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    Chapter 8 Slides

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    Ashish Shukla
    - Keynesian economic theory argues that factors other than interest rates, like expectations about future returns, can affect savings and investment levels. It also argues that excessive savings can lead to inadequate spending in the economy. - During recessions, wages and prices may be inflexible downward, so the economy can get stuck below full employment. Government spending can increase total expenditures and shift the curve to close a recessionary gap. - Keynes argued that total expenditures, not just supply, determine economic output. A change in spending, like government deficit spending, has a multiplied effect on output through the multiplier process.

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    Chapter 8 Slides

    Uploaded by

    Ashish Shukla
    64 views35 pages
    - Keynesian economic theory argues that factors other than interest rates, like expectations about future returns, can affect savings and investment levels. It also argues that excessive savings can lead to inadequate spending in the economy. - During recessions, wages and prices may be inflexible downward, so the economy can get stuck below full employment. Government spending can increase total expenditures and shift the curve to close a recessionary gap. - Keynes argued that total expenditures, not just supply, determine economic output. A change in spending, like government deficit spending, has a multiplied effect on output through the multiplier process.

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    - Keynesian economic theory argues that factors other than interest rates, like expectations about future returns, can affect savings and investment levels. It also argues that excessive savings can lead to inadequate spending in the economy. - During recessions, wages and prices may be inflexible downward, so the economy can get stuck below full employment. Government spending can increase total expenditures and shift the curve to close a recessionary gap. - Keynes argued that total expenditures, not just supply, determine economic output. A change in spending, like government deficit spending, has a multiplied effect on output through the multiplier process.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    64 views35 pages

    Chapter 8 Slides

    Uploaded by

    Ashish Shukla
    - Keynesian economic theory argues that factors other than interest rates, like expectations about future returns, can affect savings and investment levels. It also argues that excessive savings can lead to inadequate spending in the economy. - During recessions, wages and prices may be inflexible downward, so the economy can get stuck below full employment. Government spending can increase total expenditures and shift the curve to close a recessionary gap. - Keynes argued that total expenditures, not just supply, determine economic output. A change in spending, like government deficit spending, has a multiplied effect on output through the multiplier process.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 35

    Keynesian Economic Theory

    During the Great Depression, market economies were not automatically adjusting to Natural Real GDP.

    In 1936, John Maynard Keynes (Cnes) published The General Theory of Employment, Interest, and Money, establishing Keynesian theory as a major alternative to classical theory.

    Keynesian theory and Says Law


    Keynesian theory argues that factors other than the interest rate affect savings and investment.
    Expectations about future returns would affect business investment. Excessive savings could lead to inadequate Total Expenditures.

    Keynesian theory and a recessionary gap


    Keynesian theory argues that wages and prices are not flexible downward.
    If wage rates do not fall during a recessionary gap, SRAS does not shift right, and the economy can get stuck in a recessionary gap for an extended period.

    Keynesian theory and a recessionary gap


    If SRAS does not shift right, then AD must shift right to move the economy back to Natural Real GDP.
    The solution to a recessionary gap would be an increase in Total Expenditures to shift the AD curve right.

    A Recessionary Gap
    SRAS

    Pr ice Level

    AD QN Real GDP

    An increase in AD closes a recessionary gap


    SRAS

    Pr ice Level

    AD1 QN Real GDP

    AD2

    Spending Drives the Economy


    Classical theory emphasizes supply, and takes demand for granted. Keynesian theory emphasizes spending as the driving force in the economy. The level of Total Expenditures (consumption, investment, govt. purchases, and net exports) determines the level of total output.

    Consumption
    Consumption is the largest of the four types of spending making up Total Expenditures.
    Consumption is determined primarily by the level of disposable income.

    Example 2A:
    Disposable Income
    $3,000 6,000 9,000

    Consumption
    $6,600 8,400 10,200

    12,000
    15,000

    12,000
    13,800

    18,000
    21,000

    15,600
    17,400

    Consumption Function
    $21 18 15 Consumption (000s) 12 9630 0 3 6 9 12 15 18 21 C

    Disposable Income (000s)

    Marginal Propensity to Consume


    The slope of the consumption function is the marginal propensity to consume (MPC).
    MPC = change in consumption change in income

    The 45 Angle Line


    On the consumption function graph, a line drawn from the vertex at a 45 angle will represent equal amounts of consumption and disposable income. Where the consumption function intersects the 45 angle line is where disposable income and consumption are equal.

    The 45 Angle Line


    $21 18 15 Consumption (000s) 12 9630 0 45 o 3 6 9 12 15 18 21
    Dissaving Saving

    Disposable Income (000s)

    The Total Expenditures Curve


    According to Keynesian theory, the level of Total Expenditures determines the level of total output (Real GDP).
    A Total Expenditures curve (TE) shows the relationship between Total Expenditures and Real GDP.

    The Total Expenditures Curve


    In deriving a Total Expenditures curve, the following assumptions are made: 1. Consumption is directly related to Real GDP. 2. The levels of investment, government purchases, and net exports are all unrelated to the current level of Real GDP. See Example 5 on page 8-5.

    The Total Expenditures Curve


    $15.9 15.8 15.7 15.6 15.5 Total Expenditures 15.4 (Trillions of dollars) 15.3 TE

    15.2 15.1 15.0 Z N

    $15.0 15.1 15.2 15.3 15.4 15.5 15.6 15.7 15.8 15.9 16.0
    Real GDP (Trillions of dollars)

    Equilibrium Real GDP


    In Keynesian theory, equilibrium Real GDP occurs where Total Expenditures equals Real GDP (total production).
    If TE were greater than Real GDP, inventories would decrease, signaling producers to increase production.

    Equilibrium Real GDP


    In Keynesian theory, equilibrium Real GDP occurs where Total Expenditures equals Real GDP (total production).
    If TE were less than Real GDP, inventories would increase, signaling producers to decrease production.

    Equilibrium Real GDP


    In Keynesian theory, equilibrium Real GDP occurs where Total Expenditures equals Real GDP (total production).
    On the Total Expenditures graph, equilibrium Real GDP occurs where the TE curve intersects the 45 angle line.

    Equilibrium Real GDP


    $15.9 15.8 15.7 15.6 15.5 Total Expenditures 15.4 (Trillions of dollars) 15.3 TE

    15.2 15.1 15.0 Z N

    45 o

    $15.0 15.1 15.2 15.3 15.4 15.5 15.6 15.7 15.8 15.9 16.0
    Real GDP (Trillions of dollars)

    Ideal Total Expenditures


    The ideal level of Total Expenditures results in Natural Real GDP. If TE is less than the ideal, a recessionary gap will result.

    If TE is greater than the ideal, an inflationary gap will result.

    Too Little TE

    TE 1

    Total Expenditur es

    45 o QN Real GDP

    Too Much TE
    TE 2

    Total Expenditur es

    45 o QN Real GDP

    Ideal TE

    TE 3

    Total Expenditur es

    45 o QN Real GDP

    A Change in Total Expenditures


    A change in one of the components of Total Expenditures (consumption, investment, government purchases, or net exports) will lead to a new equilibrium Real GDP.
    See Example 8 on page 8-8.

    A Change in Total Expenditures


    $15.9 15.8 15.7 15.6 15.5 Total Expenditures 15.4 (Trillions of dollars) 15.3 TE 8 TE 5

    15.2 15.1 15.0 Z N

    45 o

    $15.0 15.1 15.2 15.3 15.4 15.5 15.6 15.7 15.8 15.9 16.0
    Real GDP (Trillions of dollars)

    The Multiplier Effect


    A change in one of the components of TE will lead to a multiplied change in Real GDP.
    The multiplier effect occurs because the initial change in TE triggers a chain reaction.

    The Multiplier
    The size of the multiplier effect depends on a factor called the multiplier.
    Multiplier = 1 (1 MPC)

    Change in Real GDP


    Change in Real GDP = Initial change x Multiplier The size of the multiplier depends on the MPC. The greater the MPC, the larger the multiplier. The larger the multiplier, the larger the eventual change in Real GDP. See Examples 9 and 10 on page 8-10.

    Change in Real GDP


    According to Keynesian theory, the multiplier effect works the same for an initial decrease in TE. The initial decrease in TE would lead to a multiplied decrease in Real GDP. See Example 11 on page 8-10.

    The General Theory of Employment, Interest, and Money


    In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money.
    Keyness prescription for ending the Great Depression was government deficit spending.

    The General Theory


    The deficit spending incurred to pay for World War II abruptly ended the Great Depression. Keynesian theory dominated economic theory through the 1960s. Keynesian theory had no explanation for the stagflation of the 1970s.

    The General Theory


    The most influential assertions of The General Theory include: 1. Says Law is incorrect. 2. A decrease in investment caused by a decrease in expected rates of return is the most likely cause of a recession.

    The General Theory


    3. If investors are very pessimistic about future rates of return, they may not invest more in response to lower interest rates. 4. Government deficit spending is the most effective way to restore full employment. 5. Any change in government spending or taxation will have a multiplied effect on total output.

    The General Theory


    The General Theory also includes assertions that have not proven influential.
    See the list on page 8-12.

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