1 Chapter 19 The Keynesian Model in Action Key Concepts Key Concepts Summary Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western

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3 Why is government spending considered an autonomous expenditure? Government spending is primarily the result of a political decision made independent of the level of national output

Text of 1 Chapter 19 The Keynesian Model in Action Key Concepts Key Concepts Summary Summary Practice Quiz...

  • Chapter 19 The Keynesian Model in Action

    Key Concepts Summary Practice Quiz Internet Exercises

    2002 South-Western College Publishing

  • What is the purpose of this chapter?To complete the Keynesian model by adding the government and the foreign sector to our analysis

  • Why is government spending considered an autonomous expenditure?Government spending is primarily the result of a political decision made independent of the level of national output

  • 1.000.750.500.2512341.251.501.752.005678910Real GDPTrillions of $ per yearGovernment SpendingReal Government spendingTrillions of $ per yearGovernment SpendingG1G2Autonomous Government Spending

  • Why is net exports assumed to be negative?For many years our spending for imports has exceeded the value of exports we have sold to foreigners.

  • 1.000.750.500.2512341.251.501.752.0056789Autonomous Net Exports10Real GDPTrillions of $ per yearPositive Net ExportsReal Net ExportsTrillions of $ per yearNegative Net Exports(X-M)2(X-M)1(X-M)Zero Net Exports

  • What does the term equilibrium mean?In the Keynesian model, the equilibrium is the point toward which the economy tends

  • In the Keynesian model, where is the equilibrium level of GDP?It is where the total value of goods and services produced is precisely equal to the total spending for these goods and services

  • What can pull aggregate expenditures higher or lower in Keynesian economics?Aggregate expendituresC + I + G + (X-M)

  • What affect do aggregate expenditures have on the economy?Aggregate expenditures in Keynesian economics pull aggregate output either higher or lower toward equilibrium

  • What causes a decrease in real GDP and employment?Unplanned inventory investment accumulation

  • Why does unplanned inventory investment accumulation cause unemployment? Business firms will cut back production and lay off workers when they find themselves with surpluses

  • What causes an increase in real GDP and employment?Unplanned inventory investment depletion

  • Why does unplanned inventory depletion cause economic growth?Business firms will increase production and higher more workers to meet the level of demand for their product

  • What is the aggregate expenditures-output model?The model that determines the equilibrium level of real GDP by the intersection of aggregate expenditures and aggregate output

  • 4321123456785678The Keynesian Aggregate Expenditures-Output ModelAE = YAE Real GDPReal Aggregate ExpendituresInventory DepletionC + I + G + )X-M)Inventory AccumulationEFull employmentGDP gap

  • How can full employment be reached in the previous graph?The aggregate expenditure curve must be shifted upward until the full-capacity output of $6 trillion is reached

  • 4321123456785678The Keynesian Aggregate Expenditures-Output ModelAE1 Real GDPFull employmentAE2 Real Aggregate ExpendituresLess than Full employment

  • What is theKeynesian multiplier?Any initial increase in spending will lead to a multiple increase in GDP

  • 4321123456785678The Keynesian Aggregate Expenditures-Output ModelAE1 Real GDP 1 trillion dollarsAE2 .5 trillion dollarsReal Aggregate Expenditures

  • Initial increase in government spendingOperates through a multiplierLarger increase in aggregate expenditures

  • How does themultiplier work?Any initial change in spending by the government, households, or firms creates a chain reaction of further spending

  • 4321123456785678The Keynesian Aggregate Expenditures-Output ModelAEReal GDPReal Aggregate Expenditures 2 4MPC = .5

  • What is the Marginal Propensity to Consume?MPC is the change in consumption spending resulting form a given change in income

  • What is the Marginal Propensity to Save?MPS is the fraction of any change in real disposable income that households save

  • How does the multiplier work?

  • Spending Multiplier EffectRound12 Spending$500$250$125$63...$1,00034All other roundsTotal spending

  • What is the relationship between MPC and MPS?MPC + MPS = 1

  • What is the formula for the multiplier?1 / (1 MPC)(or)1 / MPS

  • If the MPS is 1/2, what is the multiplier?1 / MPS = 1 / 1/2 = 2

  • Relationship between MPC, MPS, and the Spending MultiplierMPC105MPS4321.5Spending Multiplier.90.80.75.67.50.33.10.20.25.33.50.67

  • What is the GDP gap?The difference between full employment real GDP and actual real GDP

  • What is therecessionary gap?The amount by which aggregate expenditures fall short of the amount required to achieve full employment equilibrium

  • 4321123456785678The Keynesian Aggregate Expenditures - Output ModelAE1 Real GDPAE2 GDP gapReal Aggregate ExpendituresE1 E2Recessionary gapFull employment

  • What is the Keynesian remedy for a recessionary gap?Increase autonomous spending by the amount of the recessionary gap

  • What can the government do to close a recessionary gap?Increase government spendingLower taxesRaise transfer payments

  • What is an inflationary gap?The amount by which aggregate expenditures exceed the amount required to achieve full employment equilibrium

  • 4321123456785678The Keynesian Aggregate Expenditures - Output ModelAE2 Real GDPAE1 GDP gapReal Aggregate ExpendituresE2 E1Inflationary gapFull employment

  • What is the Keynesian remedy for an inflationary gap?Reduce autonomous spending by the amount of the inflationary gap

  • How can the government close an inflationary gap?Cut government spendingIncrease taxesReduce transfer payments

  • Key Concepts

  • Key ConceptsWhy is government spending considered an autonomous expenditure?What does the term equilibrium mean?In the Keynesian model, where is the equilibrium level of GDP?What can pull aggregate expenditures higher or lower in Keynesian economics?What causes a decrease in real GDP and employment?

  • Key Concepts cont.What causes an increase in real GDP and employment?What is the aggregate expenditures-output model?What is the Keynesian multiplier?What is the Marginal Propensity to Consume?What is the Marginal Propensity to Save?

  • Key Concepts cont.What is the relationship between MPC and MPS?What is the formula for the multiplier?What is the GDP gap?What is the recessionary gap?What is the Keynesian remedy for a recessionary gap?What is an inflationary gap?What is the Keynesian remedy for an inflationary gap?

  • Summary

  • The Keynesian argues that the economy is inherently unstable and may require government intervention to control aggregate expenditures and restore full employment.

  • If we assume that real disposable income remains the same high proportion of real GDP, then we can substitute real GDP for real disposable income in the Keynesian model.

  • Government spending and net exports can be treated as autonomous expenditures in the Keynesian model.

  • Net exports are the only component of aggregate expenditures that changes from a positive to a negative value as real GDP rises. Both exports and imports are determined by foreign or domestic income, tastes, trade restrictions, and exchange rates.

  • 1.000.750.500.2512341.251.501.752.005678910Real GDPTrillions of $ per yearGovernment SpendingReal Government spendingTrillions of $ per yearGovernment SpendingG1G2Autonomous Government Spending

  • 1.000.750.500.2512341.251.501.752.0056789Autonomous Net Exports10Real GDPTrillions of $ per yearPositive Net ExportsReal Net ExportsTrillions of $ per yearNegative Net Exports(X-M)2(X-M)1(X-M)Zero Net Exports

  • The Keynesian aggregate expenditures-output model determines the equilibrium level of real GDP by the intersection of the aggregate expenditures and the aggregate output and income schedules.

  • Each equilibrium level in the economy is associated with a level of employment and corresponding unemployment rate.

  • At any output greater or less than the equilibrium real GDP, unintended inventory investment pressures businesses to alter aggregate output and income until equilibrium at full-employment real GDP is restored.

  • At any output greater or less than the equilibrium real GDP, unintended inventory investment pressures businesses to alter aggregate output and income until equilibrium at full-employment real GDP is restored.

  • 4321123456785678The Keynesian Aggregate Expenditures-Output ModelAE = YAE Real GDPReal Aggregate ExpendituresInventory DepletionC + I + G + )X-M)Inventory AccumulationEFull employmentGDP gap

  • The spending multiplier is the ratio of the change in equilibrium output to the initial change in any of the components of aggregate expenditures.

  • Algebraically, the multiplier is the reciprocal of the marginal propensity to save. The multiplier effect causes the equilibrium level of real GDP to change by several times the initial change in spending.

  • To eliminate a positive GDP gap, the Keynesian solution is to increase autonomous spending by an amount equal to the recessionary gap and operate through the multiplier to increase equilibrium output and income.

  • To eliminate a positive GDP gap, the Keynesian solution is to increase autonomous spending by an amount equal to the recessionary gap and operate through the multiplier to increase equilibrium output and income.

  • 4321123456785678The Keynesian Aggregate Expenditures - Output ModelAE1 Real GDPAE2 GDP gapReal Aggregate ExpendituresE1 E2Recessionary gapfull employment

  • An inflat