Ch 27: Expenditure Multipliers: The Keynesian Model
Wed July 18, 2012
Keynesian model
-firms are like grocery stores -> the way they set prices and selling the q customers are willing to buy are
similar; for ex. When firms are selling and find that they are running out of inventory fast due to high
demand, they will eventually increase the price (vice versa).
-Each firm’s price are FIXED…. For economy as a whole: 1) Price level is FIXED 2) AD determines real
GDP
*Keynesian model explains fluctuations in AD at a fixed price level by identifying the forces that
determine expenditure plans
-------------------------------------------------------Lecture – multipliers
business cycle --random , irregular, unpredictable flow of as and ad – wave like flow
-inflationary gap, recessionary gap, full employment
-goal: reach an equilibrium
Shifts AD to right /upwards on same SAS curve (increase in price and gdp)
-money wage rate has not changed –wealth factor comes into play
-wages need to go up to meet up demand (SAS will shift upwards means real gdp goes down but price
level goes up or money wage rate)
Aggregate planned expenditure = c+ I +g+ (x-m)
C and imports are directly related to income = dependent on real gdp
an + in real gdp = +agg expenditure
an + agg expenditure= + real gdp
-they relate to each other
What you spend = DY (Disposable income: income received as earnings from a variety of sources. ie
transfer payments –direct taxes)
Y= C-S Net income is what is earned/spent – what is saved
consumption + savings
What influences your spending?? disposable income, interest rates, wealth effect and your expectations.
What you earn, spend, save
CP right now- all else held constant
Households : Can consume or save (MODEL 27.1 note book)
savings function , consumption function
-autonomous exp: amount of exp in short run even if there is no current income -> independent of income
induced amount: as income go up, you have induced consumption
45 degree line on consumption line to get equilibrium point
Savings function
Marginal propensity (MP)
-each extra dollar in income brings above
-marginal propensity to consume -> fraction of a change in disposable income that is spent on
consumption
-marginal propensity to save-> slope of savings function
disposable income must be used or save
MPC + MPS = DY= 1 (disposable income)
Marginal propensity to import (MPM) = Change in import/change in real gdp (DY)
Every dollar available , what your MPC???? 0; Save? 0.
Agg expenditure curve
actual agg exp = real gdp
but
agg planned exp is not ____ = actual ag exp
therefore, not _____ =to real gdp
-changes in inventory
-if agpe is less than real gdp then firms are selling less than they plan = surplus
-if agpe exceeds real gdp then firms sell more than planned = negative
Equilibrium exp is level of expenditure that occurs when agp =real gdp
Multiplier is greater than 1
increasing national income , we would increase investment
Induced injection
snowball effect
50 billion increase in investment has increased real gdp by 200 bill (shift in equilibrium)
-investment has generated 4 times in real gdp k=200/50=4
Multiplier =1/ 1-mpc
same as ….. 1/mps
imports and taxes influences the multiplier
-makes multiplier smaller
-occurs over time
Exercise
-we have a recessionary gap (shortfall in inventory…building economy. Trying to shift ag d curve. Want
to get you to spend more…)
Govnt spending: increase spending 1 billion
Multiplier = ?
increase in expenditures = ?
MPC=0.6/dollar spent
Net effect on real gdp
Answer:
Multiplier =2.5 (real gdp will increase by 2.5 by injection of 1 billion)