2. Overview
Keynesian Income Determination Models
Private sector
Consumption demand
Investment Demand
Supply & demand for money
Public Sector
Government expenditure
Government taxes
Monetary policy manipulation of money supply
International
imports, exports, net exports
3. Private Sector
Simple model
Consumption & Aggregate Demand
Savings & Investment
Consumption is consumption of "household"
Savings
in C&F, savings = savings of consumers out of unspent
income
but most savings = retained business profits
Investment: by business thru profits & borrowed $
4. Consumption function = C = f(Y)
[=c(y)in C&F]
where Y = income
and dC/dY > 0, i.e., C rises as Y rises
Consumption
Household income
C = f(Y)
5. Consumption function = C = f(Y)
[=c(y)in C&F]
where Y = income
and dC/dY > 0, i.e., C rises as Y rises
Consumption
Household income
C = f(Y)
?
6. Linear Version
We will only deal with linear versions of the
consumption function because it makes things
simpler C = a + bY
Consumption
Aggregate Income = Y
C
Y
dC/dY = b
7. Manipulate
Suppose the marginal propensity to consume rises. What
happens to the function? Under what circumstances would
"a" rise? Or fall?
C = a + bY
Consumption
Aggregate Income = Y
C
Y
dC/dY = b
8. Change in MPC
Rise in MPC, b' > b would steepen curve
C = a + b' Y
Consumption
Aggregate Income = Y
dC/dY = b
C = a + bY
9. Change in "a"
Under what circumstances would "a" rise? Or fall? Rise:
a' > a, fall: a' < a
C = a' + bY
Consumption
Aggregate Income = Y
C = a + bY
10. Savings Function - derivation
Savings function = flip side of consumption
function, what you don't spend you save
C = a +bY
Y = C + S
Y = a + bY + S
Y - a - bY = S
-a + (1 - b)Y = S
S = -a + (1-b)Y
11. 45o Line
To facilitate derivation, and future work
12. Savings Function - derivation
graphical
C = a + bY
S = -a + (1-b)Y
Consumption
Savings
a
-a
13. Investment - I
Investment = "real" investment, i.e., the
expenditure of money to buy and employ labor
and raw materials and machines to produce
commodities, i.e., M - C(MP,L) ... P... C'
Buying, employing and accumulating "capital
stock"
machines (MP)
inventories of raw materials (MP)
inventories of produced goods (C')
14. Investment - II
"Planned" investment
Planned purchases of inputs & inventory accumulation
"Actual" investment
Actual purchase & accumulation
Actual can be different than Planned I
difference is usually unexpected changes in inventories
if actual > planned, firms have excess inventory
if actual < planned, firms have less inventory
15. Investment - III
We can make various assumptions about
determinants of Investment
I = f(), investment a function of profits,dI/dp >0
I = f(Y), investment a function of level of economic
activity,dI/dY >0
I = f(Yt - Yt-1), investment a function of growth
I = I, investment assumed fixed for short run
This last is C&F assumption, easiest to start with
16. Fixed Investment
To assume I is fixed, or given, at all levels of Y
means we have an investment function like this:
I = I
I
Y
17. "Equilibrium Level of Y"
"Equilibrium" means same as with supply &
demand
any move away will set forces in motion that will return
you to equilibrium
Given expenditures C and I, the equilibrium level
of Y will = C + , or total aggregate demand.
Given investment I and savings S, the equilibrium
level of Y will be given by S = I
18. Y C + I
Equilibrium when planned expenditures = actual
expenditures, no unexpected accumulation or dis-
accumulation of inventories.
I = I
C = a + bY
C+I = a + bY + I
Y
C, I
Y
19. Y C + I
Suppose output greater than expected (A) or less than
expected (B).
C+I = a + bY + I
Y
C, I
A
B
excess
inventories
Unplanned
fall in
inventories
Y
20. S I
Equilibrium also requires that
planned I = planned S
I = I
S = -a + bY
Ye
21. S I ?
If planned I planned S, then the same
mechanism of firms responding to unexpected
changes in inventory will return Y to Ye
I = I
S = -a + (1-b)Y
Ye
S, I
Y
excess
inventory
Unplanned
fall in
inventories
22. I = f + gY
Let I = f(Y) and let f(Y) be linear,
e.g., I = f + gY
where f > 0, g > 0
I = f + gY
S = -a +(1-b)Y
Y
S, I
23. Algebraic Solutions
Y = C + I
where C = a + bY
where I = I, or I = f + gY
Solve for equilibrium Y
S = I
where S = -a + (1-b)Y
where I = I, or I = f + gY
Solve for equilibrium Y
24. Problems
Most of problems in C&F ask you to solve for
equilibrium Y given values of variables
You can also experiment to see what will happen
when various kinds of events occur in the private
sector
e.g., business goes on strike, cuts back on I
e.g., a burst of optimism (or demoralization) raises (or
lowers) b or a such that the consumption function shifts
Take real numbers and calculate parameters
25. Multiplier - I
Contemplation of the previous phenomena, using
these tools, especially with numerical examples
will lead you to notice that changes in a or I will
produce larger changes in Y, the effects will be
"multiplied"
27. No! Multiplier - II
Assume I increases, clearly
S
I
I'
>
but, by how much?
28. Multiplier - III
Y = C + I
C = a + bY
I = I
Y = a + bY + I, so now substract bY from ea. side
Y - bY = a + I, regrouping
(1 - b)Y = a + I, divide both sides by (1-b)
Y = a/(1-b) + I/(1-b), take derivative
dY/dI = 1/(1-b), so if b = .75, then dY/dI = 4
29. Multiplier - IV
S = I
S = -a + (1-b)Y
I = I
You solve for dY/dI
You solve for dY/da
30. Why?
Keynes developed this conceptual approach to
looking at the whole economy because he didn't
like the kinds of results generated by the private
sector and wanted tools that could help figure out
how to intervene
For example, in Great Depression, faced with
stock market crash and industrial unions, business
cut way back on investment, results could be
analyzed with these tools.
32. So What to Do?
Partly answer will come from widening analysis to
include government
Partly answer will come from widening analysis to
include financial sector
Both will provide tools to help government decide
how to intervene to restore the earlier (and higher)
levels of national output
