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.