Module 2: AD and the Keynesian Model

Question 1

What does Keynesian model say?

Answer 1

AS/national income adjusts to find equilibrium with AD

Question 2

What does Keynes says it affects consumption demand?

Answer 2

level of income/disposable income

Question 3

MPC definition and formula?

Answer 3

Marginal Propensity to Consume
=difference consumption / diff. disposable income

Question 4

when is inventory included in keynes model?

Answer 4

when is wanted (building up) never when is due to lower sales

Question 5

3 reactions from firms when AD>output?

Answer 5

-quantity adjusters (+output, + hours, etc)
-price adjusters (prices up, demand down) they already at full capacity
-combination

Question 6

3 reactions from firms when AD<output?

Answer 6

-quantity adjusters (layoffs, cutoff hours, etc)
-price adjusters (more common since it tackles inventory and idle workers)
-combination

Question 7

what is the multiplier formula?

Answer 7

change in level of income / change on gov’t spending

Question 8

what is the multiplier (income multiplier with respect to gov’t spending) effect?

Answer 8

it is the effect it has $1 of gov’t spent money on national income

Question 9

other multipliers are ___

Answer 9

-income multiplier with respect to money supply
-employment multiplier with respect to tax rate

Question 10

is better a big o smaller multiplier?

Answer 10

-any mistake is magnified by the multiplier effect
-creates instability since AD affects economic activity

Question 11

what are the automatic stabilizers?

Answer 11

gov’t policies that reduce the multiplier without legislative action (ex.transfer payment, income taxes…)

Question 12

what is a less obvious stabilizer?

Answer 12

interest rates. Demand for money has to be met or it affects C, I, G, X

Question 13

what is crowding out?

Answer 13

the influence of the gov’t on AD when choosing how to finance themselves (it can even offset initial fiscal action)

Question 14

which ways has the gov’t to finance themselves?

Answer 14

-raising taxes (offsets partially the gov’t spending action)
-selling bonds to the public (either raise interest rates to crowd out all other spending or smoothing consumption when people save more)
-printing money (multiplier up instead of crowding out)

Question 15

what are inventories used for?

Answer 15

-desired invent. changes are big part of AD, so it affects business cycles
-used especially in the media to forecast direction (low precedes boom, high precedes recession)

Question 16

how can the gov’t incur in budget deficit and why?

Answer 16

expansionary fiscal policies (G spending or less taxes) to maintain economy at full employment

Question 17

spending or taxes?

Answer 17

spending gives the gov’t control over production and distribution (democrats) while taxes doesn’t (republicans)

Question 18

what is the full-employment budget?

Answer 18

a measure (tax revenues as if the economy were fully employed) to help politicians be at ease with deficit so they don’t take contractionary policies that make it worse when in recession

Question 19

when does budget deficit happens?

Answer 19

when G spending is > taxes

Question 20

how to calculate deficit?

Answer 20

G spending x multiplier - taxes

Question 21

Discussion between classical school and keynesians that still lasts?

Answer 21

classic school believed wages&prices to be flexible, keynes did not (intervention)

Question 22

what is the circular flow diagram? what does it do?

Answer 22

it is keynes analysis of AD. It shows increase/decrease in equilibrium output due to changes AE/AD

Question 23

how to finance gov’t deficit?

Answer 23

selling bonds to public, central bank or foreigners

Question 24

What do AS and AD curves tell us? Keynesian cross and AS curve model

Answer 24

where the equilibrium price-income (45°) and the price-labor market (AS) are