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Keynesian Circular-Flow Analysis (As Applied to a Wholly Private Economy) Saving and Investment—and their Equilibration according to John Maynard Keynes and according to Dennis Robertson. Roger W. Garrison 2009 EXPENDITURES E=Y 45o INCOME The INCOME and the EXPENDITURES that make up the circular flow contain a large common element, namely CONSUMPTION. Income is used mainly for consumption, but some of it is saved. Expenditures are mostly for consumption, but some is for investment. In an income-expenditure equilibrium, C + S must equal C + I. EXPENDITURES C+I C = a + bY b 1 a The Even In this “Keynesian inwholly a mixed private Cross” economy, economy, marks spending the spending spot on consumption on where investment incomegoods goods equals typically accounts expenditures. counts for the for about 70%expenditures. remaining of GDP. In this wholly private We assume herecount that, for initially, full economy, it would even more. employment conditions prevail—though only by accident. 45o Yeq=Yfe INCOME EXPENDITURES C+I C = a + bY a SAVING, INVESTMENT 45o -a Yeq=Yfe INCOME Clearly,issaving Saving Investment represented spending equalsisby investment determined the vertical at distance exclusively the samebetween level by business of income the consumption psychology. at which O line. equation At income each equals and andevery the expenditures. 45 level of Saving income,isit is negative for low represented by the levels vertical of income separation and So now, let’s net out consumption increasingly between C and positive C+I. at higher levels. spending to show that S = I is an (The 45O line allows income to be alternative equilibrium condition. measured vertically as well as horizontally.) Y=0 and C=Y give us two points on the saving equation. S = -a + (1-b)Y 1-b Finally, The Investment Just slope by the themselves, ofshading isthis represented lineon these is the 1-b,by two S=I which a I graph together horizontal curves matches (Swith and line.the I)perfectly identify intercept the with (-a), the 1 allows uson income-expenditure shading tothe write Y=E thegraph. equilibrium. saving INCOME equation. SAVING, INVESTMENT S = -a + (1-b)Y I INCOME SAVING, INVESTMENT S I INCOME With this saving-investment W equilibrium, it just so happens that S the demand for labor is just strong enough to clear the labor Dmarket at the going wage. N RATE OF INTEREST SAVING, INVESTMENT S S D I INCOME With this saving-investment W equilibrium, it just so happens that S the demand for labor is just strong enough to clear the labor Dmarket at the going wage. N SAVIING (S) INVESTMENT (D) Thethe As pre-Keynesian appropriate movement in the understanding of interest the rate clears the relationship between marketsaving for loanable and investment the the W funds, took S and in appropriate form of the supply movement the wagefor demand rate loanable clears the funds. D market for labor. N I INCOME However, With Investment Keynes lower didn’t ifincomes spending people believe do and does that become hence people not In summary terms: the interest decreased increase. would more simply demands the “decide with increased for to save output, saving the W rate isthrifty, noAnd part ofconsequences the coordinating demand (i.e., more.” are not decreased He good. forargued labor falls. thatS current However, excess mechanism thatspending), brings saving wage inventories spending rates (and develop arehence “sticky saving) downward” the and and investment intoand balance, D and economy depends The increased not exclusively spirals adjust thriftiness to the upon new iscurrent market the do wage rate is downward. too downwardly conditions. Incomes income, depicted are by So, an S reduced =for upward unemployment -alabor-market + N(1-b)Y. until shiftsaving in is, sticky toi.e., allow persists once the saving again, until equation. equal suitable to investment. fiscal and adjustments. monetary policies are implemented. RATE OF INTEREST SAVING, INVESTMENT S S D SAVIING (S) INVESTMENT (D) In summary Suppose, With market now, terms: conditions thatboth people decide now interest changed, to rates saveand the more. wage wage In the pre-Keynesian rate rates adjusts respond soinworld, that, once this increased again, conventional the Wthriftiness supply waysand towould be depicted demand changes for in market labor as a rightward areS shift in the brought conditions, intosupply allowing balance. of D loanable funds. investment to correspond N to saving preferences and allowing the labor market to find its equilibrium. Keynesian Circular-Flow Analysis (Labor-Based Macroeconomics) Saving and Investment—and their Equilibration according to John Maynard Keynes and according to Dennis Robertson. Roger W. Garrison 2009