Lecture 7: Keynesian Income and Expenditure Model
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Questions and Answers

What primarily drove John Maynard Keynes to propose government intervention in the economy?

  • To promote international trade
  • To enhance taxation policies
  • To improve agricultural output
  • To address high unemployment levels (correct)

    • Which of the following equations represents aggregate demand in the Keynesian model?

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

    • What does the Keynesian model primarily analyze in relation to real GDP?

  • Technological advancements in production
  • Long-term economic growth patterns
  • The effects of consumption, savings, and investment (correct)
  • Investment strategies during inflation

    • When is the Keynesian equilibrium achieved?

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

    What is the role of the multiplier effect in the Keynesian model?

    <p>To amplify the effects of autonomous spending (B)</p> Signup and view all the answers

    Which of the following components is NOT part of the aggregate demand equation?

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

    Which type of policy is advocated by the Keynesian model to address a recessionary gap?

    <p>Discretionary fiscal policy (C)</p> Signup and view all the answers

    What does the slope of the consumption function represent?

    <p>The marginal propensity to consume (D)</p> Signup and view all the answers

    If income (Y) is zero, what is the level of consumption (C)?

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

    In the short run, which assumption does the Keynesian model make regarding prices?

    <p>Prices are fixed (C)</p> Signup and view all the answers

    What does the term 'MPS' stand for?

    <p>Marginal propensity to save (B)</p> Signup and view all the answers

    If the marginal propensity to consume is 0.75, what is the marginal propensity to save?

    <p>0.25 (B)</p> Signup and view all the answers

    What does the intercept '-a' represent in the savings function?

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

    Which of the following equations represents savings based on income (Y)?

    <p>S = -1.5 + 0.25Y (B)</p> Signup and view all the answers

    In the given consumption and savings model, what happens to savings when income is zero?

    <p>Savings will be negative (C)</p> Signup and view all the answers

    What does the intersection of the AE line with the 45-degree line represent?

    <p>Point of equilibrium (D)</p> Signup and view all the answers

    Given the consumption function $C = a + bY$, what is the value of $b$ in this context?

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

    What is the overall equation for aggregate expenditures (AE) in this model?

    <p>AE = C + I + G + (X-M) (A)</p> Signup and view all the answers

    What is the autonomous consumption indicated in the scenario?

    <p>$1.5 trillion (A)</p> Signup and view all the answers

    What is the equilibrium real GDP calculated in this scenario?

    <p>$8 trillion (A)</p> Signup and view all the answers

    In the equation $AE = 2 + 0.75Y$, what does the constant '2' represent?

    <p>Total consumption when income is zero (A)</p> Signup and view all the answers

    If an autonomous component increases, what effect does this have on the AE equation?

    <p>It shifts the AE curve upward (A)</p> Signup and view all the answers

    Which of the following represents the correct aggregate expenditure function?

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

    How is the marginal propensity to consume represented in the consumption function?

    <p>As 'b' (B)</p> Signup and view all the answers

    What does the change in an autonomous component not lead to?

    <p>The same change in real GDP (B)</p> Signup and view all the answers

    What equates to Y in the equilibrium equation Y = AE?

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

    What does the intersection of the AE line with the 45-degree line indicate?

    <p>The point of equilibrium (D)</p> Signup and view all the answers

    What does 'b' represent in the equation Y = AE = A + bY?

    <p>Marginal Propensity to Consume (B)</p> Signup and view all the answers

    How is the multiplier effect defined based on the relationship between changes in equilibrium real GDP and changes in autonomous expenditure?

    <p>It is the ratio of change in equilibrium real GDP to change in autonomous expenditure (C)</p> Signup and view all the answers

    What is the formula for the aggregate expenditure function when MPC changes to 0.80?

    <p>AE = 2 + 0.80Y (D)</p> Signup and view all the answers

    How is the equilibrium real GDP calculated in this model?

    <p>By solving the equation AE = Y (A)</p> Signup and view all the answers

    How can ΔY be calculated according to the multiplier formula?

    <p>ΔY = ΔA / (1 - b) (A)</p> Signup and view all the answers

    What happens to real GDP when the autonomous component A increases?

    <p>Real GDP increases by a greater magnitude than A (C)</p> Signup and view all the answers

    What is the consumption function formula provided in the content?

    <p>C = 1.5 + 0.80Y (A)</p> Signup and view all the answers

    In the formula ΔY = ΔA / (1 - b), what does the term (1 - b) signify?

    <p>The ratio of income not consumed (A)</p> Signup and view all the answers

    What is the value of Y at equilibrium?

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

    What does the marginal propensity to save (MPS) represent in the context of income changes?

    <p>The change in savings relative to the change in income. (B)</p> Signup and view all the answers

    Which variable is NOT included in the aggregate expenditure calculation?

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

    Which of the following is a consequence of the multiplier effect?

    <p>Changes in autonomous spending have a magnified impact on the economy (A)</p> Signup and view all the answers

    If the marginal propensity to consume (MPC) is 0.75, what is the relationship between MPC and MPS?

    <p>MPC is greater than MPS. (D)</p> Signup and view all the answers

    What effect does an increase in the marginal propensity to consume (MPC) have on the AE line?

    <p>It causes the slope of the AE line to become steeper (B)</p> Signup and view all the answers

    If the aggregate expenditure is represented as AE = 1.5 + 0.75Y, what happens when autonomous expenditure increases by 0.5?

    <p>AE becomes 2 + 0.75Y (A)</p> Signup and view all the answers

    In the equation ΔY = ΔC + ΔS, what does ΔY represent?

    <p>Change in national income. (B)</p> Signup and view all the answers

    What occurs at the point where the aggregate expenditure (AE) equals the output (Y)?

    <p>Keynesian equilibrium. (A)</p> Signup and view all the answers

    At an income level of $0, what is the level of savings according to the information provided?

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

    If the MPS is 0.25, how much will savings increase if income increases by $2 trillion?

    <p>$0.5 trillion (D)</p> Signup and view all the answers

    In the equation AE = C + I, what does 'I' represent?

    <p>Investment, which is fixed. (B)</p> Signup and view all the answers

    What is the significance of the 45-degree line in the Keynesian equilibrium graph?

    <p>Shows where aggregate expenditures equal output. (B)</p> Signup and view all the answers

    Flashcards

    Aggregate Expenditure

    The total amount of spending on goods and services in an economy at a specific income level.

    Aggregate Demand (AD)

    The total quantity of goods and services demanded in an economy across all price levels at a given time.

    Aggregate Supply (AS)

    The total quantity of goods and services that firms are willing to produce and sell at a given price level.

    Keynesian Equilibrium

    It's the condition where the total amount of spending on goods and services (aggregate expenditure) equals the total amount of goods and services produced (aggregate supply).

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    Aggregate Expenditure Curve

    The relationship between the level of income in an economy and the total amount of spending (aggregate expenditure).

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    Recessionary Gap

    A situation where the economy is operating below its full potential, with unused resources and high unemployment levels.

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    Fiscal Policy

    Government actions aimed at influencing the economy, primarily through changes in spending and taxes.

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    Keynesian Income and Expenditure Model

    A model that explains the relationship between spending and income in an economy, focusing on the short-run effects of changes in spending on the economy.

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    Marginal Propensity to Consume (MPC)

    The change in consumption divided by the change in income. It measures the proportion of an additional dollar of income that is spent on consumption.

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    Marginal Propensity to Save (MPS)

    The portion of each additional dollar of income that is saved. It's the complement of the MPC, meaning MPC + MPS = 1.

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    Consumption Function

    The relationship between aggregate consumption and disposable income. It shows how much people consume at different levels of income.

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    Autonomous Consumption

    The consumption level that occurs even when income is zero. It represents the fixed level of consumption necessary for basic needs.

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    Savings Function

    The relationship between aggregate savings and disposable income. It shows how much people save at different levels of income.

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    Autonomous Savings

    The savings level that occurs even when income is zero. It's often negative, implying borrowing to finance basic necessities.

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    Income-Expenditure Identity

    In a closed economy, all income must be either consumed or saved. This principle is used to derive the relationship between savings and consumption.

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    Aggregate Expenditure (AE)

    The total spending in an economy, including consumption, investment, government spending, and net exports.

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    Equilibrium

    The point where the aggregate expenditure (AE) line intersects the 45-degree line, representing the level of real GDP where total spending equals total output.

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    45-degree line

    A straight line with a slope of 1, representing all possible combinations of real GDP and aggregate expenditure where total spending equals total output.

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    Aggregate Expenditure (AE) function

    The relationship between planned spending and total output.

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    Investment (I)

    The component of autonomous spending that represents spending on physical capital, like buildings and equipment.

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    Autonomous Consumption (a)

    The component of autonomous spending that represents spending on consumer goods and services.

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    Keynesian Equilibrium Solving

    The process of finding the equilibrium level of real GDP in the Keynesian model by setting aggregate expenditure equal to real GDP.

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    Shift in the AE curve

    The change in the aggregate expenditure curve caused by a change in spending, like investment or government spending.

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    Induced Consumption

    The amount of spending that changes based on changes in income. This is represented by the slope of the consumption function.

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    What is MPS?

    MPS (Marginal Propensity to Save) represents the proportion of an additional dollar of income that is saved. It's calculated as the change in saving divided by the change in income.

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    What is MPC?

    MPC (Marginal Propensity to Consume) reflects the portion of an additional dollar of income that is spent on consumption. It's calculated as the change in consumption divided by the change in income.

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    What characterizes Keynesian Equilibrium?

    Keynesian Equilibrium occurs when aggregate expenditure (AE) equals national income (Y). This means the total amount spent in the economy is equal to the total value of goods and services produced.

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    Why is the 45-degree line significant?

    The 45-degree line represents all points where aggregate expenditure (AE) equals national income (Y). This line serves as a visual aid to depict equilibrium.

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    What is autonomous spending?

    Autonomous spending refers to components of aggregate expenditure that do not depend on income levels, like investment (I), government spending (G), and net exports (X-M).

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    How does the aggregate expenditure equation work?

    The sum of autonomous spending and induced spending (determined by income) equals the total aggregate expenditure (AE). It's represented as AE = A + bY, where A is autonomous spending and b is the MPC.

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    What does the slope of the AE curve represent?

    The slope of the aggregate expenditure (AE) curve is equal to MPC, reflecting how much spending changes for every dollar change in income. It shows the relationship between AE and income (Y)

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    How does AE curve help find equilibrium?

    The aggregate expenditure (AE) curve intersects the 45-degree line at the equilibrium point. This intersection represents the level of income where planned spending equals production.

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    Multiplier Effect

    The multiplier effect describes how a change in an autonomous component of aggregate expenditure (like government spending or investment) leads to a larger change in real GDP.

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    Multiplier

    The multiplier is the ratio of the change in equilibrium real GDP to the change in autonomous expenditure. It tells us how much real GDP changes for each unit change in autonomous spending.

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    Autonomous Component

    An autonomous component of aggregate expenditure is a component that doesn't depend on the level of income. Examples include government spending, investment, and exports.

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    Multiplier Equation

    The multiplier is calculated as 1/(1-MPC). A higher MPC means a larger multiplier, since more of each additional dollar of income is spent, leading to more spending and a larger change in GDP.

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    Multiplier Effect Importance

    The multiplier effect plays a key role in macroeconomics because it helps explain how changes in government spending, investment, or other autonomous components can have a significant impact on the economy.

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    Study Notes

    Lecture 7: The Keynesian Income and Expenditure Model: A Simple Economy

    • The lecture focuses on the Keynesian model, which explains income and expenditure in a simple economy.
    • Learning outcomes include understanding the history and logic of the model, identifying and explaining its components' connection to aggregate demand, analyzing and interpreting Keynesian equilibrium numerically and graphically, and comprehending the multiplier effect.
    • Solutions to a recessionary gap can include non-discretionary policy or discretionary expansionary fiscal policy (demand or supply-side).
    • John Maynard Keynes developed a framework to explain high unemployment levels in the 1920s and 1930s in Great Britain.
    • Keynes suggested government intervention as Fiscal Policy to correct recessions, based on his model, The Keynesian model.

    The Keynesian Model:

    • The model examines the effects of consumption, savings, and investment on equilibrium real GDP in the short run under a fixed price assumption.
    • Effects are analyzed based on the aggregate demand equation (AD = C + I + G + (X-M)).
    • In short-run equilibrium, aggregate demand (AD) equals aggregate supply (AS).
    • Aggregate demand is the total quantity of goods and services demanded across all levels of an economy at a particular price level and a given period.
    • Aggregate expenditure (AE) is the total amount of spending on an economy's goods and services at a given income level.
    • AD and AE are two sides of the same coin, describing total spending in the economy, though viewed differently.

    The Keynesian Model – Focus on Consumption:

    • Consumption (C) in an economy is determined by the consumption function.
    • Consumption even with zero income (autonomous consumption) is represented by the intercept in the equation (C = a + bY).
    • The slope (b) is the marginal propensity to consume (MPC), which represents the fraction of a change in disposable income spent on consumption.

    The Keynesian Model – Focus on Savings:

    • Income (Y) is either consumed or saved (Y = C + S).
    • Savings (S) is calculated as S = Y - C.
    • Savings function: S = −a + (1 − b)Y, with -a as autonomous savings and (1 − b) as the marginal propensity to save (MPS).
    • (1- MPC) = MPS
    • The intercept -a in the equation represents autonomous savings.

    Linking MPC and MPS:

    • In equilibrium, changes in income are equal to changes in consumption plus changes in savings (ΔY = ΔC + ΔS).
    • This relationship implies 1 = MPC + MPS.

    Putting Everything Together:

    • Assuming government spending (G) and net exports (X-M) do not exist and investment (I) is fixed (autonomous), the aggregate expenditure (AE) equation simplifies to AE = C + I, further simplifying to AE = A + bY (where A = a+I).

    Keynesian Equilibrium Graphically and Numerically:

    • Equilibrium is where AE = Y.
    • The 45-degree line graphically represents this equilibrium, where aggregate expenditure equals output (income).
      • Intersection of AE line on 45 degree line = equilibrium
    • Numerical examples demonstrate calculating equilibrium real GDP, given autonomous consumption, investment, and marginal propensity to consume.

    The Multiplier Effect:

    • A change in autonomous components (investment, government spending, consumption) or MPC causes a larger change in real GDP.

    • This magnified effect is attributed to the multiplier effect.

    • The multiplier (a) is calculated as 1 / (1 − b) or 1/(1 - MPC).

    Multiplier Effect Example:

    • A change in autonomous expenditure is multiplied by the multiplier to predict the resulting change in real GDP.

    Keynesian Equilibrium: Auto Component Changes:

    • Changes in autonomous components (investment or consumption) shift the AE curve, affecting the equilibrium level of real GDP.
    • The slope of the AE curve does not change with changes in autonomous components, only the intercepts.

    Keynesian Equilibrium: MPC changes:

    • Changes in MPC shift the slope of the AE function, affecting the equilibrium level of real GDP.
    • Only the slope of the AE line changes, not the intercept.

    Summary:

    • The Keynesian model provides a framework for understanding fiscal policy (government policy).
    • The model's effectiveness depends on MPC.
    • Consumption expenditure is the largest component of aggregate expenditure.

    Next Week:

    • The Keynesian model will be explored in three- and four-sector models.
    • The concept of the multiplier will be applied to these models, and the effect on equilibrium GDP will be explored, which will be compared with the two-sector model.

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    Lecture 7 - Keynesian Income and Expenditure Model - PDF

    Description

    This quiz explores the Keynesian Income and Expenditure Model, focusing on its components and connection to aggregate demand in a simple economy. Participants will analyze the model's effectiveness in addressing recessionary gaps through fiscal policy. Test your understanding of the historical context and theoretical implications of Keynesian economics.

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