Module 2: AD and the Keynesian Model Flashcards
What does Keynesian model say?
AS/national income adjusts to find equilibrium with AD
What does Keynes says it affects consumption demand?
level of income/disposable income
MPC definition and formula?
Marginal Propensity to Consume
=difference consumption / diff. disposable income
when is inventory included in keynes model?
when is wanted (building up) never when is due to lower sales
3 reactions from firms when AD>output?
-quantity adjusters (+output, + hours, etc)
-price adjusters (prices up, demand down) they already at full capacity
-combination
3 reactions from firms when AD<output?
-quantity adjusters (layoffs, cutoff hours, etc)
-price adjusters (more common since it tackles inventory and idle workers)
-combination
what is the multiplier formula?
change in level of income / change on gov’t spending
what is the multiplier (income multiplier with respect to gov’t spending) effect?
it is the effect it has $1 of gov’t spent money on national income
other multipliers are ___
-income multiplier with respect to money supply
-employment multiplier with respect to tax rate
is better a big o smaller multiplier?
-any mistake is magnified by the multiplier effect
-creates instability since AD affects economic activity
what are the automatic stabilizers?
gov’t policies that reduce the multiplier without legislative action (ex.transfer payment, income taxes…)
what is a less obvious stabilizer?
interest rates. Demand for money has to be met or it affects C, I, G, X
what is crowding out?
the influence of the gov’t on AD when choosing how to finance themselves (it can even offset initial fiscal action)
which ways has the gov’t to finance themselves?
-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)
what are inventories used for?
-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)
how can the gov’t incur in budget deficit and why?
expansionary fiscal policies (G spending or less taxes) to maintain economy at full employment
spending or taxes?
spending gives the gov’t control over production and distribution (democrats) while taxes doesn’t (republicans)
what is the full-employment budget?
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
when does budget deficit happens?
when G spending is > taxes
how to calculate deficit?
G spending x multiplier - taxes
Discussion between classical school and keynesians that still lasts?
classic school believed wages&prices to be flexible, keynes did not (intervention)
what is the circular flow diagram? what does it do?
it is keynes analysis of AD. It shows increase/decrease in equilibrium output due to changes AE/AD
how to finance gov’t deficit?
selling bonds to public, central bank or foreigners
What do AS and AD curves tell us? Keynesian cross and AS curve model
where the equilibrium price-income (45°) and the price-labor market (AS) are