1. Presentation by: Bhagyashree Chauhan
Topic: Simple Keynesian Model
Ma 2nd year Economics
Macroeconomics

2. Simple keynesian model of
income determination

3. OUTLINE
• Aggregate expenditure:
Ø Consumption function
Ø Investment function
• Aggregate output
Ø Short run supply curve
• Equilibrium income

4. Introduction
• Keynesian economics was developed during the Great
Depression (1930s).
• Keynesian theory provided an explanation for the
severe and prolonged unemployment of the 1930s.
• Keynes argued that wages and prices were highly
inflexible, particularly in a downward direction.
Thus, he did not think changes in prices and interest
rates would direct the economy back to full
employment.
• National income means the total money value of goods
and services produced in an economy in a year

5. Views:
• Keynesian View of spending and output:
• Keynes argued that spending induced business firms to
supply goods & services.
• Hence, if total spending fell, then firms would respond
by cutting back production. Less spending would lead
to less output.
• J.M.keynes in his book general thoery has used
two methods for the determination of national
income at a particular time
• Saving investment method
• Aggregate demand & aggregate supply method.
•

6. Keynesian model
In the keynesian theory , there are two
approaches to the determination of income
and output: aggregate demand-Aggregate
supply Approach and saving-investment
Approach.
§ Key Assumption:
1.Prices are constant,at given price level firms
are willing to sell any amount of the output at
that price level.

7. 2.Investment is assumed to be autonomous and thus
independent of the income level.
3.There exist only two sectors in the economy,the
households and the firms.Aggregate demand is the
total amount of goods demanded in an economy.the
aggregatedemand function can be expressed as:
AD=C+I
where,C=Aggregate demand for consumer goods
I=aggregate demand for investment goods.
4.Short run aggregate supply curve is perfectly elastic
or flat

8. Aggregate demand
• Aggregate demand is the total amount of goods demanded
in an economy. So,
aggregate demand =consumption demand+investment
AD=C+I
• CONSUMPTION DEMAND:
Consumption function is a relationship between income and
consumption expenditure.The most common form of short run
consumption function is C=a+by,
Were, a is the intercept term of the function and represents
autonomous consumption whereas b represents the slope of
consumption function.In keynes theory current consumption
expenditure depends primarily on current income and it varies
directly with disposable income.keynes had stated in his
‘fundamental psychological law’ that, in general an individual
increase his consumption expenditure when his income
increases.So, the increase in consumption is less than the
increase in income

9. • Consumption function

10. • Explaination
In above figure 1. ]national income is measured along the X-axis
and consumption demand [C] is shown on the Y-axis.in ths fig,a
straight line OZ with 45degree angle with the X-axis represents
the references income line to measure the difference between
consumption and level of the income.This is also often called
income line.this 45 degree line represents national income in
money terms.In fact,national product and income are the same
thing.In this fig a curve C has also been drawn which represents
consumption function,C=a+by of the community which slopes
upward from left to right,which shows that as income increase
the amount of consumption demand also increases.as income line
oz makes 45 degree angle with x-axis, the gap between the
consumption function curve c and the income line oz represents
the saving of the community .So y=C+S.

11. Investment demand

12. explaination:
• The other component of the aggregate demand is investment
which is crucial factor in the determination of equilibrium
level of national income .investment demand depends
upon two factors;1.marginal efficiency of capital and 2.rate
of interest. The marginal efficiency of capital means the
expeted rate of profit which the business community
hopes to get from the investment in capital assets. In
keynes theory investment being determined by marginal
efficiency of capital and rate of interest does not depend
on the level of income. As it is shown in fig.2.

13. In actual practice, when the level of
income rises,the demand for goods will
also rises and this will favourably affect the
expectations of the entrepreneurs
regarding making of profits.Rise in profit
ecpectations will raise the marginal
eeficiency of capital which in turn will
increase the level of investment .But
investment demand does not directly
depend upon income;it is only affected
indirectly by changes in income.

14. In fig.3 we have taken a given amount of investment
demand independent of the level of income and added
it to upward sloping consumption function curve to get
aggregate expenditure curve C+I

15. The distance between the c curve and
the C+I curve is parallel to the c curve
throughout which indicates that the
level of investment is constant and
does not change with the change in
income it may however be noted that
with either change in the rate of
interest or marginal efficiency of
capital investment will change .

16. Aggregate output
In the short run the level of national income and employment in a free
market economy depends upon the equilibrium between aggregate
expenditure and aggregate output. keynes assumed : prices and wages
remain constant in the short run. National income means the total money
value of goods and services produced in an economy in a year.
Constituents of aggregate output
1.the supply or output of final consumer goods and services in a year ; and
2.the output of capital goods which are also called producer goods because
they help in producing further goods.
Aggregate output which is also referred to as aggregate supply of goods of
an economy depends upon the stock of capital, the amount of labour used
and the state of technology.
Production function in the short run.
Y=(N,K,T)
where, y is national income ,K is the constant amount of capital stock, T is the
constant state of technological and n is labour employed which is variable
factor

17. 45 degree line as aggregate output with
( fixed prices)
we need to compare GDP or N.Y with aggregate expenditure or aggregate demand
which is represented on vertical axis. For this purpose we draw 45 degree line from the
origin which helps to transfer GDP or N.Y from the horizontal axis to vertical axis
.This 45 degree line is called as income line.So y = C+S because income can either be
consumed or saved .

18. Equilibrium income

19. Explaination
Through the the intersection of aggregate demand and
aggregate supply curves the equilibrium level of national
income is determined in keynes’s two sector model.C+I curve
represents the aggregate expenditure and 45 degree oz line
represents aggregate supply of output.the goods and services
are provided by firms when they think they can sell them in
themarket.there will be equilibrium in the goods market when
total output of goods and serviceproduced will be equal to the
total demand for them is represented by aggregate
expenditure.in equilibrium aggregate expenditure must equal
aggregate output.since aggregate output or GDP equals
national income we have the following condition for
equilibrium.
AE=GDP=Y.

20. In the fig 5 that aggregate expenditure curve or C+I
curve intersects 45degree line at point E which
satisfies the equilibrium condition.that is a,point E
which corresponds to the income level
OY1,aggregate expenditure is equal to aggregate
output.therefore,E is the equilibrium point and OY1
represents the equilibrium level of national
income.now,income cannot be in equilibrim at levles
smaller than OY1,since aggregate expenditure
exceeds aggregate supply of demand will be met by
the firms selling goods from their stocks or
inventories of goods kept by them.this leads to the
decline in inventories of goods below the desired
levels.

21. On the country,the equilibrium level of national
income cannot be greater than OY1because at any
level greater than OY1 aggregate expenditure or
demand[C+I] falls short of aggregate output.This will
cause the increase in inventories of goods with the
firms beyond the desired levels. Thus deficiency in
aggregate demand relative the aggregate supply of
output will lead to the fall in national income and
output until the level OY1 is reached where aggregate
expenditure[C+I]is equal to the value of aggregate
output.Thus,OY1 is the equilibrium level of national
income.

22. Thank you