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Keynesian Theory and the Aggregate Expenditure Model _ Macroeconomics.pdf

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8/12/2019 Keynesian Theory and the Aggregate Expenditure Model | Macroeconomics 1/23 MODULE 7 THE KEYNESIAN AND CLASSICAL MODELS Current Module | Pages 42 - 46 Keynesian Theory and the Aggregate Expenditure Model Learning Objectives (/courseware/wgu_C719_01Nov17_macro_econ_1/u3_economic_theory/m7_keynesian_model/p1_classical_economic_theories) (/courseware/wgu_C719_01Nov17_macro_econ_1/u3_economic_theory/m7_keynesian_model/p3_classical_keynesian_theories) Go to page 43 Describe the main principles of Keynesian economic theory. The Aggregate Expenditure Function The Keynesian model uses a measure of planned spending that is different from aggregate demand. Aggregate expenditure ( AE ) is defined as total planned spending by all sectors for an economy’s total output. Planned expenditures are distinguished from actual expenditures because sometimes households or firms will find that actual spending does not equal what was planned. Macroeconomics: Unit 4: Economic Theory and Fiscal Policy Search this course...
8/12/2019 Keynesian Theory and the Aggregate Expenditure Model | Macroeconomics 2/23 In the circular flow, there are four sectors in the economy: households, business firms, government, and the foreign sector. In the upper half of the circular flow, the business sector sells output to each of the four sectors, including business firms that are making investment purchases. Aggregate expenditure for a four- sector economy is the sum of the purchases of all sectors: In a complete model, the components of AE are C (planned consumption spending), I (planned investment spending), G (government purchases of goods and services), and X and M (exports and imports). This breakdown is not the only way of sorting planned spending into components. It is useful, however, because the factors that influence planned spending are different for each of the sectors of the economy. These four purchasers of output correspond to the four categories of purchasers used in national income accounting and to the four sectors in the circular flow model. Without government and foreign trade, planned expenditures have just two components: consumption and investment. It is useful to start with these two expenditures to develop a model of income determination and then add the others to make the model more realistic. The Consumption Function The largest component of spending is consumption. Keynes argued that the amount consumers choose to spend depends mainly on their disposable income. Disposable income is the income consumers have to save or spend after taxes have been taken out. The consumption function is any equation that shows the relationship between the disposable income of consumers and the amount they plan, or desire, to spend on currently produced final output. When disposable income increases, consumption tends to increase, but by how much?