Chapter 12

Understanding Keynesian Economics

Index

I. Aggregate Demand

II. Aggregate Demand and Equilibrium

III. Fine Tuning Economic Activity

IV. Multiplier

V. Additional Material

Part 2 Review Notes Chapters 8-14

 

 
 
 

  B. Investment is business spending on capital goods, inventory,
      and research & development.
     1. The level of investment is a function of expected profit, interest rates, and the level
         of technology required to maintain a desired competitive position.
     2. Investment spending tends to be somewhat volatile.
     3. Would a Wealth Tax affect marginal propensity to invest

    

    E. The Diminishing Contribution of Federal Spending to GDP

One problem with this simplified assumption is it assumes investment is fixed.
The following graph shows that it is not correct. source 5/7/13 

 

 

 

 


Note: Points on a 45-degree line 
equate values on  the x and y axes.

Keynes Requires an Extraordinary  Workout

 

  II. Aggregate Demand and Equilibrium
     A. Equilibrium (E) is where planned and actual AD and AS are equal.
          1. Equilibrium is where all goods produced for sale are sold. 
          2. At points below equilibrium, AD < AS, inventories are building and
              business activity is contracting. This level of economic activity was
              depicted by the horizontal (Keynesian) range of AS explained in the
              previous model.
          3. At points above equilibrium AD > AS, inventories are decreasing and 
              business activity is expanding
              as depicted by the intermediate range and eventually the classical
              range of AS.
          4. Economic activity (Real GDP) will be wherever AD intersects AS. 
              Equilibrium seldom exists as 
              economic activity is usually in one stage or another of the business
              cycle.
     B. If economic activity is not in balance, a dynamic situation exists and
           will continue until equilibrium is reached.
     C. Keynes believed that E could settle at a level of economic activity with
          large amounts of unemployment.
          1. If potential Real GDP is greater than what actual AD yields, a reces-
              sionary gap exists and may persist indefinitely. The solution to this
              unacceptable equilibrium is to increase AD.
          2. If potential Real GDP is less than what actual AD yields, an inflationary
              gap exists and the inflation may persist indefinitely. The solution to this
              unacceptable level of economic activity is to decrease AD.
          3. Inflationary and Recessionary Gaps- ACDC Economics in 60 Seconds
      D. Multiplier Affect (K) is important to determining the change in AD needed
           to reach equilibrium E.
          1. Changes in AD will result in larger changes in NNP as increases are not
               spent and respent.
          2. Decreases in AD have a similar but opposite affect.
          3. K = 1/MPS = 1?(1-MPC) Note: As MPS increases, K decreases.
          4. A MPS is 20%, Multiplier is 5 as 1/20% = 1/(1/5) = 1X 5 = 5 
          5. Fiscal policy and the multiplier... is an 9 minute video from YouTube

III. Fine Tuning Economic Activity
      A. In chapter 14 we investigate how government taxing and spending
           is used to affect AD and AS and affect the business cycle.
      B. In chapter 15 we investigate how  the Federal Reserve uses
          monetary policy to affect interest rates, AD and AS.
      C. The goal is to maximize growth while minimizing the inflationary
           and deflationary gaps.
      D. Fine Tuning is the frequent adjustments to monetary and or
           fiscal policy to alter the level of AD to keep the economy
           growing at a steady rate.
      E. Seeking Alpha blog on Paul Volcker and recent attempt to
          fine tuning U.S. Economy

IV. Multiplier
       A. When determining the required change in AD needed to achieve E,
            the Multiplier (K) concept must be considered. 
       B. This concept states that a change in AD will result in a larger change
            in Real GDP as these changes multiply (are spent and re-spent or
            not spent and re-not spent) throughout the economy. 
       C. Saving will act as a leakage eventually stopping the change.
       D. Suppose more is spent on investment and people receive this as income.
           1. People receiving the income spend some (MPC) and save some (MPS)
           2. A second group receives  the  spending of the first group as income and
               they also spend some (MPC) and save some (MPS).
           3. The process continues until savings eventually stops the progression. 
       E. Calculating multiplier (K), the multiple by which GDP will increase given
            some increase in AD.
           1. K = 1 / MPS = 1 /(1 - MPC)
           2. As MPS increases,  K decreases 
           3. If MPS = 20% then 1/MPS = 1/.2 = 5 
           4. An increase of $100 billion in investment will result in 5($100) =
               $500 billion in new national income.
           5.  K = change in Real GDP / change in AD = 500/100 = 5 
           6. Some unpleasant Keynesian arithmetic Dank Rodrik
           7. Multiplier Interactive practice problems from reff economics
      F. Fed infrastructure spending has big multiplier 12/1/12
        G. View Think Modeling  

US Government Spending About 10% Lower Than Western Europe.

 

V. Additional Material
     A. Maynard's Revenge: Keynesianism and the Crisis 1.05 hrs video, 2/16/10
     B. Keynesian economics - Wikipedia
     C. Review with information from the Institute for Economic Analysis
     D. Are you a Keynesians Quiz begins with a review.  2/24/14
     E. Are We All Keynesian Again 6/10
     F. Keynesian Economics Is Hot Again 4/10/17
     G. John Maynard Keynes

Discussion Questions

Homework Questions

Next Chapter 

Table of Contents

Other Macro Chapters

8) Measuring Total Economic Activity 
 9) The Business Cycle
10) Macro Equilibrium 
11) Competing Macro Theories and Issues

10) Macro Equilibrium 
11) Competing Macro Theories, Issues
12 Keynesian Economics: Expanded View
13 Money, Banking, Creation of Money
See Financial Crisis and The Great Recession
 14) Fiscal Policy
 15) Monetary Policy  
16) Stagflation & Supply-Side Economics
 17) Budget Deficits
See
Democratic Capitalism vs. Capitalistic Democracy 

 

 

 

 

 

wikipedia on 
/John Maynard Keynes