Keynesian Model Overview

Chapter 25: In the Short Run: The Keynesian Model

Expenditure Plans and GDP

  • In the short run, firms set fixed prices; quantity sold depends on demand.

  • Fixed price level implies aggregate demand determines real GDP.

Aggregate Expenditure Components

  • Four components: consumption, investment, government spending, net exports.

  • Aggregate planned expenditure = C + I + G + (X - M).

Two-Way Link Between Expenditure and GDP

  • Increase in real GDP raises aggregate expenditure, and vice versa.

Consumption and Saving Functions

  • Influenced by: disposable income, real interest rate, wealth, expected future income.

  • Consumption function relates consumption to disposable income; saving function relates saving to disposable income.

Marginal Propensities

  • Marginal Propensity to Consume (MPC): fraction of change in disposable income spent on consumption.

  • Marginal Propensity to Save (MPS): fraction of change in disposable income that is saved.

  • MPC + MPS = 1.

Changes Influencing Consumption and Saving

  • Shifts in consumption and saving functions occur due to factors other than disposable income (e.g., interest rates, wealth).

Import Function

  • Home imports influenced by home real GDP; marginal propensity to import defined.

Equilibrium Expenditure

  • Equilibrium occurs when planned expenditure equals actual GDP.

  • Graphically, occurs at the intersection of AE curve and 45° line.

Multiplier Effect

  • Multiplier amplifies changes in autonomous expenditure, thus magnifying changes in real GDP.

  • Influenced by slope of the AE curve.

  • Formula: Multiplier = 1/(1 - slope of AE curve).

Business Cycle and Autonomous Expenditure

  • Peaks and troughs occur with changes in autonomous expenditure.

Price Level and Aggregate Demand

  • Price level changes affect wealth and substitution effects on aggregate expenditure.

  • Increased demand may raise prices, while equilibrium expenditure may subsequently adjust.

Review Topics

  • Shifts in consumption function.

  • Marginal propensity calculations and GDP changes based on expenditure adjustments.