Chp27 - The Keynesian Model

Question 1

What is the Keynesian Model

Answer 1

• explains fluctuations in aggregate demand at a fixed price level by identifying the forces that determine expenditure plans
• Because each firm’s prices are fixed, for the economy as a whole
  
  • The price level is fixed
  • Aggregate demand determines real GDP

Question 2

Aggregate Expenditure

Answer 2

• Made up of:
  
  • Consumption Expenditure
  • Investment
  • Government Expenditure on Goods and Services
  • Net Exports

Question 3

Aggregate Planned Expenditure

Answer 3

• equal to the sum of the planned levels of consumption expenditure, investment, government expenditure, and net exports

Question 4

Two-Way Link between Aggregate Expenditure and Real GDP

Answer 4

• An increase in real GDP increases aggregate expenditure

- An increase in aggregate expenditure increases real GDP

Question 5

Factors influencing Consumption Expenditure and Saving Plans

Answer 5

• Disposable Income
• Real Interest Rate
• Wealth
• Expected Future Income

Question 6

Disposable Income

Answer 6

• aggregate income minus taxes plus transfer payments

- Aggregate income equals real GDP so disposable income depends on real GDP

Question 7

Relationship between Consumption Expenditure and Saving

Answer 7

• Households can only spend or save their disposable income; therefore, planned consumption expenditure plus planned saving always equals disposable income

Question 8

Consumption Function

Answer 8

• the relationship between consumption expenditure and disposable income
• Autonomous Consumption: the short-run consumption if people had no income
• Induced Consumption: increased consumption as a result of an increase in disposable income

Question 9

Saving Function

Answer 9

• the relationship between saving and disposable income

- as disposable income increases, saving increases

Question 10

Marginal Propensity to Consume (MPC)

Answer 10

• the fraction of a change in disposable income that is spent on consumption

Formula: change in CE/change in DI

• MPC and MPS will always sum to equal 1

Question 11

Marginal Propensity to Save (MPS)

Answer 11

• the fraction of a change in disposable income that is saved

Formula: change in S/change in DI

• MPC and MPS will always sum to equal 1

Question 12

Slopes and Marginal Propensities (MPC/MPS)

Answer 12

• the slope of the consumption function is the marginal propensity to consume (MPC)
• the slope of the saving function is the marginal propensity to save (MPS)
• ‘Rise over Run’

Question 13

Marginal Propensity to Import

Answer 13

Formula: change in I/change in realGDP

Question 14

The AE Curve

Answer 14

• A graph of the aggregate planned expenditure plotted against real GDP

Question 15

Equilibrium Expenditure

Answer 15

• the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP
• when aggregate planned expenditure and actual aggregate expenditure are unequal, a process of convergence towards equilibrium expenditure

Question 16

Convergence to Equilibrium

Answer 16

Below Equilibrium
- When planned expenditure exceeds real GDP, inventories decrease and production increases

Above Equilibrium
- When planned expenditure is below real GDP, inventories increase and production decreases

Question 17

Multiplier

Answer 17

• amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP
• the magnitude of the increase in aggregate expenditure that results from an increase in autonomous expenditure is determined by the multiplier

Formula: change in EE/change in AE
Formula: 1/MPS