End-of-Chapter Summaries from Ayers/Collinge: Chapter 10, Aggregate Expenditures
SUMMARY AND LEARNING OBJECTIVES
1. Summarize the perspective of Keynes and Keynesian economics.
●Keynesian economics takes a short-run perspective, whereas classical economics emphasizes
long-run tendencies and views unemployment as a temporary phenomenon that will be corrected
by market forces. In response to the classical contention that unemployment will be corrected by
the market, Keynes wrote, “In the long run, we are all dead.”
2. Illustrate the income–expenditure model.
●Keynesian economics is portrayed with an income–expenditure model. There are two curves in
the income–expenditure graph. The first is a 45-degree line. Since at every point along any 45degree line the value on one axis equals the value on the other axis, the 45-degree line in the
expenditure–equilibrium graph illustrates all points where spending and real GDP are equal. The
second curve is the aggregate expenditure function, which shows how much spending is planned
at each level of real GDP.
●An expenditure equilibrium occurs when aggregate planned spending equals real GDP, shown
graphically by the intersection of the aggregate expenditure function and the 45-degree line.
When real GDP and aggregate planned spending are equal, the economy’s output of goods and
services are all purchased.
●Planned spending can be autonomous or induced. Autonomous spending is the amount of
spending that would occur if people had no incomes. Even if people had no incomes, autonomous
spending would be some positive amount because people would spend out of accumulated
savings.
●Induced spending is the spending that occurs because people earn incomes. Induced spending is
in addition to autonomous spending. The larger one’s income, the greater his or her induced
spending.
●The aggregate expenditure function sums the four components of aggregate spending:
consumption, planned investment, government spending, and net exports (net spending by
foreigners).
3. Explain the adjustment process to an expenditure equilibrium.
●An expenditure equilibrium is associated with inventories of goods and services that are neither
being drawn down nor built up.
●Aggregate spending that is less than real GDP causes a recessionary gap. A recessionary gap is
associated with unemployment because planned spending is less than production, which results in
a buildup of inventories of unsold goods. Producers would cut back production to eliminate an
additional buildup of inventories. Production cutbacks typically involve layoffs of workers. Thus,
a recessionary gap leads to higher unemployment.
●An inflationary gap is the opposite of a recessionary gap. An inflationary gap leads to a decrease
in inventories. Businesses will increase production in an effort to restore inventories to their
desired level.
●In addition to recognizing the implications of differences between planned and actual
investment, Keynesian analysis also points out the significance of various aspects of consumer
behavior. The marginal propensity to consume (mpc), which is the fraction of an additional dollar
that is spent, plays a key role in the aggregate expenditure function. The maximum value of the
mpc is one, indicating that 100 percent of an additional dollar is spent. The minimum value of the
mpc is zero, indicating that none is spent. Typically, the value of the mpc for the economy will
be somewhere between zero and one.
4. Describe how new spending can have a ripple effect throughout the economy.
●Keynesian economics emphasizes the distinction between saving and spending. Every
additional dollar of income must either be spent, or by definition, saved. The fraction of an
additional dollar of income that is saved is the marginal propensity to save (mps).
●The sum of the marginal propensity to consume and the marginal propensity to save must equal
1 [mpc mps 1]. The reason is that the fraction of an additional dollar not spent must be saved. For
example, if consumers spend ninety cents of each additional dollar of income they receive, they
save ten cents by definition. Thus, the mpc 0.9 and the mps 0.1.
●Multiplier effects of spending are an important element of Keynesian economics. Induced
spending and autonomous spending both contribute to reaching an expenditure equilibrium.
When saving or consuming are consumers’ only options, the expenditure multiplier equals 1/mps.
●The expenditure multiplier assumes there are unemployed resources in the economy. It also
assumes a constant price level.
●Rather than rely upon downward price adjustments, Keynes recommended increased
government spending to move the economy to full employment. This spending will spread and,
through the multiplier effect, lead to even more spending.
5. Distinguish the tax multiplier from the balanced-budget multiplier.
●The tax multiplier shows the expansionary effect of a tax cut or the contractionary effect of a tax
increase on the economy. The tax multiplier will have a value of mpc/(1 mpc), which is less than
the expenditure multiplier.
●Combining the expenditure multiplier with the tax multiplier gives a balanced-budget multiplier
that equals one. This means that an increase in government spending financed by higher taxes
increases equilibrium income by the amount of extra government spending.
●One objection to Keynesian multiplier analysis is that the tax multiplier ignores how changing
taxes changes work and investment incentives. Keynesian multiplier analysis also ignores the
crowding-out effect, which occurs when government borrowing reduces funds available for
private sector investment.
6. Graph the relationship of the income–expenditure model to aggregate demand.
●The income–expenditure model can be used to derive an aggregate demand curve. A higher
price level shifts the aggregate expenditure function downward; a lower price level shifts it
upward. The relationship between the price level and the expenditure–equilibrium GDP is plotted
in aggregate demand.
●If the aggregate expenditure function shifts for any reason other than a change in the price level,
aggregate demand will shift. The new aggregate demand curve shows the new expenditure
equilibrium for the existing price level and for each other possible price level.
7. Compare economic analyses on the Great Depression.
●There is disagreement over the cause or causes of the Great Depression. There is also
disagreement over the success of Keynesian policy in pulling the country out of that depression.
Keynesian analysis models the Great depression as a severe recessionary gap.