Unit 5 - Keynesian Macroeconomics Flashcards
What is Keynesian Economics?
Introduced by John Maynard Keynes, it challenges classical economics, which assumes the economy is self-regulating.
Keynes argued that insufficient demand can lead to extend economic downturns.
Keynes vs. Classical Economics
Classical economics relies on Say’s Law: “Supply creates its own demand.”
Keynesian economics opposes this, stating that demand drives economic activity, and markets are not always self-correcting.
Consumption Function
Describes how households allocate disposable income (income after taxes).
Consumption: The portion spent on goods and services.
Marginal Propensity to Consume (MPC)
The fraction of additional income spent on consumption.
Example: If MPC = 0.8, 80% of extra income is spent.
Saving Function:
Explains how households allocate income to saving.
Marginal Propensity to Save (MPS)
The fraction of additional income saved.
MPC + MPS = 1:
Households either spend or save their disposable income.
Sticky Prices and Wages
Unlike classical views, Keynes argued that prices and wages don’t adjust quickly, leading to unemployment and underutilized resources.
Role of Government
Keynesian economics emphasizes government intervention (e.g., increased spending) to boost demand during recessions.
Consumer Behavior
Understanding MPC helps policymakers stimulate growth by encouraging spending.
Saving Trends
Higher savings (reflected by MPS) can slow demand but support long-term investment.
Economic Cycles
Consumer confidence about the future influences spending and saving, impacting economic stability.
Data-Driven Models
Consumption and saving functions are derived from data, helping forecast economic behavior and guide policies.
Multiplier Effect
A small increase in autonomous spending (e.g., consumption, investment, or government spending) triggers a chain reaction of increased income and spending, leading to a much larger increase in total economic output.
What is the Multiplier effect formula?
Example:
If government spending increases by $10 billion and the MPC (Marginal Propensity to Consume) is 0.8, the multiplier is 5.
Total increase in GDP: $10 billion × 5 = $50 billion.
Autonomous Spending
Independent changes in spending (C, I, G) shift the Total Expenditure (TE) and Aggregate Demand (AD) curves.
Aggregate Demand-Aggregate Supply (AD-AS) Framework:
AD Curve: Represents total demand in the economy.
Keynesian AS Curve:
Horizontal section: Price stability, increased demand raises output without inflation.
Vertical section: Economy at full employment; additional demand leads to inflation.
Recessionary Gaps:
When the economy operates below its Natural Real GDP, creating unemployment and underutilized resources.
Requires government intervention to shift the AD curve rightward.
Government’s Role in the Economy:
During recessions, increased government spending can stimulate demand and support recovery.
Importance of Autonomous Spending
Changes in spending (C, I, G) directly influence total output.
Investment or government cuts reduce GDP; spending increases stimulate growth.
AD-AS Dynamics
Horizontal AS curve: Encourages expansion without inflation.
Vertical AS curve: Indicates limits at full employment, requiring careful policy adjustments.
Recessionary Gaps
Highlight the need for active fiscal measures to stimulate the economy and restore full employment.
TE Curve and Fiscal Policy
TE reflects AD. Increases in consumption or investment shift TE upward, boosting output.
Total Expenditure Equation (TE)
TE = C + I + G
C: Consumption (based on disposable income).
I: Investment by businesses.
G: Government spending.
