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Chapter 18 The Keynesian Model

Chapter 18 The Keynesian Model. Key Concepts Summary Practice Quiz Internet Exercises. ©2002South-Western College Publishing. Who were the Classical economists?.

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Chapter 18 The Keynesian Model

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  1. Chapter 18The Keynesian Model • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2002South-Western College Publishing

  2. Who were theClassical economists? The Classical economists believed that a continuing depression is impossible because markets will eliminate persistent shortages or surpluses

  3. When were the ideas of the Classical economists widely accepted? Prior to the Great Depression of the 1930’s

  4. What is Say’s Law? The belief of the Classical economists that the economy was always tending toward full employment

  5. What doesSay’s Law say? Supply creates its own demand

  6. Why is Say’s Law a full employment theory? Generally speaking, producers produce goods that consumers want and consumers have the money to buy because of the wages they were paid

  7. Under Say’s Law, is unemployment possible? Yes, but it is a short-lived adjustment period in which wages and prices decline or people voluntarily choose not to work

  8. What changed people’s mind about Say’s Law? The Great Depression and the publication of The General Theory of Employment, Interest, and Money published in 1936

  9. Why did Keynes’ believe that “supply did not create its own demand”? Aggregate expenditures (demand) can be forever inadequate for an economy to achieve full employment

  10. What is the main idea of this chapter? Keynes’s theory for the determination of consumption and investment expenditures

  11. What determines your family’s spending for goods and services? Disposable income

  12. What is theconsumption function? The graph that shows the amount households spend for goods and services at different levels of disposable income

  13. What is savings? Disposable income minus consumption, the amount households do not spend for consumer goods and services

  14. What is dissaving? The amount by which personal consumption expenditures exceed disposable income

  15. How do people dissave? Negative savings is financed by by drawing down previously accumulated financial assets or by borrowing

  16. What is autonomous consumption? Consumption that is independent of the level of disposable income

  17. What happens when disposable income is zero? Spending will equal autonomous consumption because households will dissave to satisfy basic consumption needs

  18. What is the marginal propensity to consume? The change in consumption resulting from a given change in real disposable income

  19. MPC =  C  Yd

  20. What is marginal propensity to save? The change in saving resulting from a given change in real disposable income

  21. MPS =  S  Yd

  22. MPC + MPS = 1

  23. The Consumption Function 8 C = Yd C 7 Dissaving Real ConsumptionTrillions of $ per year 6 5 C 4 3 Yd Saving 2 1 Real Disposable IncomeTrillions of $ per year 45° 1 2 3 4 5 6 7 8 9 10

  24. What happens if factors other than income change? There is a shift or relocation in the consumption schedule

  25. The Consumption Function 8 C = Yd C2 7 Real ConsumptionTrillions of $ per year 6 C1 5 4 MPC = .75 3 MPC = .50 2 1 Real Disposable IncomeTrillions of $ per year 45° 1 2 3 4 5 6 7 8 9 10

  26. The Consumption Function 8 C2 = a2 + bYd 7 Real ConsumptionTrillions of $ per year 6 5  nonincome determinant B 4 A 3 C1 = a1 + bYd 2 1 Real Disposable IncomeTrillions of $ per year  real consumption 1 2 3 4 5 6 7 8 9 10

  27. Why does the consumption function shift? • Expectations • Wealth • Price level • Interest rate • Stock of durable goods

  28. How do expectations affect the consumption function? Consumers expectations of things to happen in the future will affect their spending decisions today

  29. How does wealth affect the consumption function? Holding all other factors constant, the more wealth households accumulate, the more they spend at any current level of disposable income

  30. How does the price level affect the consumption function? Any change in the general price level shifts the consumption schedule by reducing or enlarging the consumers purchasing power

  31. How does the interest rate affect the consumption function? A high interest rate will discourage people from borrowing money and a low interest rate will encourage people to borrow money

  32. How does the stock of durable goods affect the consumption function? When durable goods are suppressed, like during WWII, afterwards there is an increase in the demand for goods not previously made available

  33. How does consumption compare with investment? Consumption is more stable than investment

  34. According to the Classical Economists, what determined the level of investment? The interest rate

  35. According to Keynes, what determines the level of investment? Expectations of future profits is the primary factor, the interest rate is the financing cost of any investment proposal

  36. What is the investment demand curve? The curve that shows the amount businesses spend for investment goods at different possible rates of interest

  37. Movement along the firm’s investment demand curve 16% Interest rate A Investment Demand Curve 12% B 8% 4% Real investment 10 5 15 20

  38. Shift in the firm’s investment demand curve 16% 12% C Interest rate 8% B I2 4% I1 Real investment 10 5 15 20

  39. Why is investment demand unstable? • Expectations • Technological change • Capacity utilization • Business taxes • Autonomous reasons

  40. How do expectations affect investment? Businesspeople are quite susceptible to moods of optimism and pessimism

  41. How does technological change affect investment? The introduction of new products and new ways of doing things have a big impact on investment decisions

  42. What happens when capacity utilization is low? When capacity utilization is low, firms can meet an increase in demand without expanding

  43. What happens when capacity utilization is high? When capacity utilization is high, firms must increase investment to meet an increase in demand

  44. How do business taxes affect investment? Business decisions depend on the expected after-tax rate of profit

  45. What isautonomous expenditure? Spending that does not vary with the current level of disposable income

  46. 16% Aggregate Investment Demand Curve 14% 12% Interest Rate 10% A 8% 6% Autonomous investment 4% 2% Real Investment .4 .2 1.4 1.6 .6 .8 1.2 1.0

  47. Aggregate Autonomous Investment Demand Curve 1.6 1.4 1.2 1.0 .8 .6 Autonomous investment .4 Real Disposable Income trillions of dollars per year .2 2 1 7 8 3 4 6 5

  48. What is the aggregate expenditure function? The function that represents total spending in an economy at a given level of real disposable income

  49. Aggregate Expenditures Schedule and Function 8 AE 7 E C 6 5 C + I 4 3 2 Real Disposable Income trillions of dollars per year 1 2 1 7 8 3 6 4 5

  50. Key Concepts

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