Macroeconomic Views: The
Keynesian Model
AP Macroeconomics
This unit, National Income & Price
Determination…
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Will explore the Keynesian Model, income
and expenditure, aspects of Aggregate
Demand and Aggregate Supply, and Fiscal
Policy and the Multiplier
We will spend a substantial amount of time
exploring concepts and models in this unit.
Fort Myers, FL
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Boom town in 2003, 2004
Unemployment rate 3%
Something went wrong. Jobs became scarce.
Unemployment rate reaches 14%. Foreclosures
galore.
What happened?
People were buying and selling houses as
investments, pushing the cost of housing up higher
than what people were willing to pay
They key here is investment spending – the
business cycle is driven by ups and downs in the
investment spending
It all began in 1933…
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The term “macroeconomics” was coined in
1933 by Ragnar Frisch
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However, the study was well underway long
before that
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Mostly concerned with aggregate price level
and aggregate output
The Classical Model of the Price Level
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As the money supply increases, so too does
the aggregate price level (ultimately leading
to inflation)
Prior to 1930s, this model dominated
economic thought, and it guided monetary
policy
They left out the effect of price on aggregate
output…
John Maynard Keynes (1883-1946)
John Maynard Keynes (a background)
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Classical economists felt that consumption
was a function of interest rates
Keynes felt that consumption was a function
of income
Technically, as income rises, then so too
should expenditures (or output)
However, consumption expenditures do not
equal income
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Why not? Even if people’s income is zero, they
can beg and borrow, and even steal. Another
reason is savings.
John Maynard Keynes
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The Keynesian Model is the simplest macro
model, and is the starting point from the
national income accounting identity:
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GDP = C + I + G + X-M (or GDP = C + I + G + NX)
This model helps us to find the equilibrium
income and to understand the relationship
among the concepts of income, consumption,
and spending
GDP = C + I + G + X-M is always
true…kinda…
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Planned aggregate expenditures (GDP) are equal
to the sum of planned consumption, planned
investment, government spending, and net exports
Planned consumption (C) always occur
Government spending (G) always occurs
Net exports (X-IM or NX) always occur
However, investment spending (I) does not
necessarily occur
Why doesn’t (I) always necessarily occur?
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Sometimes, inventories accumulate more
than businesses planned, and sometimes
businesses draw down inventories more than
planned
Simple Keynesian Model
This line represents
production 
Planned aggregate expenditure = C + I + G + NX
45 degree line: all points where production (real
GDP) = aggregate expenditure
Equilibrium occurs where planned aggregate
expenditure equals production (the equilibrium is
where the 45 degree line intersects the C + I + G +
NX line)
 This line represents
income (Y)
Visual 3.1
Unit 3: Macroeconomics
National Council on Economic Education
Consumption
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Consumption can be represented by the equation C = a +
bY, where Y is income or output
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b is the marginal propensity to consume (MPC), which
shows the amount by which consumption will increase if
income increases by $1
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MPC = change in consumption/change in income
http://www.reffonomics.com/textbook2/macroeconomics2/ke
ynesianthought/keynesianformulas.swf
Equilibrium & Disequilibrium in the
Keynesian Model
•The equilibrium output level
is Y
•Aggregate expenditures
equal output at this point
•At Y1, the total output
produced is 0B and the total
expenditures are 0A
•0B is greater than 0A
•Therefore, more is produced
than is demanded disequilibrium
Unit 3: Macroeconomics
National Council on Economic Education
Visual 3.2
Why more produced than is demanded?
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Firms experience a build-up of inventories:
More product is unsold and sitting in the
warehouse
Firms respond by producing less and laying
off workers
Output decreases and moves the economy
toward the equilibrium level of output Y
•If we draw a vertical line at
a level of output below Y,
what’s going on in the
economy?
•More demanded than
supplied
•Firms experience
unplanned inventory
production and
employment, and the
economy moves toward Y
Important Note
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The Keynesian Model is at the heart of the study of
Macroeconomics, helping us to understand the
consumption function and something called the
“multiplier process” (discussion to come)
This model holds the price level constant, which is
not a realistic representation of the economy
The aggregate demand and aggregate supply
model (which the price level and output are
determined) is the central model for macroeconomic
analysis.
And now…
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Some resources:
http://www.reffonomics.com/textbook2/macroec
onomics2/keynesianthought/keynesiancross.
swf
Works Cited
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Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.