Review Notes - The Keynesian Macroeconomic Model

- difference between classical and Keynesian models

- classical focuses on AS and asserts that AS is vertical

- Keynesian focuses on AD and assumes that AS is horizontal, at least in the short-run (thus, AD determines employment while AS determines prices.)

- Aggregate Expenditures (AE) = total value of domestic spending on goods and services.

- AE = C+I+G+(X-M)

- Consumption and Saving

- C = C_a + mpc*Y_d

- mpc = marginal propensity to consume = D C/D Y_d

- apc = average propensity to consume = C/Y_d

- C_a = autonomous consumption (what does autonomous mean?)

- mpc*Y_d = induced consumption

- what is dissaving? How can C > Y_d be possible?

- S = -C_a + mps*Y_d

- mps = marginal propensity to save = D S/D Y_d

- aps = average propensity to save = S/Y_d

- Y_d = C + S

- mpc + mps = 1

- 0 < mpc < 1 and 0 < mpc < 1

- apc + aps = 1

- apc > 0 but aps may be < 0 (how?)

- what else affects C (besides Y_d)?

- Investment (I)

- what is the relationship between I and i (the interest rate)? be able to explain this.

- what else affects I (besides i)? How?

- how does an increase in I affect AE?

- Government spending (G)

- autonomous

- Net Exports = Exports (X) - Imports (M)

- Both X and M are assumed to be autonomous

- AE = C + I + G + (X - M)

- but recall that C = C_a + mpc*Y_d

- so AE = C_a + mpc*Y_d + I + G_a + (X_a - M_a)

- what does the AE function look like graphically?

- what is the relationship between C and National Income (Y)?

- assume no taxes, no transfers, no retained earnings => Y = Y_d = GDP

- Equilibrium in the Keynesian Model

- begin by assuming no government spending, taxes, or net exports.

- Equilibrium exists when:

- Y = AE

- S (leakages) = I (injections)

- unplanned I = 0

- Equilibrium Y = AE_a/(1-mpc) (why? - no G or T)

- AE_a = C_a + I_a (all autonomous spending)

- if Y is not equal to AE what force moves us to equilibrium?

- unplanned changes in inventories (unplanned I)

- how?

- the Keynesian multiplier (m)

- if AE increases by $1 how much does equilibrium Y increase by?

- m = 1/mps (why?)

- Equilibrium Y = m*AE_a

- what is full employment income/output (Y_f)?

- what is a recessionary, inflationary, and GDP gaps?

- if mpc=.8 and GDP gap = 100, by how much must AE_a increase to reach Y_f?

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