment

Result of unplanned inventory investment accumulation

Businesses reduce production, which results in a decrease in real GDP and employment

Aggregate Expenditures Model

The model that determines the equilibrium level of real GDP by intersection of the aggregate expenditures and aggregate output and income (real GDP) curves

Conclusion of Keynesian economics, equilibrium and full employment

According to Keynesian economics, an equilibrium real GDP can occur at, below, or above the full employment real GDP level

GDP gap

The difference between the full-employment output (potential real GDP) and the equilibrium output (actual real GDP)

How can full employment be reached

By shifting the aggregate expenditures curve upwards

Spending Multiplier (SM)

The ratio of the change in real GDP to an initial change in any component of aggregate expenditures, including consumption, investment, government spending, and net exports

Formula for the spending multiplier

Spending multiplier = (1)/(1-MPC) or Spending Multiplier = 1/MPS

Conclusion of changes in total spending and changes in real GDP

Relatively small changes in total spending translate into much larger changes in real GDP because of the multiplier effect

Recessionary gap

The amount by which the aggregate expenditures fall short of the amount required to achieve full employment equilibrium

Keynesian solution to eliminate a recessionary gap

Increase autonomous spending by an amount equal to the recessionary gap

Government solutions to close recessionary gap

Increase government spending

Cut taxes

Raise transfer payments (welfare, unemployment, social security)

Tax Multiplier

The change in aggregate expenditure (total spending) resulting from an initial change in taxes

Tax Multiplier formula

Tax Multiplier= 1-spending multiplier

Inflationary gap

The amount by which the aggregate expenditures exceed the amount required to achieve full-employment equilibrium

Keynesian solution to eliminate inflationary gap

Decrease autonomous spending by an equal amount

What can the government do to close an inflationary gap

Decrease government spending

Raise taxes

Cut transfer payments

Role of government in Keynesian economics

Keynesians want an active role in government to balance out gaps and promote full employment and economic growth