Building the Building the Aggregate Aggregate

Expenditures Expenditures ModelModelKeynesian EconomicsKeynesian Economics

John Maynard KeynesJohn Maynard Keynes

British Economist (1883-1946)British Economist (1883-1946) Theorized that “Classical Theorized that “Classical

Economics” was plagued by a Economics” was plagued by a periodic recession and required periodic recession and required government assistance to help jump government assistance to help jump start the economystart the economy

Recent resurgence due to the Recent resurgence due to the instability and corruption of 2008instability and corruption of 2008

John Maynard KeynesJohn Maynard Keynes

General Theory of General Theory of EmploymentEmployment

Bretton Woods Bretton Woods conference prior to conference prior to WWII gave birth to WWII gave birth to the creation of the the creation of the World Bank and World Bank and the I.M.F. which the I.M.F. which still exist todaystill exist today

Equilibrium GDPEquilibrium GDP

Firms look to produce an amount equal Firms look to produce an amount equal to that of what they believe will be to that of what they believe will be purchasedpurchased

Aggregate Expenditures schedule Aggregate Expenditures schedule depicts these outputs at various levelsdepicts these outputs at various levels

Remember, for this chapter consumption Remember, for this chapter consumption is directly related to the income level is directly related to the income level where investment is not. Investment is where investment is not. Investment is planned regardless of income situationplanned regardless of income situation

DisequilibriumDisequilibrium

The economy will work to achieve The economy will work to achieve equilibrium from either the equilibrium from either the consumer end or the producer end, consumer end or the producer end, but according to Keynes, requires but according to Keynes, requires the government to intervene and the government to intervene and stimulate aggregate demand.stimulate aggregate demand.

Other FeaturesOther Features

GDP = Investment + ConsumptionGDP = Investment + Consumption Savings represents a leakage from the Savings represents a leakage from the

spending stream and causes C to be less spending stream and causes C to be less than GDPthan GDP

Investment is referred to as an injectionInvestment is referred to as an injection

SimplificationsSimplifications

For this chapter we need to assume For this chapter we need to assume the following:the following:

Aggregate spending only consists of Aggregate spending only consists of consumption and investmentconsumption and investment

GDP = NI = PI = DIGDP = NI = PI = DI There is no account of government There is no account of government

spending or foreign trade in this spending or foreign trade in this chapter for purposes of simplicitychapter for purposes of simplicity

Consumption & SavingsConsumption & Savings

Consumption is the largest Consumption is the largest component of aggregate expenditurescomponent of aggregate expenditures

DI = Consumption + SavingsDI = Consumption + Savings What is not spent is considered What is not spent is considered

savingssavings Disposable income has a direct Disposable income has a direct

relationship with both consumption & relationship with both consumption & savingssavings

Consumption & SavingsConsumption & Savings

Break-even Income – Point at which Break-even Income – Point at which household consumption = incomehousehold consumption = income

APC – Avg. Propensity to ConsumeAPC – Avg. Propensity to Consume APS – Avg. Propensity to SaveAPS – Avg. Propensity to Save APC = Consumption / IncomeAPC = Consumption / Income APS = Savings / IncomeAPS = Savings / Income

Marginal PropensitiesMarginal Propensities

MPS – Marginal Propensity to SaveMPS – Marginal Propensity to Save MPC – Marginal Propensity to MPC – Marginal Propensity to

ConsumeConsume Is measured to see how income will Is measured to see how income will

change the amounts that are saved change the amounts that are saved and spentand spent

MPC + MPS always = 1 , APC + APS MPC + MPS always = 1 , APC + APS =1=1

Non-Income Non-Income Determinants Determinants

WealthWealth Expectations of Future Economic Expectations of Future Economic

ActivityActivity TaxationTaxation Household DebtHousehold Debt

InvestmentInvestment

Second component of private spendingSecond component of private spending Investment decision weighs marginal Investment decision weighs marginal

benefit vs. marginal costbenefit vs. marginal cost Rate of return = BenefitRate of return = Benefit Interest Rate = CostInterest Rate = Cost Rate of Return = Revenue – CostRate of Return = Revenue – Cost If Real Interest Rate exceeds Rate of If Real Interest Rate exceeds Rate of

Return, investment should not be madeReturn, investment should not be made

Investment DataInvestment Data

Measured with Investment Demand Measured with Investment Demand ScheduleSchedule

Shows inverse relationship between Shows inverse relationship between Return and InterestReturn and Interest

Understand reduction of interest Understand reduction of interest rates directly effects investmentrates directly effects investment

Investment DataInvestment Data

Shifts in the curve are caused by Shifts in the curve are caused by other factors. These include:other factors. These include:

Capital Goods acquired, maintained, Capital Goods acquired, maintained, & operated & operated

Business TaxesBusiness Taxes TechnologyTechnology Stock of Capital GoodsStock of Capital Goods Future ExpectationsFuture Expectations

Investment SchedulesInvestment Schedules

Economists define by determining Economists define by determining exactly how much individual exactly how much individual businesses will invest at every level businesses will invest at every level of GDP or DI.of GDP or DI.

Assume investment is independent Assume investment is independent from incomefrom income

Investment VolatilityInvestment Volatility

Capital Goods are durable meaning Capital Goods are durable meaning investment can be postponedinvestment can be postponed

Innovation occurs irregularlyInnovation occurs irregularly Profits vary considerablyProfits vary considerably Expectations Change EasilyExpectations Change Easily

Equilibrium GDPEquilibrium GDP

We measure producer output and We measure producer output and income by depicting these graphicallyincome by depicting these graphically

Producers seek to reach equilibriumProducers seek to reach equilibrium It is assumed that income level = It is assumed that income level =

outputoutput Investment is independent of income Investment is independent of income

and planned regardlessand planned regardless C + Ig = GDP (Output)C + Ig = GDP (Output)

Equilibrium GDPEquilibrium GDP

Savings and planned investment are Savings and planned investment are equalequal

Saving represent a “leakage” in Saving represent a “leakage” in consumption causing it to be less than consumption causing it to be less than GDPGDP

The economy is in never ending state to The economy is in never ending state to reach this equilibrium. The goal is to reach this equilibrium. The goal is to have Income = Output. Until that have Income = Output. Until that happens, inventories will always happens, inventories will always fluctuate based on circumstance. fluctuate based on circumstance.