Economy in the short-run: two factor income-expenditure model

Июль 26, 2022

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Economy in the short-run: two factor income-expenditure model

Содержание

2. Lecture objectives What is the essence of the Keynesian doctrine? How can economic crises be explained
3. John Maynard Keynes (1883-1946) Model explaining causes of crises and suggesting methods of counteracting them. „The
4. The Keynesian perspective Aggregate demand as the cause of crises Government intervention as the remedy for
5. Model assumptions Two factor analysis: the only types of economic subjects are domestic households and firms
6. Circular flow in the model
7. The essence of aggregate demand Aggregate demand (AD): sum of expenditures for various goods and services
8. Consumption component of AD Two things concerning „C” must be noted: it is directly dependent on
9. Marginal propensity to consume Marginal propensity to consume (MPC): the fraction of the additional current income
10. Autonomous consumption Autonomous consumption (CA): the part of consumption that is not financed by current income
11. Consumption function Notice that MPC and CA are key variables in consumption function formula: 1) MPC
12. Technical note Changes in nouseholds’ current income result in shifts along the consumpion line. Changes in
13. Saving Saving means unconsumed income. Y = C + S C = MPC×Y + CA S
14. Saving function Notice that saving function is the mirror reflection of the consumption function formula: 1)
15. Investment component of AD Special status in the Keynesian doctrine Outstanding variability Independent of the current
16. Investment function
17. Aggregate demand: recollection Aggregate demand: the sum of households’ and firms’ expenditures (for consumption and investments,
18. Aggregate demand function
19. 45 degrees line At any point on the 45° line the distance to the horizontal axis
20. Check point: the meaning of „Y” So far the letter „Y” was using to denote „income”.
21. Keynesian cross Plotting AD and 45 degrees lines on the same chart allows you to study
22. Equilibrium & equilibrium output Equilibrium output (YE): the level of GDP at which the aggregate demand
23. Short-run equilibrium in the market for goods and services
24. Equilibrium: numerical example (static analysis) C = 50 + 0,7×Y S = – 50 + 0,3×Y
25. Equilibrium: two approaches First approach: AD = Y 450 + 0,7×Y = Y YE = 1500
26. Disequilibrium: shortage (insufficient production) STATUS Assume that Y = 1200 Then AD = 450 + 840
27. Disequilibrium: surplus (excess production) STATUS Assume that Y = 1800 Then AD = 450 + 1260
28. Beware of the misunderstanding! At the short-run disequilibrium: Splanned ≠ Iplanned Sactual = Iactual
29. Equilibrium: numerical example (dynamic analysis) Assume that: C = 50 + 0,7×Y I = 400 →
30. Investment multiplier Investment multiplier: a measure that informs how many times the change in the equilibrium
31. Investment multiplier and economic cycles Higher multiplier >>> more volatile GDP Lower multiplier >>> less volatile
32. Check point: true / false test The Keynesian model assumes that the production is basically determined
33. Check point: true / false test (cont.) The relation of consumption planned by households to their
34. Test your understanding: matching
35. Lecture objectives What is the essence of the Keynesian doctrine? How can economic crises be explained
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Lecture objectives
What is the essence of the Keynesian doctrine?
How can economic

crises be explained by the aggregate demand fluctuations?
What are the key factors determining consumption and investment?
What is the meaning of so called „multiplier” in the vulnerability of the economy to crises?

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John Maynard Keynes (1883-1946)
Model explaining causes of crises and suggesting methods

of counteracting them.
„The General Theory of Employment, Interest and Money”

georgiapolicitalreview.com

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The Keynesian perspective
Aggregate demand as the cause of crises
Government intervention as

the remedy for crises
Equilibrium with unemployment

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Model assumptions
Two factor analysis: the only types of economic subjects are

domestic households and firms (H and F)
Crisis circumstances: there are production factors that are not used (actual production is smaller than potential production)
Price stability: short-run approach (short enough to assume that prices don’t change)
One dimension: the subject of the analyses is the market for goods and services

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Circular flow in the model

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The essence of aggregate demand
Aggregate demand (AD): sum of expenditures for

various goods and services that are planned at various levels of current income (Y).
Consumption (C): expenditures for consumption goods planned by households.
Investment (I): expenditures for investment goods (including inventory) planned by firms.
AD = C + I

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Consumption component of AD
Two things concerning „C” must be noted:
it is

directly dependent on households’ income
it can be financed not only by current income but also by past or future income
The relationship between „C” and current income can be presented as marginal propensity to consume (MPC).
The part of „C” which is independent of current income is known as autonomous consumption (CA).

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$Marginal propensity to consume Marginal propensity to consume (MPC): the fraction$

Marginal propensity to consume
Marginal propensity to consume (MPC): the fraction of

the additional current income which households are going to spend on additional consumption.
MPC = ΔC/ΔY

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Autonomous consumption
Autonomous consumption (CA): the part of consumption that is not

financed by current income (consumption that does not depend on current income).
Yet, it can be covered by past income (i.e. saving) or future income (i.e. borrowing).

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Consumption function
Notice that MPC and CA are key variables in consumption

function formula:
1) MPC is responsible for the slope
2) CA is responsible for the intercept point (and the parallel shifts of the line).

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Technical note
Changes in nouseholds’ current income result in shifts along the

consumpion line.
Changes in the autonomous consumption result in parallel movements of the consumption line.
Changes in MPC result in the different angle of the consumption line.

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Saving
Saving means unconsumed income.
Y = C + S
C = MPC×Y +

CA
S = MPS×Y – CA
Marginal propensity to save (MPS): the fraction of the additional current income which households are going to save.

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Saving function
Notice that saving function is the mirror reflection of the

consumption function formula:
1) MPS is responsible for the slope
2) CA is responsible for the intercept point.

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Investment component of AD
Special status in the Keynesian doctrine
Outstanding variability
Independent of

the current state of the economy (including current income); in that sense they’re fully autonomous
Dependent on factors such as:
expectations concerning future terms of business
interest rates

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Investment function

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Aggregate demand: recollection
Aggregate demand: the sum of households’ and firms’ expenditures

(for consumption and investments, respectively) planned at various levels of current income.
AD = C + I

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Aggregate demand function

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45 degrees line
At any point on the 45° line the distance

to the horizontal axis is the same as the distance to the vertical axis.
The 45° line joins points at which AD (demand) equals Y (supply).

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Check point: the meaning of „Y”
So far the letter „Y” was

using to denote „income”.
From now on it will be used to denote not only „income” but also „production”.
How can we justify such decision?

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Keynesian cross
Plotting AD and 45 degrees lines on the same chart

allows you to study equilibium and disequilibrium terms in the market for goods and services.

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Equilibrium & equilibrium output
Equilibrium output (YE): the level of GDP at

which the aggregate demand for output equals the amount that is produced.
DEMAND = SUPPLY

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Short-run equilibrium in the market for goods and services

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Equilibrium: numerical example (static analysis)
C = 50 + 0,7×Y
S = –

50 + 0,3×Y
I = 400
AD = C + I = 450 + 0,7×Y

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Equilibrium: two approaches
First approach:
AD = Y
450 + 0,7×Y = Y
YE =

1500
Second approach:
S = – 50 + 0,3×1500 = 400 = I
S = I

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Disequilibrium: shortage (insufficient production)
STATUS
Assume that Y = 1200
Then AD = 450

+ 840 = 1290
AD>Y
S = – 50 + 360 = 310
S

ADAPTATION TO THE STATUS
Planned investment: 400
Unplanned investment: -90
Actual investment (planned + unplanned): 310

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Disequilibrium: surplus (excess production)
STATUS
Assume that Y = 1800
Then AD = 450

+ 1260 = 1710
ADS = – 50 + 540 = 490
S>I

ADAPTATION TO THE STATUS
Planned investment: 400
Unplanned investment: 90
Actual investment (planned + unplanned): 490

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Beware of the misunderstanding!
At the short-run disequilibrium:
Splanned ≠ Iplanned
Sactual = Iactual

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Equilibrium: numerical example (dynamic analysis)
Assume that:
C = 50 + 0,7×Y
I =

400 → I’ = 550 (ΔI = 150)
AD’ = 600 + 0,7×Y
YE’ = 2000
YE’ = 2.000
ΔYE/ΔI = 500/150 = 3,33

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Investment multiplier
Investment multiplier: a measure that informs how many times the

change in the equilibrium output (that is reaction to the change in investment) will be greater than the change in invesment.
M = ΔYE/ΔI = 1/(1 – MPC)

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Investment multiplier and economic cycles
Higher multiplier >>> more volatile GDP
Lower multiplier

>>> less volatile GDP

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Check point: true / false test
The Keynesian model assumes that the

production is basically determined by the demand.
Sum of marginal propensity to consume and marginal propensity to save equals 1.
Planned saving is always the same as planned investment.
The slope of the consumption function depends solely on the autonomous consumption.
Consumption is zero when the income at households’ disposal is also zero

Слайд 33

Check point: true / false test (cont.)
The relation of consumption planned

by households to their income at disposal is named marginal propensity to consume.
The higher marginal propensity to consume, the more steep aggregate demand line.
Investment is inversely dependent on the interest rate.
Change in investment always causes shifts of AD line down.
Investment multiplier equals 1/marginal propensity to save

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Test your understanding: matching

Слайд 35

Lecture objectives
What is the essence of the Keynesian doctrine?
How can economic

crises be explained by the aggregate demand declines?
What are the key factors determining consumption and investment?
What is the meaning of so called „multiplier” in the vulnerability of the economy to crises?

Economy in the short-run: two factor income-expenditure model

Содержание

Lecture objectivesWhat is the essence of the Keynesian doctrine?How can economic

John Maynard Keynes (1883-1946)Model explaining causes of crises and suggesting methods

The Keynesian perspectiveAggregate demand as the cause of crisesGovernment intervention as

Model assumptionsTwo factor analysis: the only types of economic subjects are

Circular flow in the model

The essence of aggregate demandAggregate demand (AD): sum of expenditures for

Consumption component of ADTwo things concerning „C” must be noted:it is

Marginal propensity to consumeMarginal propensity to consume (MPC): the fraction of

Autonomous consumptionAutonomous consumption (CA): the part of consumption that is not

Consumption functionNotice that MPC and CA are key variables in consumption

Technical noteChanges in nouseholds’ current income result in shifts along the

SavingSaving means unconsumed income.Y = C + SC = MPC×Y +

Saving functionNotice that saving function is the mirror reflection of the

Investment component of ADSpecial status in the Keynesian doctrineOutstanding variabilityIndependent of

Investment function

Aggregate demand: recollectionAggregate demand: the sum of households’ and firms’ expenditures

Aggregate demand function

45 degrees lineAt any point on the 45° line the distance

Check point: the meaning of „Y”So far the letter „Y” was

Keynesian crossPlotting AD and 45 degrees lines on the same chart

Equilibrium & equilibrium outputEquilibrium output (YE): the level of GDP at

Short-run equilibrium in the market for goods and services

Equilibrium: numerical example (static analysis)C = 50 + 0,7×YS = –

Equilibrium: two approachesFirst approach:AD = Y450 + 0,7×Y = YYE =

Disequilibrium: shortage (insufficient production)STATUSAssume that Y = 1200Then AD = 450

Disequilibrium: surplus (excess production)STATUSAssume that Y = 1800Then AD = 450

Beware of the misunderstanding!At the short-run disequilibrium:Splanned ≠ IplannedSactual = Iactual

Equilibrium: numerical example (dynamic analysis)Assume that:C = 50 + 0,7×YI =

Investment multiplierInvestment multiplier: a measure that informs how many times the

Investment multiplier and economic cyclesHigher multiplier >>> more volatile GDPLower multiplier

Check point: true / false testThe Keynesian model assumes that the

Check point: true / false test (cont.)The relation of consumption planned

Test your understanding: matching

Lecture objectivesWhat is the essence of the Keynesian doctrine?How can economic

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Lecture objectives
What is the essence of the Keynesian doctrine?
How can economic

John Maynard Keynes (1883-1946)
Model explaining causes of crises and suggesting methods

The Keynesian perspective
Aggregate demand as the cause of crises
Government intervention as

Model assumptions
Two factor analysis: the only types of economic subjects are

The essence of aggregate demand
Aggregate demand (AD): sum of expenditures for

Consumption component of AD
Two things concerning „C” must be noted:
it is

Marginal propensity to consume
Marginal propensity to consume (MPC): the fraction of

Autonomous consumption
Autonomous consumption (CA): the part of consumption that is not

Consumption function
Notice that MPC and CA are key variables in consumption

Technical note
Changes in nouseholds’ current income result in shifts along the

Saving
Saving means unconsumed income.
Y = C + S
C = MPC×Y +

Saving function
Notice that saving function is the mirror reflection of the

Investment component of AD
Special status in the Keynesian doctrine
Outstanding variability
Independent of

Aggregate demand: recollection
Aggregate demand: the sum of households’ and firms’ expenditures

45 degrees line
At any point on the 45° line the distance

Check point: the meaning of „Y”
So far the letter „Y” was

Keynesian cross
Plotting AD and 45 degrees lines on the same chart

Equilibrium & equilibrium output
Equilibrium output (YE): the level of GDP at

Equilibrium: numerical example (static analysis)
C = 50 + 0,7×Y
S = –

Equilibrium: two approaches
First approach:
AD = Y
450 + 0,7×Y = Y
YE =

Disequilibrium: shortage (insufficient production)
STATUS
Assume that Y = 1200
Then AD = 450

Disequilibrium: surplus (excess production)
STATUS
Assume that Y = 1800
Then AD = 450

Beware of the misunderstanding!
At the short-run disequilibrium:
Splanned ≠ Iplanned
Sactual = Iactual

Equilibrium: numerical example (dynamic analysis)
Assume that:
C = 50 + 0,7×Y
I =

Investment multiplier
Investment multiplier: a measure that informs how many times the

Investment multiplier and economic cycles
Higher multiplier >>> more volatile GDP
Lower multiplier

Check point: true / false test
The Keynesian model assumes that the

Check point: true / false test (cont.)
The relation of consumption planned

Lecture objectives
What is the essence of the Keynesian doctrine?
How can economic