W3P1 - NotebookLM Flashcards
What is the ISLM model?
A Keynesian model that combines the goods market (Keynesian cross model) with the money market. It is used to analyse short-term fluctuations in the economy.
What is the Keynesian Cross model?
A demand-side model that focuses on the goods market, ignoring the money market. It examines the equilibrium condition where aggregate expenditure (demand) equals production (supply).
What are the components of aggregate expenditure (AE) in the Keynesian Cross model?
Personal consumption (C), investment (I), and government spending (G). The equilibrium condition is Y = C + I + G, where Y represents the supply of goods.
What assumptions are made in the Keynesian Cross model?
o Prices are fixed, and inflation is zero.
o Firms react to demand by adjusting production.
o Interest rates, taxes, and government spending are exogenous variables.
Describe the consumption function in the model.
C = C0 + C1 * (Y - T), where:
o C0 is autonomous consumption.
o C1 is the marginal propensity to consume (MPC).
o Y is income, and T is taxes.
How do firms adjust to imbalances between aggregate expenditure and output?
o If AE > Y, inventories decrease, and firms increase production.
o If Y > AE, inventories increase, and firms decrease production.
o Equilibrium is reached when Y = AE.
Explain the effect of an increase in government spending (G) in the Keynesian Cross model.
An increase in G shifts the aggregate expenditure schedule upwards, leading to a new equilibrium with higher output (Y). The increase in output is larger than the increase in government spending due to the multiplier effect.
What is the government spending multiplier?
The ratio of the change in output (ΔY) to the change in government spending (ΔG), which is greater than one in the Keynesian Cross model. Formula: 1 / (1 - MPC).
Explain the multiplier effect.
An initial increase in government spending leads to an increase in income (Y), which in turn increases consumption (C). This increase in consumption further increases income, leading to multiple rounds of increased spending and income.
What is the tax multiplier?
The ratio of the change in output (ΔY) to the change in taxes (ΔT). Formula: -MPC / (1 - MPC). It is negative, indicating that an increase in taxes leads to a decrease in output.
What is the balanced budget multiplier?
If government spending and taxes are increased by the same amount, the net effect on output is equal to the increase in government spending. This is a controversial feature of the model that relies on specific assumptions.
