1 / 45

AGGREGATE DEMAND: THE SIMPLE KEYNESIAN MODEL

AGGREGATE DEMAND: THE SIMPLE KEYNESIAN MODEL. STUDY UNITS 7 & 8. STUDY OBJECTIVES. Identify the relationship between income, production and spending. Explain the assumptions of the Keynesian model. Define, explain and graphically represent the consumption function.

kamil
Download Presentation

AGGREGATE DEMAND: THE SIMPLE KEYNESIAN MODEL

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. AGGREGATE DEMAND:THE SIMPLE KEYNESIAN MODEL STUDY UNITS 7 & 8

  2. STUDY OBJECTIVES • Identify the relationship between income, production and spending. • Explain the assumptions of the Keynesian model. • Define, explain and graphically represent the consumption function. • Define and calculate the marginal propensity to consume (MPC) and the marginal propensity to save (MPS). • Define, explain and graphically represent the investment function. • Determine equilibrium in an economy that consists of only households and firms. • Use the multiplier to calculate the impact of an investment in the economy.

  3. Production, income & spending – the three main flows in a mixed economy • Production creates income for the production factors. • Part of this income is spend to buy goods and services. Production Income Spending

  4. PRODUCTION, INCOME AND SPENDING • Income used to buy products. • Products are created through production • Production generates income • Therefore in theory income = production • In reality in any economy three possibilities exist: • Spending = production and income – production and income at equilibrium levels. • Spending may be larger than production and income – production and income will increase, due to declining inventory levels. • Spending may be less than production and income – production and income decreases as a result of increases in inventory levels.

  5. KEYNESIAN MODEL - ASSUMPTIONS • Keynes suggested that: • If economy operating below full employment level (Yf) – stimulative economic policy must be applied – due to unemployment that exist. • If economy operating above full employment level (Yf) – contractionary economic policy must be applied – due to inflation that exist. • Assumptions of Keynesian model: • Wages and prices are fixed • Money market is ignored • Consumption, savings and imports are directly related to income • Investment, government expenditure and exports are autonomous.

  6. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C) • Y = C + S • MPC: • Definition • MPC (c) = ΔC ΔY • Autonomous consumption vs. Induced consumption. • Consumption function expressed in an equation: • C = C + cY • Savings function expressed in an equation: • S = - C + (1-c)Y

  7. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C) • Illustrate on graph: • C > Y • C = Y • C < Y

  8. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C)

  9. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C)

  10. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C)

  11. KEYNESIAN MODEL – CONSUMPTION EXPENDITURE (C)

  12. CONSUMPTION - GRAPHICALLY Y=A C

  13. SAVINGS - GRAPHICALLY

  14. EXCERCISES - MPC 0,7

  15. EXCERCISES - MPC 0,7

  16. EXCERCISES - MPC 0,7

  17. EXCERCISES

  18. KEYNESIAN MODEL - INVESTMENT • Definition of investment • Investment autonomous • Factors responsible for changes in investment are: • Interest rates • Level of savings by households • Tax policies since profit levels of companies is affected • Technology • Combine investment with consumption graphically • Definition of multiplier • Calculation of multiplier

  19. CONSUMPTION, INVESTMENT - GRAPHICALLY Y=A C + I E1 C E I

  20. KEYNESIAN MODEL - INVESTMENT • Definition of multiplier • Calculation of multiplier = 1 1 - c

  21. EXAMINATION QUESTIONSSuppose C = 50 + 0,9YIf equilibrium income is 1000

  22. CALCULATIONS TO SLIDE 20 • C = 50 + 0,9Y • C = 50 + 0,9 (1000) • C = 50 + 900 • C = 950 • S = Y – C • S = 1000 – 950 • S = 50

  23. Calculate multiplier if c =2/3 • Calculation of multiplier = 1 1 – c = 1 1 – 2/3 • = 1 1/3 • = 3

  24. EXAMINATION QUESTION 3Illustrate on the graph below the change if investment increases A=Y A C A Y Ye

  25. EXAMINATION QUESTION 3Illustrate on the graph below the change if investment increases C + I A=Y A E1 C E A Y Ye Ye1

  26. KEYNESIAN MODEL – GOVERNMENT EXPENDITURE • Definition of government expenditure • Government expenditure is autonomous • Show graphically government expenditure • Combine consumption, investment and government expenditure graphically • Multiplier also important when dealing with government expenditure • Recessionary gap vs. inflationary gap • Define and illustrate graphically

  27. CONSUMPTION, INVESTMENT - GRAPHICALLY C + I + G C + I C G

  28. Calculate multiplier if c =2/3 and t = 1/10 • Calculation of multiplier = 1 1 – c(1-t) = 1 1 – 2/3(1-1/10) • = 1 1- 2/3(9/10) • = 1 1- 18/30 = 1 12/30 • = 2,5

  29. RECESSIONARY GAP C, I, G Income line = 450 C+I+ G E 500 1000(Yf) Income (Y) in millions

  30. RECESSIONARY GAP C, I,G Income line = 450 C+I+G1 E1 C+I+G A E 200 G Y 150 500 1000(Yf) Income (Y) in millions

  31. INFLATIONARY GAP C, I,G Income line = 450 C+I+G E 100 1000(Yf) 1400 Income (Y) in millions

  32. INFLATIONARY GAP - REDUCED C, I,G Income line = 450 C+I+G C+I+G1 E D E1 G=50 100 50 Y=400 1000(Yf) 1400 Income (Y) in millions

  33. IMPACT OF TAX ON KEYNESIAN MODEL C, I,G Income line = 450 C+I+G C+I+G1 E E1 C Y Y2 Y1 Income (Y)

  34. IMPACT OF TAX ON CONSUMPTION FUNCTION GRADIENT C C1

  35. IMPORTS AS A FUNCTION OF INCOME Import Function Slope = MPZ ZA =

  36. IMPACT OF IMPORTS ON TOTAL EXPENDITURE AND TOTAL lNCOME Income line = 450 C+I+G C+I+G+Z E2 E1

  37. KEYNESIAN MODEL – FOREIGN SECTOR • Factors having an influence on the foreign sector (imports and exports) • Real GDP • Prices of domestic goods in comparison to foreign prices • Changes in the exchange rate • Interest rates

  38. Figure 8.14 I + X I

  39. COMPLETE KEYNESIAN MODEL Income line = 450 C+I+G + (X-Z) =TE C+I+G E3 C+I C E2 E1 E Y = 10 000

  40. MACROECONOMIC EQUILIBRIUM – AD/AS MODEL P AS E Pe AD 0 Income/Production (Y) Ye Yz Ya

  41. THE IMPACT ON MACROECONOMIC EQUILIBRIUM – STIMULATIVE POLICY APPLIED P AS E1 Pe1 E Pe AD1 AD2 0 Ye Ye1 Income/Production (Y) Yf

  42. Examination questionsSuppose c = 5/6 and t = 1/10. Calculate multiplier • Calculation of multiplier = 1 1 – c(1-t) = 1 1 – 5/6(1-1/10) • = 1 1- 5/6(9/10) • = 1 1- 45/60 = 1 15/60 • = 4,0

  43. EXAMINATION QUESTION • Autonomous consumption = R500 • Government expenditure = R600 • Investment spending = R900 • c = ¾ • t = 1/5 • Full employment = R6000 • 1. Calculate the multiplier • 2. What is value of autonomous spending • 3. What is equilibrium income value • 4. What is equilibrium expenditure value • 5. By which amount must investment increase to reach full employment.

  44. Examination questionsSuppose c = 3/4 and t = 1/5. Calculate multiplier • Calculation of multiplier = 1 1 – c(1-t) = 1 1 – 3/4(1-1/5) • = 1 1- 3/4(4/5) • = 1 1- 12/20 = 1 8/20 • = 2,5

  45. Examination questions • 2. Autonomous expenditure = C + I + G = 500 + 600 + 900 2000 3. Equilibrium income = multiplier X autonomous expenditure = 2,5 X 2000 = 5000 4. Equilibrium expenditure = 5000 A=Y at equilibrium 5. 1000 (6000 – 5000) ÷ multiplier 1000 ÷ 2,5 = 400

More Related