Keynesian Macroeconomics

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					Keynesian Macroeconomics
       Classical economists
• Focused on analysis of economic
  efficiency and total production
• Looked at aggregate supply, paying little
  attention to aggregate demand
• Flexible prices and wages would enact
  self-correction toward full employment
                Say’s Law
• Supply creates its own demand
• Demand will be sufficient to purchase goods
  produced since income payments to resource
  suppliers will equal value of goods produced
• Purchasing power necessary to buy products is
  generated by production
• “Products are paid for with products”
   Self correcting mechanism
• Business instability- market prices and
  wages decline in recession quickly enough
  to return to full employment
• Pricing system corrects for imbalances
• Production of goods generates demand
  sufficient to purchase goods produced
• If unemployment high, wages fall, reduced
  costs, lower prices until excess supply of
  labor eliminated
Viable before Great Depression
      John Maynard Keynes
• Revolutionized economic thinking
• Spending induced firms to supply goods
  and services
• Argued that wages and prices were highly
• Rejected classical view that wages and
  prices reduction would eliminate
         Keynesian equilibrium
• Total spending=current output
• Changes in output (due to increases/decreases in
  expenditures), rather than changes in prices, direct
  economy toward equilibrium
• If total spending is less than full employment output, then
  output is cut back
• When total spending deficient, equilibrium output is less
  than full employment output and unemployment results
• Businesses produce only quantity of goods and services
  they believe consumers, investors, governments, and
  foreigners plan to buy
       Keynes key concept
Planned aggregate expenditures
C + I + G + (X-M)
Current income is primary determinant of
  consumption expenditure
Increases in income lead to increases in
  consumption (but not by as much)
         Consumption function
• Positive relationship between consumption spending and
  disposable income
• At lower levels of aggregate income, consumption
  exceeds disposable income
• As income increases, aggregate income eventually
  exceeds consumption (encourages saving)
• Independent of income
• Expenditures on fixed assets and changes
  in inventories of raw materials and final
  products not yet sold
• Function of current sales relative to plant
  capacity, expected future sales, interest
• Independent of income
• Policy variable determined by political
• Often spend more money than is received
  in taxes
• All levels of government
                Net exports
• Dependent on income levels abroad and
  international spending choices
• Level of imports increases as income rises
• Net exports declines as income expands
       Keynesian equilibrium
• Planned aggregate expenditures
  C+I+G+(X-M)=value of current output
• Businesses able to sell total amount of
  goods and services they produce with no
  unexpected changes in inventories
• No incentive to expand or contract output
If expenditures exceed output…
• Inventories decline
• Firms expand output
   If output greater than planned
• Unwanted inventories accumulate
• Firms reduce production
Keynes’ equilibrium need not take place
 at full employment!!

Recessions can last.
Unemployment may remain high.
This is due to insufficient spending.
       Restoring equilibrium
• Changes in output and employment, not
  prices changes, restore equilibrium
• Wage and price reductions ruled out as
  mechanism to direct economy toward full
  employment capacity
         Additional spending
• Shifts AE (aggregate expenditure) curve
• Want total spending=output at level of full
• Beyond certain point, increase in AE
  results only in higher price level
            Changes in AE
• Lead to changes in real output and
• Regulation of AE is basis of sound
  macroeconomic policy
• Assure large enough AE to achieve
  capacity output, but not so large as to
  result in inflation

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