Aggregate Expenditures Model

1. Aggregate Expenditures Model • (Keynesian Economic Model -or- Keynesian Cross) • Explain how the economy’s equilibrium RGDP relates to total spending and how changes in total spending affect levels of RGDP • Clarify the basic determinants of the levels of output and employment. • Assumes a constant price level (is a “SHORT RUN” model / view of the economy)

2. Full Output Potential GDP Aggregate Expenditures AE *Assumes constant Price level* Real GDP Real National Income

3. I. HistoryA. Classical Economists • Market systems would ensure full employment of the economy’s resources • Acknowledge deviations from full employment • but insist there are “automatic adjustments” {prices, wages, interest rates} to restore the economy • “self - correcting”

4. Ex- if you experience a decrease in output and employment….. • Lead to lower prices, wages and interest rates….. • Lower prices = increase C • Lower interest rates = increase Investment • Lower wages = increase employment

5. Say’s Law • If You Build It; They Will Come Ensure full employment Self correcting The very act of producing goods generates an amount of income = to the value of the goods produced. “Supply Creates Its Own Demand” There will always be sufficient consumption Works as a “LONG RUN” view

6. Specifically, what aspects of Say’s Law did Keynes criticize and for each point he criticized, what was his offered solution? • A. • Not all income will be spent • Unsold goods = accumulated inventory • Producers reduce output and cut employment….= recession or depression

7. B. • Capitalism is not self regulating • Failure of certain fundamental economic decisions (saving and investment) to be synchronized • In Short Run – prices and wages are inflexible • Extended periods of overproduction and underconsumption …… = ? • Recession or depression will prevail before prices or wages significantly change.

8. Keynes’ Solution ***need govt. deficit spending ……………GREAT DEPRESSION and NEW DEAL created believers of KEYNESIAN ECONOMICS

9. ………….Led to……………. 1946 Full Employment Act – responsibility of the govt. to promote maximum employment, ….. production, and purchasing power, and price stability (control inflation) ….now much of it shared with Fed Reserve

10. Keynesian vs. Austrian (Hayek) • Keynes vs. Hayek: The Great Debate Continues • Newly discovered letters from two great economists shed light on today's discussion of economic 'stimulus.'

11. 1. “Classical” economic theory and “Keynesian” economic theory are: • Similar • Exactly Same • Opposite

12. 2.“Classical” theory and Hayek’s (or Austrian) theory are: • Same • Different

13. 3.Which of the following correctly identifies similar economic ideas and people? • Keynes, Hayek, Say • Say, Classical, Austrian • Classical, Austrian, Keynes • Hayek, Say’s Law, Okun’s Law • Keynesian, Say’s Law, Okun

14. 4. The economy, left to natural market forces, will find its way to a full employment equilibrium. Who would agree with this? • Keynes • Hayek • Austrian economists • Say • Classical economists • All of the above • All except Keynes

15. 5. At the outset of the Great Depression, the generally accepted economic solution from the view of the government was to….. • Turn to Communist Manifesto • Move to Canada • Lower corporate tax rates • Enact trickle down policies • Engage in expansionary fiscal policy • Do nothing

16. 6. Keynes’ proposed solution to FDR included • Balancing the budget • Tax increases • Interest rate increases • Austerity measures • Deficit spending • Debt refinancing *prior- goal was to keep balanced budget