Keynesian Expenditure Model and Money

Keynesian Expenditure Model

Introduction to Keynesian Expenditure Model

• Concept of Spending in the Economy:

  • Spending is critical for the economy to achieve desired objectives.

  • Objectives include maintaining a satisfactory level of output and keeping the workforce employed.

• Spending Equation:

  • The spending line in the Keynesian model is represented as:
    C + I + G + (X - N)
    Where:

  • C = Consumption

  • I = Investment

  • G = Government spending

  • X = Exports

  • N = Imports

Impact of Increased Spending

• Maintainable GDP (Gross Domestic Product):

  • When spending increases, not only does the maintainable GDP improve, but it does so via the multiplier effect.

  • E.g., an increase of 20,000,000,000 in spending leads to a greater positive effect on maintainable GDP.

  • In the discussed example, the initial infusion was multiplied by a factor of 80.

• Multiplier Effect Defined:

  • The multiplier effect indicates that the growth in maintainable GDP reflects a value greater than the increase in the spending infusion.

Calculating the Spending Multiplier

• Example Calculation of the Spending Multiplier:

  • Given:

  • Marginal Propensity to Consume (MPC) = 0.75

  • Marginal Propensity to Save (MPS) = 0.25

  • Formula for Spending Multiplier:
    ext{Spending Multiplier} = rac{1}{MPS}

  • Calculation:
    Spending Multiplier = rac{1}{0.25} = 4

• Contextual Clarification:

  • The multiplier effect is based on a hypothetical table provided by the author, not necessarily reflecting societal reality.

Fiscal Policy Tools

• Definition of Fiscal Policy:

  • Fiscal policy consists of government spending and taxation strategies to influence economic performance.

• Government Spending vs. Taxation:

  • The tools can be understood via the following principles:

  • Increasing government spending:

    • E.g., if government spending rose by 50,000,000,000, maintainable GDP would grow by:
      50,000,000,000 imes 4 = 200,000,000,000

  • Decreasing taxes:

    • Increases taxpayers' disposable income, stimulating spending.

    • Fewer taxes lead to increased consumption, thus contributing further to the GDP multiplier effect.

Comparison of Government Spending and Tax Cuts

• Relative Strength of Each Tool:

  • Government Spending:

  • Direct infusion of capital into the economy dollar-for-dollar.

  • Every dollar spent contributes directly to GDP.

  • Tax Cuts:

  • Not all tax relief translates to increased consumption.

  • If taxes were reduced by 50,000,000,000, actual increase in GDP would be lower than the equivalent amount spent.

  • Calculation of actual increase in GDP from tax cuts:

    • Increase in taxpayer disposable income = 50,000,000,000

    • Increase in consumption spending = 0.75 imes 50,000,000,000 = 37,500,000,000

    • Resulting change in GDP = 37,500,000,000 imes 4 = 150,000,000,000

Tax Multiplier

• Tax Multiplier Definition and Calculation:

  • Formula:
    ext{Tax Multiplier} = rac{MPC}{MPS}

  • For the discussed scenario:
    ext{Tax Multiplier} = rac{0.75}{0.25} = 3

  • Impact of tax change (e.g., 50,000 tax cut) on GDP:
    50,000 imes 3 = 150,000

Balanced Budget Multiplier

• Understanding Balanced Budget Multiplier:

  • Examines the impact of equal changes in government spending and taxation.

  • Key Points:

  • If government spending increases by 50,000 and taxes are simultaneously increased by the same amount, the budget stays balanced while GDP can still change.

  • Change in spending leads to a change in GDP of 50,000 imes 1 = 50,000, while the tax increase reduces consumption.

  • Balanced budget multiplier indicates that although the deficit remains the same, GDP may still increase or decrease based on relative changes.

Transition to Money and Banking

• Introduction to Money, Banking System, and the Federal Reserve:

  • Transition in learning from Keynesian economics to the banking system and the Federal Reserve.

• Importance of Money in Society:

  • Discussing why understanding money can be challenging due to its omnipresence in daily life.

  • Money facilitates economic transactions and adds efficiency to the economy.

Functions of Money

• Three Primary Functions:

  1. Medium of Exchange:

  • Money facilitates transactions and trade.

  1. Standard of Value:

  • Allows for consistent pricing and value comparison of goods and services.

  1. Store of Value:

  • Allows for the preservation of purchasing power over time.

Medium of Exchange

• Role:

  • Money allows for easy exchange without the necessity of barter, which requires a dual coincidence of wants, making trades less efficient.

Standard of Value

• Role:

  • Stipulates prices for goods, simplifying transactions.

  • Without money, pricing goods in barter would be cumbersome and inefficient.

Store of Value

• Role:

  • Money must be durable and maintain its purchasing power over time.

  • Inflation must be controlled to preserve its value as a store of wealth.

Definition of Money

• Comprehensive Definition:

  • Money consists of currency and coin not held in banks plus demand deposits.

  • Demand Deposits:

    • Refers to checking accounts that facilitate transactions and purchases in modern economies.

Value of Money

• Underlying Value:

  • The value of money is derived from government backing, not from commodities.

  • Fiat Currency Explained:

  • Currency has value because the government maintains its legitimacy and ensures its acceptance.

  • If a government dissolves, its currency may lose its value, as seen with the Confederacy.

• Scarcity's Role in Value:

  • Money retains its value through relative scarcity.

  • Excessive money supply relative to goods leads to inflation, causing loss of money's value.

Conclusion

• Understanding these core principles of the Keynesian expenditure model, fiscal policy, money, and the banking system is critical for evaluating how economies operate and respond to changes in spending and taxation.