Keynesian Theory and the Aggregate Expenditure Model _ Macroeconomics.pdf

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8/12/2019Keynesian Theory and the Aggregate Expenditure Model | Macroeconomics1/23MODULE 7THE KEYNESIAN AND CLASSICAL MODELSCurrent Module| Pages 42 - 46Keynesian Theory and the AggregateExpenditure ModelLearning 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 page43Describe the main principles of Keynesian economic theory.The Aggregate Expenditure FunctionThe Keynesian model uses a measure of planned spending that is different fromaggregate demand.Aggregate expenditure (AE)is defined as total plannedspending by all sectors for an economy’s total output. Planned expenditures aredistinguished from actual expenditures because sometimes households or firmswill find that actual spending does not equal what was planned.Macroeconomics:Unit 4:Economic Theory and Fiscal PolicySearch this course...
8/12/2019Keynesian Theory and the Aggregate Expenditure Model | Macroeconomics2/23In the circular flow, there are four sectors in the economy: households, businessfirms, 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 businessfirms 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 ofAEareC(planned consumptionspending),I(planned investment spending),G(government purchases of goodsand services), andXandM(exports and imports). This breakdown is not the onlyway of sorting planned spending into components. It is useful, however, becausethe factors that influence planned spending are different for each of the sectorsof the economy. These four purchasers of output correspond to the fourcategories of purchasers used in national income accounting and to the foursectors 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 incomedetermination and then add the others to make the model more realistic.The Consumption FunctionThe largest component of spending is consumption. Keynes argued that theamount consumers choose to spend depends mainly on their disposableincome. Disposable income is the income consumers have to save or spend aftertaxes have been taken out. The consumption function is any equation that showsthe relationship between the disposable income of consumers and the amountthey plan, or desire, to spend on currently produced final output. Whendisposable income increases, consumption tends to increase, but by how much?

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