Ch12 - Expenditure Multipliers The Keynesian Model CHAPTER...

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Unformatted text preview: Expenditure Multipliers: The Keynesian Model CHAPTER 12 2 After studying this chapter you will be able to Explain how expenditure plans and real GDP are determined when the price level is fixed Explain how real GDP is determined when the price level is fixed Explain the expenditure multiplier when the price level is fixed Explain the relationship between aggregate expenditure and aggregate demand and explain the multiplier when the price level changes Economic Amplifier or Shock Absorber? A voice can be a whisper or fill New York’s Central Park, depending on the amplification. A limousine with good shock absorbers can ride smoothly over terrible potholes on a less well-repaired city street. Investment and exports can fluctuate like the amplified voice or the terrible potholes; does the economy react like a limousine, smoothing out the bumps, or like an amplifier, magnifying the fluctuations? These are the questions this chapter addresses. Fixed Prices and Expenditure Plans Keynesian model describes the economy in the very short run when prices are fixed. Fixed prices have two implications for the economy as a whole: 1. Because each firm’s price is fixed, the price level is fixed. 2. Because demand determines the quantities that each firm sells, aggregate demand determines the aggregate quantity of goods and services sold, which equals real GDP. What determines aggregate expenditure plans? Fixed Prices and Expenditure Plans Expenditure Plans The components of aggregate expenditure sum to real GDP. That is, Y = C + I + G + X – M Two of the components of aggregate expenditure, consumption and imports, are influenced by real GDP. So there is a two-way link between aggregate expenditure and real GDP. Fixed Prices and Expenditure Plans The two-way link between aggregate expenditure and real GDP: Other things remaining the same, An increase in real GDP increases aggregate expenditure An increase in aggregate expenditure increases real GDP Fixed Prices and Expenditure Plans Consumption and Saving Plans Consumption expenditure is influenced by many factors but the most direct one is disposable income. Disposable income is aggregate income or real GDP, Y , minus net taxes, T . Call disposable income YD. The equation for disposable income is YD = Y – T Fixed Prices and Expenditure Plans Disposable income is either spent on consumption goods and services, C , or saved, S . That is, YD = C + S. The relationship between consumption expenditure and disposable income, other things remaining the same, is the consumption function . The relationship between saving and disposable income, other things remaining the same, is the saving function . Fixed Prices and Expenditure Plans Figure 12.1 illustrates the consumption function… and the saving function....
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Ch12 - Expenditure Multipliers The Keynesian Model CHAPTER...

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