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John Maynard Keynes
British economist whose influential work offered an explanation of the Great Depression and suggested as a cure, that the government should pla an active role in the economy.
The theory that supply creates its own demand.
Theory dominated thinking from 1770's to gReat Depression. They believed recessions would naturally cure themselves because the price system would automatically restore full employment.
The Consumption Function
LOOK AT GRAPH
The graph or table that shows the amount households spend for goods and services at different levels of disposable income.
Consumption that is independent of the level of disposable income.
Algebra of Consumption Function
- where a=autonomous consumption
- Yd=disposable income
Marginal Propensity to consume
The change in consumption resulting form a given change in real disposable income.
MPC=change in consumption / change in real disposable income
Marginal Propensity to Save
The change in saving resulting from a given change in real disposable income.
MPS=change in saving/ change in real disposable income.
Variables which might shift the consumption function up or down
- Expectations -are optimistic or pessimistic views of the future which can change consumption spending in the present. Expectations may involve the future inflation rate, the likelihood of becoming unemployed, the likelihood of receiving higher income, or the future shortage of products resulting from a war or other circumstances. THe effect of such Expectation would be to trigger current spending and shift consumption schedule upward.
- Wealth-holding all other factores constant, the more wealth households accumulate, the more they spend at any current level of disposable income, causing the consumption function to shift upward. Wealth owned by households includes both real assets, such as homes, automobiles, and land, and financial assets, including cash savings accounts, stocks, bonds, insurance policies and pensions.
- The price Level- shifts the consumption shedule by reduing or enlarging the purchasing power of financial assets (wealth) with fixed nominal value. Once the real value of financial wealth falls, families are poorer and spend less at any level of current disposable income. As a result the comsumption function shifts downward.
- Interest Rates- includes the option of borrowing to finance spending. A lower rate of interest on loans enourages consumers to borrow more and higher interest rae discourages consumer purchases. The result is a shift upward.
- Stock of Durable Goods- WWII Americans had pent-up demand for many durable goods. WHen goods are not produced , massive buying spree caused an upward shift in consumption function.
Investment Demand Curve
The curve that shows the amount businesses spend for the investment goods at different possible rates of interest.
Factors that can shift the investment demand curve.
- EXPECTATIONS- Expectations about the future translate into estimates for futre sales, futrue costs, and future profitability of investment projects.
- TECHNOLOGICAL CHANGE- Techonological progress included the introduction of new products and new ways of doing things. Firms buy the latest inovations in order to improve their production capabilities, causing the investmant demand curve to shift RIGHTWARD.
- CAPACITY UTILIZATION- Capacity is defined as the maximum possible output of a firm or industry. If the nations capital stock dtood idle, firms had little incentive to buy more, the investment shifted far to the left. Firms may be operating their plants at a high rate of capacity utilization and the outlook for sales growth is optimisitic, there is pressure on firms to invest in new investment projects, and curve shifts right.
- BUSINESS TAXES- taxes on business firms can shift the curve. An increase in business taxes therefore would lower profits and shift the investment demand curve to the left. But if the Us government wishes to have a tax policy shifts right.
Aggregate Expenditure Function
The function that represents total spending in an econom at a given level of real disposable income.
Aggregate Expenditrue output model
The model that determines the equilibrium level of real GDP by the intersection of the aggregate expenditures and aggregate output (and income) curves.
- The ratio of change in real GDP to an initial change in any compnent of aggregate expenditures, including consumption, investment, government spending, and net exports. As a formula the spending multiper equals
- 1/(1-MPC) or 1/MPS
Recessionary Gap-The amount by which the aggregate expenditures curve must be increased to achieve full employment equilibrium.
Inflationary Gap- The amount by which the aggreagate expenditures curve must be decreased to achieve full employment equilibrium.
Why there is a spending multiplier
The multiplier is important in the Keynesian model because it means that the the initial change in aggregate expenditures results in an amplified chang in the equilibrium level of real GDP.
The change in aggregate expenditures (total spending resulting from an initial change in taxes. As a formula, the tax multiplier equals 1-spending multiplier.
Aggregate Demand Curve
The curve that shows the level of real GDP purchased by households, businesses, government, and foreigners at different possible price levels furing a time period, ceteris paribus.
The reasons for the downward slope of an aggregate demand curve include the real balances effect, the interest rate effect, and the net export effect.
- REAL BALANCES EFFECT- The impact of total spendin(real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value.
- INTEREST RATE EFFECT- The impact on total speding (real GDP) caused by the direct relationship between the price level and the interest rate.
- NET EXPORT EFFECTS- The impact on total spending (real GDP) caused by the inverse relationship between the price level and the net exports of an economy.
Aggregate Supply Curve
The curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus.
Three Ranges of The Aggregate Supply Curve
- The Keynesian Range- horizontal segment of the aggregate supply curve, which represents an economy in a severe recession.
- The Intermediate Range- The rising segment of the aggregate supply curve, which represents an economy as it approaches full-employment output.
- Classical Range- The vertical segment of the aggregate supply curve, which represents an econom at full employment output.
Demand-Pull inflation on AS/AD graph
on page 258
A rise in the general price level resulting from an excess of total spending (demand) caused by a rightward shift in the aggregate demand curve.
Stagflation- The condition tha occurs when an econonmy experiences the twin maladies of high unemployment and rapid inflation simultaneously.
Cost- push inflation- An increase in the general price level resulting from an increase in the cost of production that causes the aggregate supply curve to shift leftward.
Discretionary fiscal policy- The deliberate use of changes in government spending or taxes to alter aggregate demand and stablizie the economy.
Fiscal Policy-The use of government spending and taxes to influence the nation's spending, employment, and price level.
Federal expenditures and tax revenues that automatically change levels in order to stablize an economic expansion or contraction; sometimes referred to as nondiscretionary fiscal policy.
Fereral budget defecit/balance/ surplus
- Budget Surplus-a budget in which government revenues exceed in a given time period
- Budgt deficit- A budget in which fovernment expenditures exceed government revenues in a given time period.