Chapter 6: A simple Keynesian model of the economy

Question 1

What is the multiplier?

Answer 1

Examining the relationship of the 3 central flows.

• Total production (output)
• Total income
• Total spending
• Consumption spending (households)
• Investment spending (firms)

Determine equilibrium level of output.

This process is called the multiplier.

Question 2

What is the Keynesian model?

Answer 2

Explain the function of the economy, predict what might happen and analyse policy.

Keynes simply put is the idea that total output and income is determined by total spending.

Question 3

What do the following symbols stand for?

Y

A

C

I

Answer 3

Y = total production, output or income. (GDP, GNI)

A = aggregate or total spending

C = Consumption spending

I = Investment spending

Question 4

What are the 4 types of consumption spending?

Answer 4

• Durable (household furniture, appliances, etc - more erratic)
• Semi durable (car parts, clothing, etc - more erratic)
• Non-durable (most stable: food and beverages, pharmaceuticals, tobacco, fuel, etc)
• Services

Question 5

What is the consumption function?

Answer 5

• Consumption increases as income increases
• Consumption isn’t zero even when income is zero
• Consumption increases by less than what income increases (savings etc)

Question 6

Differentiate autonomous consumption and induced consumption?

Answer 6

Autonomous consumption is consumption that is independent of income. (funded by credit / savings) (y-intercept)

Induced consumption is determined by the level of income. (slope)

Question 7

The ratio of a change in C to the change in Y is called…

Answer 7

Marginal propensity to consumer (c)

Question 8

What is the function C?

Answer 8

C = C-hat + cY

Consumption = autonomous spending + mpc x disposable income

Question 9

MPC / marginal propensity to consume =

Answer 9

Derivative of C / Y

Question 10

What are non-income determinants?

Answer 10

Interest rates: More expensive to get durable goods on credit and higher incentive to save more for good growth

Expectations: Expectations on inflation impact consumer behaviour

Wealth: As asset values increase rich people spend more

Income distribution: Lower income households spend bigger portion of income - distributing money to lower income households increases consumption

Other factors: Level of tax, age distribution, etc

Question 11

Y = ? + ?

Answer 11

C + S

Consumption + spending

Question 12

How is autonomous saving related to consumption?

Answer 12

Autonomous saving = - autonomous consumption

Question 13

What is 1 - C?

Answer 13

Marginal propensity to save

Question 14

What is the saving function?

Answer 14

S = S (hat) + sY

Saving = autonomous saving + mps x Income

Question 15

What determines investment spending and how is it related to spending and income?

Answer 15

Determined by cost of capital goods and expected revenue.

Interest rate is important because firms often borrow to invest.

Not related to spending

Autonomous with respect to income

Question 16

What is A and where is its equilibrium?

Answer 16

Aggregate demand / total spending

Equilibrium when A = Y

Question 17

What makes up aggregate demand?

Answer 17

C + I

Question 18

What is the 45 degree line?

Answer 18

A line through the origin that shows all possible equilibrium points.

Above = excess demand

Below = excess supply

Question 19

The multiplier is what ratio?

Answer 19

The ratio between the initial investment and the eventual change.

Question 20

What is the multiplier symbol and formula?

Answer 20

K

K = 1 / 1 - mpc

Question 21

Equilibrium = ?

Answer 21

Alpha (multiplier) * autonomous spending