Lecture 7: Keynesian Income and Expenditure Model
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Questions and Answers

What is the primary purpose of government intervention according to the Keynesian model?

  • To eliminate all fiscal policies
  • To stabilize prices in a free market
  • To correct recessionary gaps (correct)
  • To decrease consumer confidence

    • Which equation represents the aggregate demand in the Keynesian model?

  • AD = I + C + S + (X-M)
  • AD = C + I + G + T
  • AD = C + S + G + (X-M)
  • AD = C + I + G + (X-M) (correct)

    • What does the AE model focus on in relation to the economy?

  • The relationship between income and total spending (correct)
  • The relationship between aggregate supply and price levels
  • The relationship between government interventions and employment
  • The relationship between spending and inflation

    • In which economic scenario did John Maynard Keynes develop his framework?

    <p>During the Great Depression (D)</p> Signup and view all the answers

    How is aggregate demand visualized in the Keynesian model?

    <p>Using the AD curve (C)</p> Signup and view all the answers

    What key component is not included in the aggregate expenditure equation?

    <p>Savings (B)</p> Signup and view all the answers

    What effect does autonomous spending have on the economy according to the Keynesian model?

    <p>It can create a multiplier effect (D)</p> Signup and view all the answers

    Which of the following elements is essential for achieving short-run equilibrium in the Keynesian model?

    <p>Aggregate demand equals aggregate supply (A)</p> Signup and view all the answers

    What is the value of autonomous consumption in the consumption function $C = 1.8 + 0.75Y$?

    <p>$1.8 trillion (A)</p> Signup and view all the answers

    What does the slope of the consumption function, represented by $b$, indicate?

    <p>Fraction of an increase in income that is spent on consumption (C)</p> Signup and view all the answers

    If the marginal propensity to save (MPS) is 0.25, what is the marginal propensity to consume (MPC)?

    <p>0.75 (D)</p> Signup and view all the answers

    In the equation $S = -1.8 + 0.25Y$, what does the value -1.8 represent?

    <p>Autonomous savings (C)</p> Signup and view all the answers

    What is the relationship between change in income, change in consumption, and change in savings expressed as $ rac{ΔY}{ΔC + ΔS}$?

    <p>It equals 1. (A)</p> Signup and view all the answers

    How much will consumption increase with a $1 increase in income if the MPC is 0.75?

    <p>$0.75 (B)</p> Signup and view all the answers

    If the change in consumption is $1.5 trillion and the change in income is $2 trillion, what is the value of the marginal propensity to consume (MPC)?

    <p>0.75 (B)</p> Signup and view all the answers

    What does the negative savings value mean when income is zero in the context of the savings function?

    <p>Negative savings mean debt can increase. (D)</p> Signup and view all the answers

    What is the aggregate expenditure (AE) equation derived when G and (X-M) components are assumed to not exist?

    <p>AE = A + bY (B)</p> Signup and view all the answers

    In the context of Keynesian Equilibrium, what does the 45-degree line represent?

    <p>All points where aggregate expenditures and output are equal (C)</p> Signup and view all the answers

    How is equilibrium real GDP numerically solved in the provided example?

    <p>By solving 2 + 0.75Y = Y (B)</p> Signup and view all the answers

    If autonomous consumption increases, what will happen to the AE line?

    <p>It will shift up, maintaining the same slope (C)</p> Signup and view all the answers

    What value of marginal propensity to consume (MPC) is used in the provided numerical example?

    <p>0.75 (C)</p> Signup and view all the answers

    What happens when AE is greater than Y at the same output level?

    <p>Firms are signaled to produce more (D)</p> Signup and view all the answers

    If the investment (I) is considered autonomous and is initially at $0.5 trillion, what is the total autonomous expenditure (A) when consumption is $1.5 trillion?

    <p>$2.0 trillion (B)</p> Signup and view all the answers

    What is the consumption function represented in the example?

    <p>$1.5 + 0.75Y$ (A)</p> Signup and view all the answers

    What happens to the slope of the aggregate expenditure line if the marginal propensity to consume (MPC) increases from 0.75 to 0.80 while the autonomous component remains constant?

    <p>The slope increases. (A)</p> Signup and view all the answers

    If the aggregate expenditure function is represented as AE = 2 + 0.80Y, what is the equilibrium real GDP when AE equals Y?

    <p>10 trillion dollars (C)</p> Signup and view all the answers

    How is the multiplier calculated using the formula derived from the equilibrium condition?

    <p>Multiplier = $ rac{1}{1-b}$ (A)</p> Signup and view all the answers

    What is the multiplier when the MPC is 0.75?

    <p>4 (A)</p> Signup and view all the answers

    If autonomous expenditure increases by 10 trillion dollars and the multiplier is 4, what will be the total change in real GDP?

    <p>40 trillion dollars (C)</p> Signup and view all the answers

    Which of the following statements accurately describes the multiplier effect?

    <p>The multiplier effect amplifies the changes in real GDP based on the MPC. (B)</p> Signup and view all the answers

    In the equation for aggregate expenditure, what does the 'a' represent?

    <p>The intercept of the aggregate expenditure line when income is zero. (D)</p> Signup and view all the answers

    What is the relationship between changes in the autonomous component and the final change in real GDP?

    <p>The final real GDP change is always less than the change in the autonomous component. (B)</p> Signup and view all the answers

    Flashcards

    What is the Keynesian model?

    The Keynesian model is a macroeconomic theory that explains how government intervention can influence economic activity, particularly during recessions.

    What are the key components of the Keynesian model?

    The model focuses on the relationship between consumption, savings, and investment, examining their impact on the equilibrium level of Real GDP in the short run.

    What is aggregate demand (AD) and how is it represented?

    Aggregate demand (AD) is the total quantity of goods and services demanded at various price levels in a given period.

    What is aggregate expenditure (AE) and how is it related to aggregate demand?

    Aggregate expenditure (AE) is the total amount of spending on goods and services at a given level of income.

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    How is the aggregate expenditure (AE) model different from the aggregate demand (AD) model?

    The Aggregate expenditure (AE) model focuses on the relationship between total spending and the economy's income or output.

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    What are the key assumptions of the Keynesian model?

    The Keynesian model assumes prices are fixed in the short run, meaning the focus is on changes in output and employment levels.

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    How is the Keynesian model used to understand economic policy?

    The model is used to understand how changes in government spending, taxation, and monetary policy can influence real GDP.

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    What are some policy implications of the Keynesian model?

    The Keynesian model suggests that government intervention can be used to stimulate economic activity during recessions by increasing government spending, reducing taxes, or both.

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    Marginal Propensity to Consume (MPC)

    The portion of a change in disposable income that is spent on consumption.

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    Marginal Propensity to Save (MPS)

    The portion of a change in disposable income that is saved.

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    Consumption Function

    The relationship between disposable income and consumption, represented by the equation C = a + bY, where 'a' is autonomous consumption and 'b' is the MPC.

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    Autonomous Consumption

    The amount of consumption that occurs even when income is zero.

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    Savings Function

    The relationship between disposable income and savings, represented by the equation S = -a + (1-b)Y, where '-a' is autonomous savings and (1-b) is the MPS.

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    Autonomous Savings

    The amount of savings that occurs even when income is zero.

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    MPC + MPS = 1

    The sum of the MPC and the MPS must equal 1, reflecting the fact that income is either consumed or saved.

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    Aggregate Expenditure (AE)

    The total planned spending in an economy, represented by the equation AE = C + I + G + (X-M), where 'C' is consumption, 'I' is investment, 'G' is government spending, and 'X-M' is net exports.

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    Aggregate Expenditure Function

    The relationship between planned aggregate expenditure and the level of real GDP.

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    Keynesian Equilibrium

    The point where planned aggregate expenditure (AE) equals real GDP (Y).

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    Autonomous Expenditure

    The portion of aggregate expenditure that does not depend on the level of income.

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    Autonomous Component

    A component of autonomous expenditure that is directly influenced by changes in investment, government spending, or net exports.

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    45-Degree Line

    A representation of all points where aggregate expenditures are equal to real GDP.

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    Multiplier Effect

    The change in aggregate expenditure that results from a one-unit change in the autonomous component.

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    Multiplier

    The change in real GDP divided by the change in autonomous expenditure. It measures how much real GDP changes for every dollar change in autonomous spending.

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    MPC

    The portion of additional income that households spend on consumption goods and services.

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    Autonomous Component (A)

    The part of aggregate expenditure that does not depend on the level of income. It includes spending on consumption, investment, government spending, and net exports that doesn't change with income.

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    Aggregate Expenditure (AE) Function

    The relationship between aggregate expenditure and the level of real GDP. It shows how much spending occurs at different levels of income.

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    Change in Real GDP (ΔY)

    The change in real GDP resulting from a change in autonomous expenditure. It is the multiplier effect multiplied by the change in autonomous expenditure.

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    Study Notes

    Lecture 7: Keynesian Income and Expenditure Model

    • The lecture covers the Keynesian Income and Expenditure Model for a simple economy.
    • Learning objectives include understanding the model's history and logic, identifying its components and their connection to aggregate demand, analyzing and interpreting Keynesian equilibrium numerically and graphically, and understanding the multiplier effect.
    • The model examines the effects of consumption, savings, and investment on equilibrium real GDP.
    • The aggregate demand equation is AD = C + I + G + (X-M)
    • Aggregate demand is the total quantity of goods and services demanded across all levels of an economy at a specified price level.
    • Aggregate expenditure describes the total spending on goods and services within an economy, related to its current income level.

    Learning Outcomes

    • Students will understand the Keynesian model's rationale
    • Components of the Keynesian model and their connection to aggregate demand
    • Analyze Keynesian equilibrium through numerical and graphical methods
    • Comprehend the multiplier effect, affecting autonomous spending's economic impact.

    Recessionary Gap Solution

    • Discretionary expansionary fiscal policy can address recessionary gaps, focusing on either demand or supply sides.
    • The relevant macroeconomic equation is AD = C + I + G + (X-M)

    History of Government Intervention

    • John Maynard Keynes developed a framework to explain high unemployment levels during the 1930s.
    • Keynes proposed fiscal policy intervention, now recognized as crucial during economic downturns.
    • The lecture explores the evolution of the Keynesian model.

    The Keynesian Model

    • The model examines the effects of consumption, savings, and investment on short-run equilibrium real GDP, assuming constant prices.
    • AD = C + I + G + (X-M) is the aggregate demand equation.

    Keynesian Model – Focus Consumption

    • Consumption (C) in an economy is determined by the consumption function.
    • C = a + bY, where 'a' is autonomous consumption and 'b' is the marginal propensity to consume (MPC).
    • The slope 'b' represents the fraction of disposable income spent on consumption.

    Keynesian Model – Focus Savings

    • Savings (S) are calculated as: S = Y - C.
    • Savings are determined by the savings function: S = -a + (1-b)Y , where 'a' is autonomous, and (1-b) is the Marginal Propensity to Save (MPS).
    • MPS + MPC = 1

    Linking MPS and MPC

    • MPC and MPS are related: 1 = MPC + MPS

    Putting Everything Together

    • AE = C + I.
    • AE = a + bY + I = A + bY, where A = a + I.
    • A represents autonomous expenditure.

    Keynesian Equilibrium Graphically

    • Equilibrium occurs when aggregate expenditure (AE) equals aggregate income (Y) on a 45-degree line graph.

    Keynesian Equilibrium Numerically

    • Equilibrium is determined by setting the aggregate expenditure function equal to the aggregate income level; example calculations are provided including the influence on output of a change in autonomous expenditure.

    Multiplier Effect

    • A change in autonomous expenditure has a magnified impact on real GDP.
    • The multiplier effect is the ratio of the change in equilibrium real GDP to an initial change in autonomous expenditure (e.g., investment, consumption).
    • The multiplier is 1/(1-MPC)
    • Multiplier effect shows that the change in aggregate demand leads to a larger change in output.

    Summary

    • The Keynesian model justifies discretionary government policy.
    • The model's efficacy depends heavily on the MPC.
    • Consumption expenditure significantly influences aggregate expenditure.

    Next Week

    • Lectures on three-sector and four-sector models of the economy, emphasizing how autonomous factor changes affect equilibrium output and multiplier values.
    • These models will delve deeper into macroeconomic modeling.

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    Lecture 7: Keynesian Income and Expenditure Model

    Description

    This quiz explores the Keynesian Income and Expenditure Model, emphasizing its components and their relationship to aggregate demand. Students will learn about the model's history, the multiplier effect, and how consumption, savings, and investment influence equilibrium real GDP. Additionally, the quiz involves interpreting the aggregate demand equation and analyzing Keynesian equilibrium both numerically and graphically.

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