10 Keynes model 2.docx

# 10 Keynes model 2.docx - The consumption and saving...

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The consumption and saving function Assume that the economy consists of only two sectors, households and firms In the two-sector model, consumption and saving depend on GDP. C= ´ C +c Y S=Y-C S=- ´ C + (1-c) Y S=- ´ S + s Y The investment function Assuming that GDP does not influence firms’ investment plans. Keynesian economists do not deny this possibility that firms are more likely to invest more when the economy is performing strongly. Their rationale for assuming that investment is exogenous is that other factors that influence firms’ investment plans are much more important . Two sector Equilibrium A: PAE=Y B INJ=WD (In the two-sector model, where I=S). Three sector Equilibrium C= ´ C + c Y S= - ´ C + (1-c) Y Y C, S I p => Injections S= - ´ C + (1-c) Y=> withdrawals 45 o Degree line Y PAE Y e - ´ C ´ C Consumption function, slope c Saving function, slope 1-c 1. Real interest rate 2. Entrepreneur’s expectations Y I I p Equilibrium A Equilibrium B W=S+T

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Ignore the income tax T= ´ T Y= 1 1 c ( ´ C + ´ I + ´ G -c ´ T ) Recognize the income tax, using the tax function T= ´ T +t Y t= ∆T ∆Y Y= 1 1 c + ct [ ´ C + ´ I + ´ G -c ´ T ] Autonomous expenditure multiplier 1 1 c + ct < 1 1 c Taxation multiplier c 1 c + ct < c 1 c Both AEM and TM are reduced, because
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