Keynesian Economics

Question 1

Key Assumption of Keynesian Economics

Answer 1

Prices and wages do not fully adjust in the short run (sticky prices – prices do not fluctuate wildly over short time periods)

Question 2

Planned Aggregate Expenditure

Answer 2

PAE = C + I + G

Question 3

Planned Consumption

Answer 3

C = C̅ + c(Y – T)

c is marginal propensity to consume (responsiveness of consumption to changes in disposable income)

C̅ is autonomous consumption (not dependent on much disposable income exists)

Question 4

Short Run Equilibrium of Output

Answer 4

When PAE = AE

Question 5

PAE < AE

Answer 5

Surprisingly low demand → inventory accumulation

Question 6

PAE > AE

Answer 6

Surprisingly high demand → inventory drawn down

Question 7

Government Spending Multiplier

Answer 7

dy/dG̅ = 1/(1– c) if tax is exogenous (T̅)

o An increase to G̅ will increase Y by more than one-for-one → therefore multiplier effect
o Increase G → increase Y directly and through consumption because Y is included in consumption equation

Question 8

Paradox of Thrift

Answer 8

o More savings → less demand → less output
o If output is demand determined, being thrifty is harmful to the economy overall

Question 9

Long Run Benefits of Savings

Answer 9

Savings funds investment → increases productive capacity

Question 10

Equilibrium in Savings/Investment

Answer 10

Equilibrium output is when planned investment and planned savings are the same

Question 11

Change in G̅ on Y

Answer 11

1+c/(1 - c )

Question 12

Change in T̅ on Y

Answer 12

-c/(1 - c )

Question 13

Investment in Closed Economy

On Formula Sheet

Answer 13

I = S + (T – G)

Question 14

Investment in Open Economy

Answer 14

I = S + (T – G) + (X – M)

Question 15

Planned Private Savings

Answer 15

S = (Y − T ) − C = (1 − c)(Y − T ) − C̅

1 – c is propensity to save

Question 16

Multiplier with Tax

Answer 16

1/(1–c) + cT