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Chapter 18 The Keynesian Model

• Key Concepts

• Summary

• Practice Quiz

• Internet Exercises

http://var/www/apps/conversion/tmp/scratch_2/%23Slide%2084http://var/www/apps/conversion/tmp/scratch_2/%23Slide%2084

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Who were the

Classical Economists?The Classical economists elie!ed that a continuin"depression is impossile

ecause mar#ets $illeliminate persistentshorta"es or surpluses

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When were the ideas ofthe Classical Economists

widely accepted?Prior to the &reat

'epression o( the 1)%*+s

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What is Say’s Law?The elie( o( the

Classical Economiststhat the economy $asal$ays tendin" to$ard(ull employment

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What doesSay’s Law say?

Supply creates itso$n demand

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Why is Say’s Law a Full

Employment theory?&enerally spea#in"/

producers produce "oodsthat consumers $ant and

consumers ha!e themoney to uy ecause o(the $a"es they $ere paid

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Under Say’s Law, isUnemployment possile?

es/ ut it is a shortli!edad3ustment period in $hich$a"es and prices decline or

people !oluntarily choosenot to $or#

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What chan!ed people’smind aout Say’s Law?

The &reat 'epression andthe pulication o( TheGeneral Theory of

Employment, Interest, and Money pulished in 1)%.

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)

Why did "eynes’ elie#ethat $supply did notcreate its own demand%?5""re"ate expenditures6demand7 can e (ore!er

inade8uate (or an economyto achie!e (ull employment

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What is the mainidea of this chapter?

Keynes+s theory (or thedetermination o(consumption and

in!estment expenditures

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What determines yourfamily’s Spendin! for&oods and Ser#ices?

'isposale income

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What is theConsumption Function?

The "raph that sho$s theamount households spend(or "oods and ser!ices at

di((erent le!els o(disposale income

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1%

What is Sa#in!s?'isposale income minus

consumption/ theamount households do

not spend (or consumer"oods and ser!ices

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What is 'issa#in!?The amount y $hich personal consumptionexpenditures exceeddisposale income

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(ow do people 'issa#e?

9e"ati!e sa!in"s is(inanced y y dra$in"do$n pre!iously

accumulated (inancialassets or y orro$in"

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1.

What is )utonomousConsumption?

Consumption thatis independent o(the le!el o(

disposaleincome

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What happens

when 'isposale*ncome is +ero?

Spendin" $ill e8ualautonomous consumption

ecause households $illdissa!e to satis(y asicconsumption needs

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What is the ar!inal-ropensity to Consume?The chan"e in consumptionresultin" (rom a "i!en chan"ein real disposale income

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1)

MPC :∆

C∆ d

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2*

What is ar!inal-ropensity to Sa#e?

The chan"e in sa!in"resultin" (rom a "i!en

chan"e in realdisposale income

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MPS :∆

S∆ d

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MPC ; MPS : 1

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2%

./

0

1

1 0 / .

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8

2 3 8 4

5he Consumption Function

16

'issa#in!

Sa#in!

C

7 e a l C o n s u m p

t i o n

5 r i l l i o n s o f 8 p e

r y e a r

7eal 'isposale *ncome5rillions of per year

C

9d

C : 9d

.;

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2,

What happens ifFactors other than*ncome chan!e?

There is a shi(t orrelocation in theconsumption schedule

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2-

./

0

1

1 0 / .

23

8

2 3 8 4


16

C1 7 e a l C o n s u m p

t i o n


r y e a r


C : 9d

.;

-C :

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2.

./

0

1

1 0 / .

23

8

2 3 8 4


16

7 e a l C o n s u m p

t i o n


r y e a r


C1 : a1 = 9d

C0

: a0

= 9d

)

>

realconsumption

nonincomedeterminant

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Why does the Consumption

Function Shift?

• Expectations

•

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(ow do Epectations affectthe Consumption Function?

Consumers expectations o(thin"s to happen in the(uture $ill a((ect theirspendin" decisions today

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2)

(ow does Wealth affect the

Consumption Function?

=oldin" all other (actors

constant/ the more $ealthhouseholds accumulate/

the more they spend atany current le!el o(disposale income

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(ow does the -rice

Le#el affect theConsumption Function?

5ny chan"e in the "eneral price le!el shi(ts theconsumption schedule y

reducin" or enlar"in" theconsumers purchasin" po$er

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(ow does the *nterest

7ate affect theConsumption Function?

5 hi"h interest rate $illdiscoura"e people (rom

orro$in" money and a lo$interest rate $ill encoura"e people to orro$ money

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(ow does the Stoc@ of

'urale &oods affect theConsumption Function?

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(ow does Consumptioncompare with *n#estment?

Consumption is more stalethan in!estment

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%,

)ccordin! to the

Classical Economists,what determined the le#el

of *n#estment?The interest rate

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)ccordin! to "eynes,what determines the le#el

of *n#estment?

Expectations o( (uture pro(its is the primary

(actor/ the interest rate isthe (inancin" cost o( anyin!estment proposal

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%.

What is the *n#estment'emand Cur#e?

The cur!e that sho$s theamount usinesses spend (orin!estment "oods at di((erent

possile rates o( interest

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%0

12A

10A

8A

.A

16 1 06

7eal in#estment

* n

t e r e s t r a

t e

)

>

*n#estment'emand Cur#e

o#ement alon! the firm’sin#estment demand cur#e

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%4

12A

10A

8A

.A

16 1 06

* n t e r e s t

r a t e

C

>

Shift in the firm’sin#estment demand cur#e

*1*07eal in#estment

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%)

Why is *n#estment

'emand unstale?• Expectations

• Technolo"ical chan"e

• Capacity utilization

• >usiness taxes

• 5utonomous reasons

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(ow do Epectations

affect *n#estment?>usinesspeople are 8uite

susceptile to moods o(optimism and pessimism

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(ow does 5echnolo!icalchan!e affect *n#estment?

The introduction o( ne$ products and ne$ $ayso( doin" thin"s ha!e a

i" impact onin!estment decisions

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What happens whenCapacity UtiliBation is low?

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What happens whenCapacity UtiliBation is hi!h?

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(ow do >usiness 5aesaffect *n#estment?

>usiness decisionsdepend on the expectedafter-tax rate o( pro(it

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What is

)utonomous Ependiture?

Spendin" that does not !ary

$ith the current le!el o(disposale income

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,.

8A2A

.A

0A

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What is the )!!re!ateEpenditure Function?

The (unction that representstotal spendin" in an

economy at a "i!en le!el o(real disposale income

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,)

./

0

1

1 0 / .

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8

2 3 8

)!!re!ate EpendituresSchedule and Function

)E

C

C = *

E

7eal 'isposale *ncometrillions of dollars per year

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"ey Concepts

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"ey Concepts

• Who were the Classical Economists?

• When were the ideas of the Classical Eco

nomists widely accepted?

• What is Say’s Law?

• What does Say’s Law say?

• Why did "eynes’ elie#e that $supply did

not create its own demand%?• What determines your family’s Spendin!

for &oods and Ser#ices?

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"ey Concepts cont<

• What is the Consumption Function?

• What is Sa#in!s?

• What is 'issa#in!?

• What is )utonomous Consumption?

• What is the ar!inal -ropensity to Consume?

• What is ar!inal -ropensity to Sa#e?• What happens if Factors other than *ncome c

han!e?

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"ey Concepts cont<• Why does the Consumption Function Shift?

• )ccordin! to the Classical Economists, what d

etermined the le#el of *n#estment?

• )ccordin! to "eynes, what determines the

le#el of *n#estment?

• What is the *n#estment 'emand Cur#e?

• Why is *n#estment 'emand unstale?

• What is )utonomous Ependiture?

• What is the )!!re!ate Ependiture Function?

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Summary

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Say+s ?a$ is the classical theorythat @supply creates its o$n demandAand there(ore the &reat 'epression$as impossileB Say+s ?a$ is the elie(that the !alue o( production "eneratesan e8ual amount o( income and/ inturn/ total spendin"B

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The classical economists re3ectedthe challen"e that underconsumptionis possile ecause they elie!ed

(lexile prices/ $a"es/ and interestrates soon estalish alance et$eensupply and demandB

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ohn Maynard Keynes re3ected the

classical theory that the economy sel(corrects in the lon" run to (ullemploymentB The #ey in Keynesian

theory is a""re"ate demand/ ratherthan the classicals+ (ocus on a""re"atesupplyB Dnless a""re"ate spendin" is

ade8uate/ the economy can experience prolon"ed and se!ere unemploymentB

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The consumption (unction 6C7is determined y chan"es in the

le!el o( disposale incomeB5utonomous consumption isconsumption that occurs e!en i(

disposale income e8uals zeroBChan"es in such nonincomedeterminants as expectations/

$ealth/ the price le!el/ interest rates/and the stoc# o( durale "oodscause shi(ts in the consumption(unctionB


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-)

./

0

1

1 0 / .

23

8

2 3 8 4


16

'issa#in!

Sa#in!

C

7

e a l C o n s u m p t i o n

5 r i l l i o n s o f 8 p e r y e a r


C

9d

C : 9d

.;

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The mar"inal propensity toconsume 6MPC7 is the chan"e inconsumption associated $ith a "i!enchan"e in disposale incomeB The MPCtells ho$ much o( an additional dollaro( disposale income households $illspend (or consumptionB

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The mar"inal propensity to sa!e6MPS7 is the chan"e in sa!in"associated $ith a "i!en chan"e in

disposale incomeB The MPSmeasures ho$ much o( an additionaldollar o( disposale income

households $ill sa!eB

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The in!estment demand cur!e

6I7 sho$s the amount usinessesspend (or in!estment "oods atdi((erent possile rates o( interestBThe determinants o( this scheduleare the expected rate o( pro(it andrate o( interestB Shi(ts in thein!estment demand cur!e result

(rom expectations/ technolo"icalchan"e/ capacity utilization/ and

usiness taxesB

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5n autonomous expenditure isspendin" that does not !ary $ith thecurrent le!el o( disposale incomeBThe Keynesian model applies thissimpli(yin" assumption toin!estmentB 5s a result/ thein!estment demand cur!e is a (ixed

amount determined y the rate o( pro(it and the interest rateB

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The a""re"ate expenditures(unction 65E7 sho$s the totalspendin" in an economy at a "i!enle!el o( disposale incomeB5ssumin" in!estment spendin" isautonomous/ the slope o( the 5E(unction is determined y the MPCB

) t E dit

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.-

./

0

1

1 0 / .

23

8

2 3 8

)!!re!ate EpendituresSchedule and Function

)E

C

C = *

E


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..

Chapter 18 uiB

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1< 5he French classical economist Dean >aptisteSay transformed the euality of production

and spendin! into a law that can e epressedas follows

a< 5he in#isile hand creates its own supply<

< Wa!es always fall to the susistence le#el<

c< Supply creates its own demand<

d< )!!re!ate output does not always eualconsumption<

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0< )utonomous consumption is

a< positi#ely related to the le#el of consumption<

< ne!ati#ely related to the le#el ofconsumption<

c< positi#ely related to the le#el of disposaleincome<

d< independent of the le#el of disposaleincome<

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.)

/< 5he consumption function represents therelationship etween consumer ependituresand

a< interest rates<

< sa#in!<

c< the price le#el<d< disposale income

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< )o#e the rea@Ge#en disposale income forthe consumption function, which of the

followin! occurs?a< 'issa#in!<

< Sa#in!<

c< Heither IaJ nor IJoth IaJ and IJ

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0%

2< Which of the followin! chan!es produces anupward shift in the consumption function?

a< )n increase in consumer wealth<< ) decrease in consumer wealth<

c< ) decrease in autonomous consumption<

d< >oth IJ and IcJ <


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./

0

1

1 0 / .

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8

2 3 8 4


16

C

7

e a l C o n s u m

p t i o n

5 r i l l i o n s o f 8 p e r y e a r


C : 9d

.;

-C :

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3< )n upward shift in the consumption schedule,other thin!s ein! eual, could e caused yhouseholds

a< ecomin! optimistic aout the state of theeconomy<

< ecomin! pessimistic aout the state of the

economy<c< epectin! future income and wealth to

decline<

d< none of the ao#e<

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8< 5he in#estment demand cur#e represents

the relationship etween usiness spendin!for in#estment !oods and

a< &'-<

< interest rates<

c< disposale income<d< sa#in!<

4 Which of the follo in! chan!es prod ces a

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4< Which of the followin! chan!es produces aleftward shift in the in#estment demand cur#e?

a< ) wa#e of optimism aout futureprofitaility<

< 5echnolo!ical chan!e<

c< (i!h plant capacity utiliBation<

d< )n increase in usiness taes<

Shift in the firm’s

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12A

10A

8A

.A

16 1 06

* n t e r e s t r a t e

C

>

Shift in the firm sin#estment demand cur#e

*1 *0

7eal in#estment

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Ehiit 11

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./

0

1

1 0 / .

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8

2 3 8

)!!re!ate EpendituresSchedule and Function )E

C

C = *

E


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11< *n Ehiit 11, what is the households’mar!inal propensity to consume I-CJ?

a< 6

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10< *n Ehiit 11, a!!re!ate income will eualconsumption plus in#estment and theeconomy will e in euilirium when realdisposale income is

a< 0

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