Download Keynesian System Part III The Keynesian Aggregate Expenditure

The Keynesian Aggregate
Expenditure Model
The Consumption and Saving Functions
Keynesian System Part III
When consumption
(C) is greater than
disposable income
(DI), savings is
negative
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8
S a vin g
C
7
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5
D issa vin g
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Chapter 11
When disposable
(DI) income is
greater than
consumption (C),
savings is positive
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2
1
0
0
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10
Disposable income (in trillions of dollars)
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Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Review of Consumption Function
The Keynesian Aggregate Expenditure
Model
The Investment Sector
Real GDP (in trillions of dollars)
When C + I represents
aggregate demand, how
much is equilibrium GDP
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C + I
C
7
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5
Answer: Approximately $7.0
trillion
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3
2
1
45û
0
• Note the savings will be spent in the Investment but the
question raised by Keynes was “What if Saving is greater
than Investment?”
0
1
2
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5
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7
Real GDP (in trillions of dollars)
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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1
Aggregate Demand Exceeds
Aggregate Supply
• When aggregate demand exceeds aggregate
supply the economy is in disequilibrium
• When aggregate supply exceeds
aggregate demand the economy is in
disequilibrium
– Output is increased
– Eventually, the economy approaches full capacity
followed by price increases
– Inventories rise and output is decreased
– Workers are laid off further depressing
aggregate demand as these workers cut back
on their consumption
– Eventually, inventories are sufficiently
depleted
• It appears that there are two ways to raise
aggregate supply
– By increasing output
– By increasing prices
• By doing this aggregate supply is raised
relative to aggregate demand and equilibrium
is restored
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Saving In Keynesian Model
Aggregate Supply Exceeds
Aggregate Demand
• In the meantime, aggregate supply has
fallen back into equilibrium with aggregate
demand
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Consumer Confidence Shifts Ag.
Demand
Workers in fear of being laid off further cut
spending depressing aggregate demand as these
workers cut back on their consumption
• Saving = Not Consuming and output NOT
purchased.
2
Summary: How Equilibrium Is
Attained
• When the economy is in disequilibrium,
it automatically moves back into
equilibrium
• It is always aggregate supply that
adjusts
– When aggregate demand is greater than
aggregate supply, aggregate supply rises
– When aggregate supply is greater than
aggregate demand, aggregate supply
declines
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11-46
When consumption is greater than disposable income , saving is
negative, when disposable income is greater than consumption,
saving is positive
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11-48
Summary: How Equilibrium
Is Attained
• Aggregate demand (C + I) must equal
the level of production (aggregate
supply) for the economy to be in
equilibrium
• When the two are not equal,
aggregate supply must adjust to
bring the economy back into
equilibrium
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11-47
When C+I represents demand, equilibrium GDP is $7 trillion
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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3
Keynesian Policy Prescriptions
Keynesian Policy
Prescriptions
• Keynes’s position was that recessions are
not necessarily temporary
• The Classical position summarized
– Recessions are temporary because the
economy is self-correcting
• Declining investment will be pushed up again
by falling interest rates
• If consumption falls, it will be raised by falling
prices and wages
– Because recessions are self-correcting,
the role of government is to stand back
and do nothing
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Aggregate Expenditure
=C+I+G+(X-M)
• Note: this is
everything
Consumption,
Investment,
Government,
Export and
Import.
– The self-correcting mechanisms of falling interest
rates and falling prices and wages might be
insufficient to push investment and consumption
back up again
– Therefore it is necessary for the government to
intervene by spending money
• How much money? As much money as it takes
– When the government spends more money, that’s
not the same thing as printing more money.
Generally it borrows more money and then spends it
• Keynes would have prescribed lowering
aggregate demand to bring down inflation
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Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11-51
Aggregate Expenditure =C+
I+G+(X-M)
• If everything is
counted
Income= Expenditure
• Point d or 2000 is
the equilibrium
GDP
• Full Employment
is 3000
• Next Chapter you
will learn this is a
Recessionary
GAP
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Why Didn’t New Deal Spending
Get Us out of the Economic
Crisis of the 1930s?
• It did succeed in bringing about rapid
economic growth between1933 and 1937
• However, Roosevelt suddenly decided to
try to balance the federal budget
• Until the 1970s the American economy was
essentially a closed system
– We made it and then we bought it
– Our system was best describe by Say’s Law:
Supply creates its own demand
• Today, we no longer operate a closed system
– He raised taxes and cut government spending
• The Federal Reserve sharply cut the rate
of growth of the money supply
• Output plunged and the unemployment
rate soared
Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Current Issue: Keynes and
Say in the 21st Century
– We consume much more than we produce
– Neither Keynes nor Say is giving us what we need
– We are running huge and growing trade deficits
which are not good for our long term economic
health
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Copyright ©2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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