MACRO Chapter #9 KEYNESIAN MODEL

John Maynard Keynes

British economist who wrote "the General Theory" in 1936, known for the keynesian model

keynesian critique of the classical model

wages, prices and interest rates may be "sticky" (fixed) so that means markets aren't always clear

money illusion may exist

keynesian model focuses of short-run flactuations

keynesian model also focuses on demand side economy (importance of spending)

classical model v keynesian

classical model: says' law spending adjusts to output

supply side economics

keynesian model: output adjusts to spending

importance of business confidence

role for government

demand side economics

classical model graph v. fixed price keynesian model product market graph

classical model: product market: aggregate supply is vertical, aggregate demand is hyperbola thingy

fixed price keynesian model: product market: aggregate supply is horizontal, aggregate demand is downward sloping

fixed price keynesian model asumptions

wages, prices and interest rates are fixed

consumption spending depends on income (endogenous- inside the model)

Investments, Government spending, X(exports) and M(imports) are FIXED (exogenous- outside the model)

Taxes= 0

c

Co

Yd

Y

T

b

c= consumption

Co= autonomous consumption spending

Yd= disposible income

Y- real income(GDP)

T- taxes

b-MPC

Yd

disposable income Yd= Y-T

income available for the consumer to spend as they want

b

MPC- marginal propensity to consume

change in consumption spending/ change in GDP

b<1

b>0

consumption function equation

C= Co+ (b)(Yd)

savings function equation

S= -Co+ (1-b) (Yd)

-Co

1-b/ MPS

-Co= autonomous dissavings - money spent, not saved

1-b- MPS (marginal propensity to save) = change in savings/ change in GDP

MPS

marginal propensity saving

change in savings/ change in output/disposible income

1-b

aggregate expenditure function equation

Co+(b)(Yd)+I+G+X+M

orrrr

AEo+ (b)(Yd)

keynesian equilibrium

occurs when Y=AE

Output = spending

Y= 1/(1-b) X ( AEo)

spending multiplier formula

1/(1-b+d) or 1/1-mpc+mpim

keynesian cost diagram/ income-expenditure model, above equilibrium

output is greater than spending which means inventories are rising and firms now have the incentive to decrease their output products

keynesian cost diagram/ income-expenditure model, below equilibrium

spending is greater than output which means inventories are falling and firms now have the incentive to increase their output products

keynesian cross

45 degree line that is Y=AE

find aggregate expenditure function

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

AE0 is where the AE curve starts

find equilibrium

set Y= AE to find equilibrium,

the weird 1/1-number is the spending multiplier

change in a factor to find new equilibrium

plug new factor into the AE function and then plug Y=AE

MPC has to be less than 1

MPC equal to 1

MPC greater than 1

flatter than AE therefore economy is at equilibrium

slope of AE is parallel and economy is not at equilibrium

slope is higher and there will never be equilibrium because the keynesian cross will intersect at a negative AE point

alternative concept of equilibrium

leakages = injections

leakages

S + T + M (savings, taxes and imports)

represents income not spent on current domestic output

injections

I + G + X

(investments, government spending and exports)

represents spending by other sectors besides households

leakages and injections relationship

when households dont spend their income, the money turns into (savings, taxes and imports)

then other sectors use that money for injections back into the economy (investments, government spending and exports)

injections > leakages

more income > subtracting income

income increases

leakages > injections

subtracting income > more income

income decreases

paradox of thrift

in the fixed-price keynesian model, an increase in savings leads to a decline in real GDP, LEAKAGES > INJECTIONS

paradox because households benefit for saving but saving too much according to the keynesian model leads to consumption decreasing and as a result GDP decreases

classical model vs fixed price keynesian model when it comes to savings

classical model measures long run so savings are beneficial but in the short run like fixed-price keynesian model measures, savings aren't benefical

extending fixed price keynesian model assumptions

taxes > 0, Yd= Y-T

and we have an import function M=M0 + (d)(Yd)

import function

M= M0 + (d)(Yd)

d

MPIM- marginal propensity to import

MPIM= change in imports/ change in output or disposible income

fixed price keynesian model spending multiplier

change in Y= 1/1-MPC+MPIM x change in AE

fixed price keynesian model tax multiplier

change in Y= -MPC+MPIM/ 1-MPC+MPIM x change in AE

spending multiplier and tax multiplier

spending multiplier + tax multiplier = 1