Keynesian economics
Sector model of Keynesian with multiple effects
Keynesian economics
“ I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years— the way the world thinks about economic problems.”
-- John Maynard Keynes
Keynesian economics Vs Classical economics
• Keynesian economics is a theory of total spending in the economy (called aggregate demand) and its effects on output and inflation. Although the term has been used (and abused) to describe many things over the years, six principal tenets seem central to Keynesianism. The first three describe how the economy works. Keynes sought to distinguish his theories from and oppose them to "classical economics," by which he meant the economic theories of David Ricardo and his followers, including John Stuart Mill, Alfred Marshall, Francis Ysidro Edgeworth, and Arthur Cecil Pigou. A central tenet of the classical view, known as Say's law, states that "supply creates its own demand". Say's Law can be interpreted in two ways. First, the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity, and is therefore indisputable. A second and stronger claim, however, that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment. In particular, Keynes argued that the second, strong form of Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment.[12] Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy. Because of what he considered the failure of the “Classical Theory” in the 1930s, Keynes firmly objects to its main theory—adjustments in prices would automatically make demand tend to the full employment level. Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. Through the distribution of the monetary policy, demand and supply can be adjusted. If there were more labor than demand for it, wages would fall until hiring began again. If there was too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing
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The General Theory of Employment, Interest and Money
• A macroeconomic model based on the principles of Keynesian economics that is used to identify the equilibrium level of, and analyze disruptions to, aggregate production and income. This model identifies equilibrium aggregate production and income as the intersection of the aggregate expenditures line and the 45-degree line. The Keynesian model comes in three basic variations designated by the number of macroeconomic sectors included--two-sector, three-sector, and four sector. The Keynesian model is also commonly presented in the form of injections and leakages in addition to the standard aggregate expenditures format. This model is used to analyze several important topics and issues, including multipliers, business cycles, fiscal policy, and monetary policy. The Keynesian model, commonly presented as the Keynesian cross intersection between the aggregate expenditures line and the 45-degree line, was the standard macroeconomic analysis throughout the mid-1900s, from the Great Depression to the early 1980s. While it was largely replaced by aggregate market analysis (or AS-AD analysis) in the 1980s, it continues to provide important insight into the workings of the macroeconomy.
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Keynesian Sector Model
• The Keynesian model comes in three basic variations designated by the number of macroeconomic sectors included--two-sector, threesector, and four sector • The Keynesian model is also commonly presented in the form of injections and leakages in addition to the standard aggregate expenditures format. • This model is used to analyze several important topics and issues, including multipliers, business cycles, fiscal policy, and monetary policy • The Keynesian model, commonly presented as the Keynesian cross intersection between the aggregate expenditures line and the 45degree line, was the standard macroeconomic analysis throughout the mid-1900s, from the Great Depression to the early 1980s
TWO-SECTOR KEYNESIAN MODEL
• A Keynesian model of the macroeconomy that includes the two private sectors, the household sector and the business sector. This Keynesian model variation, often termed the basic Keynesian model or the private sector Keynesian model, captures the interaction between induced consumption expenditures and autonomous investment expenditures. This model is commonly used to illustrate the basic workings of Keynesian economics, including equilibrium, disequilibrium, and the multiplier. Equilibrium is identified as the intersection between the C + I line and the 45-degree line. Two related variations are the three-sector Keynesian model and the four-sector Keynesian model The two-sector Keynesian model is the simplest representation of the key principles of Keynesian economics. It is commonly termed the basic or private sector Keynesian model because it (1) captures the basic essence of Keynesian economics and (2) includes only the two private sectors--household and business. This variation is typically used in introductory economics courses to introduce Keynesian economic theory. The private sector, as noted above, contains the household and business sectors. Household Sector: The household sector includes everyone in an economy who consumes goods and services. It is the entire population of an economy. The household sector is responsible for consumption expenditures on gross domestic product. Business Sector: The business sector contains the private, profit-seeking firms in the economy that combine scarce resources into the production of wants-and-needs satisfying goods and services. The business sector is responsible for investment expenditures on gross domestic product.
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Aggregate Expenditures: The C + I Line
• • Aggregate Expenditures: The C + I Line The place to begin with the two-sector Keynesian model is the aggregate expenditures line. In this particular model, the aggregate expenditures line is comprised of expenditures from the two private sectors--induced consumption expenditures by the household sector and autonomous investment expenditures by the business sector (hence the name "two-sector" Keynesian model). The exhibit to the right can be used to illustrated the two-sector (C + I) aggregate expenditures line. We begin with the consumption line. This graph measures expenditures on the vertical axis and aggregate production on the horizontal axis. The consumption line (C) presented here is positively sloped. The intercept is autonomous consumption and the slope of the line is induced consumption, measured by the marginal propensity to consume. The aggregate expenditures line is derived by adding investment to the consumption line. Investment is assumed to be totally autonomous. As such, the aggregate expenditures line is obtained by adding a constant amount of investment to the consumption line. The resulting aggregate expenditures line can be displayed by clicking the [AE] button. Equilibrium in the two-sector Keynesian model requires a balance between aggregate expenditures and aggregate production. The aggregate expenditures line is a critical part of this equilibrium, but ONLY part. The other part is an equilibrium guide line
C + I Line
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the two-sector Keynesian model are now in place. To identify equilibrium, let's go to the exhibit at the right. Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $12 trillion of aggregate production. At this level, aggregate expenditures are also $12 trillion. Only at $12 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. At this $12 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories •
Equilibrium
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THREE-SECTOR KEYNESIAN MODEL
• A Keynesian model of the macroeconomy that includes the three domestic sectors, the household sector, the business sector, and the government sector. This Keynesian model variation adds the government sector (or public sector) to the household and business sectors that make up the two-sector model. This model enables an analysis of government stabilization policies, especially how fiscal policy changes in government purchases and taxes can be used to close recessionary gaps and inflationary gaps. Equilibrium is identified as the intersection between the C + I + G line and the 45-degree line. Two related models are the two-sector Keynesian model and the four-sector Keynesian model.
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The three-sector Keynesian model is perhaps the most commonly used representation of Keynesian economics. It contains the three essential components of the macroeconomy needed to analyze business-cycle instability.
First, consumption expenditures by the household sector capture induced expenditures. Second, investment expenditures by the business sector incorporate autonomous private sector expenditure changes that are considered a prime source of business cycles in Keynesian economics.
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Third, government purchases and taxes by the government sector then highlight the use of policy actions to address businesscycle instability.
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The Public Sector
The three-sector Keynesian model adds the government sector to the two-sector model containing only the household and business sectors. In other words, it includes the public sector in Keynesian analysis. The public sector is another term for the government sector, the sector that forces involuntary resource allocation decisions on the rest of the economy through laws, rules, and regulations. The public sector enters this model in two ways--by adding government purchases to aggregate expenditures and by subtracting taxes from aggregate expenditures. Whichever term is used, government takes center stage in Keynesian economics as the means of correcting business-cycle instability. For example, the decline in business sector investment that would move the economy toward a contraction, can be countered by an increase in government sector purchases or a decrease in taxes.
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Aggregate Expenditures: The C + I + G Line
• The first step to adding government to the two-sector Keynesian model is relatively easy. Government purchases are merely one more layer added to the aggregate expenditures stack that includes consumption and investment. Let's derive the aggregate expenditures line for the three-sector Keynesian model.
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This diagram displays the consumption and investment layers that make up the two-sector aggregate expenditures line. The consumption line is labeled C and the combination of consumption and investment is labeled C + I. Because investment is assumed to be autonomous, both lines have slopes equal to the marginal propensity to consume.
The three-sector Keynesian model is commonly constructed assuming that government purchases are also autonomous. While this is not particularly realistic, it does enable a number of important conclusions about the government sector without overly complicating the analysis. Adding the government sector to the C + I line is a simple matter of adding a fixed amount of government purchased to each level of aggregate production. You can display this threesector aggregate expenditures line by clicking the [Add Government] button. The resulting line is labeled AE = C + I + G. Because government purchases (as well as investment) are autonomous, the slope of the AE = C + I + G is parallel to the consumption line (C) and the C + I line. All three lines have the same slope equal to the marginal propensity to consume. If induced government purchases are used rather than autonomous government purchases, then the slope of the line is equal to the marginal propensity to consume plus the marginal propensity for government purchases. This would make the AE = C + I + G line steeper than the consumption line.
C + I + G Line
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Aggregate Expenditures: Subtracting Taxes
• The government sector not only contributes to aggregate expenditures through government purchases, it takes away from aggregate expenditures by imposing taxes. Taxes reduce income which, at the very least, reduces consumption. The exhibit to the immediate right illustrates the three-sector aggregate expenditures line containing C, I, and G. Including taxes in this model means less income is available for spending by the two private sectors, in particular, consumption by the household sector. In effect, the inclusion of taxes causes the aggregate expenditures line to shift down a bit. While it might seem that the reduction of aggregate expenditures caused by taxes would exactly offset the increase in aggregate expenditures caused by government purchases, such is not the case. Even if taxes are equal to government purchases (which is not necessarily the case), the aggregate expenditures line does not shift down by the same vertical distance as the size of the G layer of government purchases. The reason is that taxes do not decrease consumption dollar for dollar. Because changes in income affect both consumption and taxes, a portion of taxes also comes out of reduced saving. To see how the inclusion of taxes causes the AE = C + I + G line to shift down, click the [Adjust for Taxes] button. The resulting aggregate expenditures line is labeled AE' = C + I + G. Once again, to keep the analysis simple, taxes are assumed to be autonomous. If the adjustment is made with induced taxes, then the slope fo the aggregate expenditures
Subtracting Taxes
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the three-sector Keynesian model are now in place. To identify equilibrium, consider the exhibit at the right.Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $16 trillion of aggregate production. At this level, aggregate expenditures are also $16 trillion. Only at $16 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. • At this $16 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. • The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. • A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories
Equilibrium
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FOUR-SECTOR KEYNESIAN MODEL:
• A Keynesian model of the macroeconomy that includes all four macroeconomic sectors, the household sector, the business sector, the government sector, and the foreign sector. This Keynesian model variation adds the foreign to the three domestic sectors (household, business, and government) in the three-sector model. This model provides the complete Keynesian representation of the macroeconomy, including the export-import interaction between the domestic economy and the foreign sector. Equilibrium is identified as the intersection between the C + I + G + (X - M) line and the 45-degree line. Two related variations are the two-sector Keynesian model and the three-sector Keynesian model. The four-sector Keynesian model is the complete Keynesian model, containing all four macroeconomic sectors--household, business, government, and foreign. It adds the foreign sector to the three domestic sectors, thus including the role of foreign trade, or net exports, in the analysis of equilibrium. Including the foreign sector is a simple matter of adding another layer-net exports--onto the aggregate expenditures stack of the three-sector Keynesian model. The Foreign Sector The four-sector Keynesian model adds the foreign sector to the three-sector model containing the household, business, and government sectors. The foreign sector is responsible for all economic activity beyond the boundaries of an economy. The boundaries in question are usually political boundaries.The foreign sector includes households, businesses, and governments that reside in other countries. The domestic economy trades goods with the foreign sector through exports and imports. This foreign trade is an extension of regular market activity, except the buyers and sellers reside in different countries. Exports: Goods produced by the domestic economy that are purchased by the foreign sector are exports. Imports: Goods produced by the foreign sector and purchased by the domestic economy are imports. Imports are subtracted from exports to derive net exports, which is the
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Aggregate Expenditures: The C + I + G + (X - M) Line
• Adding the foreign sector to the three-sector Keynesian model is relatively easy. Net exports are merely one more layer added to the aggregate expenditures stack that includes consumption, investment, and government purchases. Let's derive the aggregate expenditures line for the four-sector Keynesian model. The three-sector aggregate expenditures line, labeled AE = C + I + G is displayed in this diagram. It contains expenditures by the three domestic sectors. Net exports add another layer to this stack. Click the [Add Net Exports] button to add this layer. In this model, imports are realistically assumed to be induced and increase with the level of aggregate production. Because induced imports are subtracted from exports, this net exports layer shrinks with larger aggregate production levels and even becomes negative. This is the four-sector aggregate expenditures line. The induced nature of net exports means that the slope of the four-sector aggregate expenditures line is less than the slope of the three-sector aggregate expenditures line, which (assuming that investment, government purchases, and taxes are all autonomous) is the marginal propensity to consume . The inclusion of the foreign sector in the Keynesian framework is not nearly as important as the other three sectors. Consumption expenditures capture the induced expenditure mechanism that is critical to the multiplier process. Investment expenditures illustrate how autonomous expenditure changes by the private sector can trigger business-cycle instability. Government purchases and taxes are the essential components of fiscal policy used to stabilize the business cycle. By way of contrast, net exports do not highlight any comparable aspects of the macroeconomy. As such, the foreign sector and net exports are not needed for most of analyses of the macroeconomy.
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C + I + G + (X - M) Line
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the four-sector Keynesian model are now in place. To identify equilibrium, let's go to the exhibit at the right. Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $15.5 trillion of aggregate production. At this level, aggregate expenditures are also $15.5 trillion. Only at $15.5 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. At this $15.5 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories.
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Equilibrium
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The Multiplier Effect
• An important bit of analysis undertaken using the Keynesian model is the multiplier. The basic Keynesian multiplier is the cumulatively reinforcing induced interaction between consumption and production that amplifies autonomous expenditure changes, especially investment, government spending, exports. The essence of the multiplier is that relatively small changes in autonomous expenditures cause relatively large overall changes in aggregate production and income. The resulting changes in aggregate production are typically a "multiple" of the initial expenditure changes, hence the term "multiplier."To see how the multiplier process works, consider the Keynesian cross equilibrium presented here. The aggregate expenditures line (AE) intersects the 45-degree line (Y = AE) at $12 trillion of aggregate production. This production level is bound to change if the aggregate expenditures line shifts. The reason for the change is a $1 trillion increase in government purchases, the result of expansionary fiscal policy. This autonomous change in government purchases is just the thing that shifts the aggregate expenditures line. To display the shift of the aggregate expenditures line, click the [$1 Trillion More] button. This reveals a new aggregate expenditures line that is $1 trillion higher than the original line. The new equilibrium is found at the intersection of the 45-degree line and the new aggregate expenditures line, which is $16 trillion of aggregate production. The difference between the original equilibrium and the new equilibrium is $4 trillion. This is four times the initial change in government purchases, a multiple of the initial change. The resulting multiplier is based on the marginal propensity to consume. The change in government purchases increases production and income, which then induces changes in consumption according to the marginal propensity to consume. The changes in consumption then cause additional changes in production and income, which then induces more changes in consumption. A larger marginal propensity to consume results in a larger multiplier. •
Multiplier
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PRESNTATION BY GROUP 5
• • • • • • Sai Krishna Radha Ankita Rubina Asjad AvneetPranav.
doc_972632710.pptx
Sector model of Keynesian with multiple effects
Keynesian economics
“ I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years— the way the world thinks about economic problems.”
-- John Maynard Keynes
Keynesian economics Vs Classical economics
• Keynesian economics is a theory of total spending in the economy (called aggregate demand) and its effects on output and inflation. Although the term has been used (and abused) to describe many things over the years, six principal tenets seem central to Keynesianism. The first three describe how the economy works. Keynes sought to distinguish his theories from and oppose them to "classical economics," by which he meant the economic theories of David Ricardo and his followers, including John Stuart Mill, Alfred Marshall, Francis Ysidro Edgeworth, and Arthur Cecil Pigou. A central tenet of the classical view, known as Say's law, states that "supply creates its own demand". Say's Law can be interpreted in two ways. First, the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity, and is therefore indisputable. A second and stronger claim, however, that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment. In particular, Keynes argued that the second, strong form of Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment.[12] Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy. Because of what he considered the failure of the “Classical Theory” in the 1930s, Keynes firmly objects to its main theory—adjustments in prices would automatically make demand tend to the full employment level. Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. Through the distribution of the monetary policy, demand and supply can be adjusted. If there were more labor than demand for it, wages would fall until hiring began again. If there was too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing
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The General Theory of Employment, Interest and Money
• A macroeconomic model based on the principles of Keynesian economics that is used to identify the equilibrium level of, and analyze disruptions to, aggregate production and income. This model identifies equilibrium aggregate production and income as the intersection of the aggregate expenditures line and the 45-degree line. The Keynesian model comes in three basic variations designated by the number of macroeconomic sectors included--two-sector, three-sector, and four sector. The Keynesian model is also commonly presented in the form of injections and leakages in addition to the standard aggregate expenditures format. This model is used to analyze several important topics and issues, including multipliers, business cycles, fiscal policy, and monetary policy. The Keynesian model, commonly presented as the Keynesian cross intersection between the aggregate expenditures line and the 45-degree line, was the standard macroeconomic analysis throughout the mid-1900s, from the Great Depression to the early 1980s. While it was largely replaced by aggregate market analysis (or AS-AD analysis) in the 1980s, it continues to provide important insight into the workings of the macroeconomy.
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Keynesian Sector Model
• The Keynesian model comes in three basic variations designated by the number of macroeconomic sectors included--two-sector, threesector, and four sector • The Keynesian model is also commonly presented in the form of injections and leakages in addition to the standard aggregate expenditures format. • This model is used to analyze several important topics and issues, including multipliers, business cycles, fiscal policy, and monetary policy • The Keynesian model, commonly presented as the Keynesian cross intersection between the aggregate expenditures line and the 45degree line, was the standard macroeconomic analysis throughout the mid-1900s, from the Great Depression to the early 1980s
TWO-SECTOR KEYNESIAN MODEL
• A Keynesian model of the macroeconomy that includes the two private sectors, the household sector and the business sector. This Keynesian model variation, often termed the basic Keynesian model or the private sector Keynesian model, captures the interaction between induced consumption expenditures and autonomous investment expenditures. This model is commonly used to illustrate the basic workings of Keynesian economics, including equilibrium, disequilibrium, and the multiplier. Equilibrium is identified as the intersection between the C + I line and the 45-degree line. Two related variations are the three-sector Keynesian model and the four-sector Keynesian model The two-sector Keynesian model is the simplest representation of the key principles of Keynesian economics. It is commonly termed the basic or private sector Keynesian model because it (1) captures the basic essence of Keynesian economics and (2) includes only the two private sectors--household and business. This variation is typically used in introductory economics courses to introduce Keynesian economic theory. The private sector, as noted above, contains the household and business sectors. Household Sector: The household sector includes everyone in an economy who consumes goods and services. It is the entire population of an economy. The household sector is responsible for consumption expenditures on gross domestic product. Business Sector: The business sector contains the private, profit-seeking firms in the economy that combine scarce resources into the production of wants-and-needs satisfying goods and services. The business sector is responsible for investment expenditures on gross domestic product.
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Aggregate Expenditures: The C + I Line
• • Aggregate Expenditures: The C + I Line The place to begin with the two-sector Keynesian model is the aggregate expenditures line. In this particular model, the aggregate expenditures line is comprised of expenditures from the two private sectors--induced consumption expenditures by the household sector and autonomous investment expenditures by the business sector (hence the name "two-sector" Keynesian model). The exhibit to the right can be used to illustrated the two-sector (C + I) aggregate expenditures line. We begin with the consumption line. This graph measures expenditures on the vertical axis and aggregate production on the horizontal axis. The consumption line (C) presented here is positively sloped. The intercept is autonomous consumption and the slope of the line is induced consumption, measured by the marginal propensity to consume. The aggregate expenditures line is derived by adding investment to the consumption line. Investment is assumed to be totally autonomous. As such, the aggregate expenditures line is obtained by adding a constant amount of investment to the consumption line. The resulting aggregate expenditures line can be displayed by clicking the [AE] button. Equilibrium in the two-sector Keynesian model requires a balance between aggregate expenditures and aggregate production. The aggregate expenditures line is a critical part of this equilibrium, but ONLY part. The other part is an equilibrium guide line
C + I Line
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the two-sector Keynesian model are now in place. To identify equilibrium, let's go to the exhibit at the right. Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $12 trillion of aggregate production. At this level, aggregate expenditures are also $12 trillion. Only at $12 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. At this $12 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories •
Equilibrium
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THREE-SECTOR KEYNESIAN MODEL
• A Keynesian model of the macroeconomy that includes the three domestic sectors, the household sector, the business sector, and the government sector. This Keynesian model variation adds the government sector (or public sector) to the household and business sectors that make up the two-sector model. This model enables an analysis of government stabilization policies, especially how fiscal policy changes in government purchases and taxes can be used to close recessionary gaps and inflationary gaps. Equilibrium is identified as the intersection between the C + I + G line and the 45-degree line. Two related models are the two-sector Keynesian model and the four-sector Keynesian model.
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The three-sector Keynesian model is perhaps the most commonly used representation of Keynesian economics. It contains the three essential components of the macroeconomy needed to analyze business-cycle instability.
First, consumption expenditures by the household sector capture induced expenditures. Second, investment expenditures by the business sector incorporate autonomous private sector expenditure changes that are considered a prime source of business cycles in Keynesian economics.
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Third, government purchases and taxes by the government sector then highlight the use of policy actions to address businesscycle instability.
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The Public Sector
The three-sector Keynesian model adds the government sector to the two-sector model containing only the household and business sectors. In other words, it includes the public sector in Keynesian analysis. The public sector is another term for the government sector, the sector that forces involuntary resource allocation decisions on the rest of the economy through laws, rules, and regulations. The public sector enters this model in two ways--by adding government purchases to aggregate expenditures and by subtracting taxes from aggregate expenditures. Whichever term is used, government takes center stage in Keynesian economics as the means of correcting business-cycle instability. For example, the decline in business sector investment that would move the economy toward a contraction, can be countered by an increase in government sector purchases or a decrease in taxes.
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Aggregate Expenditures: The C + I + G Line
• The first step to adding government to the two-sector Keynesian model is relatively easy. Government purchases are merely one more layer added to the aggregate expenditures stack that includes consumption and investment. Let's derive the aggregate expenditures line for the three-sector Keynesian model.
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This diagram displays the consumption and investment layers that make up the two-sector aggregate expenditures line. The consumption line is labeled C and the combination of consumption and investment is labeled C + I. Because investment is assumed to be autonomous, both lines have slopes equal to the marginal propensity to consume.
The three-sector Keynesian model is commonly constructed assuming that government purchases are also autonomous. While this is not particularly realistic, it does enable a number of important conclusions about the government sector without overly complicating the analysis. Adding the government sector to the C + I line is a simple matter of adding a fixed amount of government purchased to each level of aggregate production. You can display this threesector aggregate expenditures line by clicking the [Add Government] button. The resulting line is labeled AE = C + I + G. Because government purchases (as well as investment) are autonomous, the slope of the AE = C + I + G is parallel to the consumption line (C) and the C + I line. All three lines have the same slope equal to the marginal propensity to consume. If induced government purchases are used rather than autonomous government purchases, then the slope of the line is equal to the marginal propensity to consume plus the marginal propensity for government purchases. This would make the AE = C + I + G line steeper than the consumption line.
C + I + G Line
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Aggregate Expenditures: Subtracting Taxes
• The government sector not only contributes to aggregate expenditures through government purchases, it takes away from aggregate expenditures by imposing taxes. Taxes reduce income which, at the very least, reduces consumption. The exhibit to the immediate right illustrates the three-sector aggregate expenditures line containing C, I, and G. Including taxes in this model means less income is available for spending by the two private sectors, in particular, consumption by the household sector. In effect, the inclusion of taxes causes the aggregate expenditures line to shift down a bit. While it might seem that the reduction of aggregate expenditures caused by taxes would exactly offset the increase in aggregate expenditures caused by government purchases, such is not the case. Even if taxes are equal to government purchases (which is not necessarily the case), the aggregate expenditures line does not shift down by the same vertical distance as the size of the G layer of government purchases. The reason is that taxes do not decrease consumption dollar for dollar. Because changes in income affect both consumption and taxes, a portion of taxes also comes out of reduced saving. To see how the inclusion of taxes causes the AE = C + I + G line to shift down, click the [Adjust for Taxes] button. The resulting aggregate expenditures line is labeled AE' = C + I + G. Once again, to keep the analysis simple, taxes are assumed to be autonomous. If the adjustment is made with induced taxes, then the slope fo the aggregate expenditures
Subtracting Taxes
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the three-sector Keynesian model are now in place. To identify equilibrium, consider the exhibit at the right.Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $16 trillion of aggregate production. At this level, aggregate expenditures are also $16 trillion. Only at $16 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. • At this $16 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. • The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. • A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories
Equilibrium
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FOUR-SECTOR KEYNESIAN MODEL:
• A Keynesian model of the macroeconomy that includes all four macroeconomic sectors, the household sector, the business sector, the government sector, and the foreign sector. This Keynesian model variation adds the foreign to the three domestic sectors (household, business, and government) in the three-sector model. This model provides the complete Keynesian representation of the macroeconomy, including the export-import interaction between the domestic economy and the foreign sector. Equilibrium is identified as the intersection between the C + I + G + (X - M) line and the 45-degree line. Two related variations are the two-sector Keynesian model and the three-sector Keynesian model. The four-sector Keynesian model is the complete Keynesian model, containing all four macroeconomic sectors--household, business, government, and foreign. It adds the foreign sector to the three domestic sectors, thus including the role of foreign trade, or net exports, in the analysis of equilibrium. Including the foreign sector is a simple matter of adding another layer-net exports--onto the aggregate expenditures stack of the three-sector Keynesian model. The Foreign Sector The four-sector Keynesian model adds the foreign sector to the three-sector model containing the household, business, and government sectors. The foreign sector is responsible for all economic activity beyond the boundaries of an economy. The boundaries in question are usually political boundaries.The foreign sector includes households, businesses, and governments that reside in other countries. The domestic economy trades goods with the foreign sector through exports and imports. This foreign trade is an extension of regular market activity, except the buyers and sellers reside in different countries. Exports: Goods produced by the domestic economy that are purchased by the foreign sector are exports. Imports: Goods produced by the foreign sector and purchased by the domestic economy are imports. Imports are subtracted from exports to derive net exports, which is the
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Aggregate Expenditures: The C + I + G + (X - M) Line
• Adding the foreign sector to the three-sector Keynesian model is relatively easy. Net exports are merely one more layer added to the aggregate expenditures stack that includes consumption, investment, and government purchases. Let's derive the aggregate expenditures line for the four-sector Keynesian model. The three-sector aggregate expenditures line, labeled AE = C + I + G is displayed in this diagram. It contains expenditures by the three domestic sectors. Net exports add another layer to this stack. Click the [Add Net Exports] button to add this layer. In this model, imports are realistically assumed to be induced and increase with the level of aggregate production. Because induced imports are subtracted from exports, this net exports layer shrinks with larger aggregate production levels and even becomes negative. This is the four-sector aggregate expenditures line. The induced nature of net exports means that the slope of the four-sector aggregate expenditures line is less than the slope of the three-sector aggregate expenditures line, which (assuming that investment, government purchases, and taxes are all autonomous) is the marginal propensity to consume . The inclusion of the foreign sector in the Keynesian framework is not nearly as important as the other three sectors. Consumption expenditures capture the induced expenditure mechanism that is critical to the multiplier process. Investment expenditures illustrate how autonomous expenditure changes by the private sector can trigger business-cycle instability. Government purchases and taxes are the essential components of fiscal policy used to stabilize the business cycle. By way of contrast, net exports do not highlight any comparable aspects of the macroeconomy. As such, the foreign sector and net exports are not needed for most of analyses of the macroeconomy.
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C + I + G + (X - M) Line
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An Equilibrium Guide: The 45-Degree Line
• The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.
45-Degree Line
• The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures. Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line. We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.
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The Equilibrium Intersection
• The parts needed to identify equilibrium for the four-sector Keynesian model are now in place. To identify equilibrium, let's go to the exhibit at the right. Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production. Equilibrium is achieved with $15.5 trillion of aggregate production. At this level, aggregate expenditures are also $15.5 trillion. Only at $15.5 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production. At this $15.5 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level. A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories.
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Equilibrium
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The Multiplier Effect
• An important bit of analysis undertaken using the Keynesian model is the multiplier. The basic Keynesian multiplier is the cumulatively reinforcing induced interaction between consumption and production that amplifies autonomous expenditure changes, especially investment, government spending, exports. The essence of the multiplier is that relatively small changes in autonomous expenditures cause relatively large overall changes in aggregate production and income. The resulting changes in aggregate production are typically a "multiple" of the initial expenditure changes, hence the term "multiplier."To see how the multiplier process works, consider the Keynesian cross equilibrium presented here. The aggregate expenditures line (AE) intersects the 45-degree line (Y = AE) at $12 trillion of aggregate production. This production level is bound to change if the aggregate expenditures line shifts. The reason for the change is a $1 trillion increase in government purchases, the result of expansionary fiscal policy. This autonomous change in government purchases is just the thing that shifts the aggregate expenditures line. To display the shift of the aggregate expenditures line, click the [$1 Trillion More] button. This reveals a new aggregate expenditures line that is $1 trillion higher than the original line. The new equilibrium is found at the intersection of the 45-degree line and the new aggregate expenditures line, which is $16 trillion of aggregate production. The difference between the original equilibrium and the new equilibrium is $4 trillion. This is four times the initial change in government purchases, a multiple of the initial change. The resulting multiplier is based on the marginal propensity to consume. The change in government purchases increases production and income, which then induces changes in consumption according to the marginal propensity to consume. The changes in consumption then cause additional changes in production and income, which then induces more changes in consumption. A larger marginal propensity to consume results in a larger multiplier. •
Multiplier
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PRESNTATION BY GROUP 5
• • • • • • Sai Krishna Radha Ankita Rubina Asjad AvneetPranav.
doc_972632710.pptx