Aggregate Demand, Consumption, and the Multiplier
In this unit you will carefully investigate aggregate demand. The tool for exploring aggregate demand is the Keynesian model . Among other things, this
model allows one to better understand the causes of changes in aggregate demand. One of the immediate consequences of this development of the mode
of aggregate demand is that you will be able to solve the two main problems (gaps) from before. You will also learn one of the most important issues i
macroeconomics: the multiplier effect.
What will we learn in this lesson?
When you are done with this lesson, you should be able to:
State the basic assumptions of the Keynesian model.
Explain the relationship between consumption, savings and disposable income.
Determine the average propensity to consume (APC), average propensity to save (APS), marginal propensity to consume (MPC) and marginal
propensity to save (MPS).
Add investment, government, and foreign spending to the model.
Explain how equilibrium is determined in the Keynesian model.
Understand the multiplier concept and be able to apply it to the analysis of aggregate demand.
Tie the Keynesian model back to the aggregate demand curve.
If you have any questions, please post them to our
I Don't Understand
discussion forum (not e-mail), located under the Communicate or the Lesson tab
in ANGEL. Your instructor will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you are able
to help out another student.
The Keynesian Model of Aggregate Demand
One of the most important concepts to come from this chapter is an effect known as the multiplier effect. It explains why consumers are so important in
an economy. Have you ever wondered what happens to the money you spend at a restaurant? Where does it go? The multiplier begins to explain that as
well as show why your going to a restaurant is not only desirable for you, but also for the economy as a whole. So let's get started by focusing our
attention on the aggregate demand curve under the assumption of Keynesian economics.
Before we get too far into this new model, we have to make a very important set of assumptions. If we assume: businesses pay no indirect taxes and
distribute all profits to shareholders, no depreciation and the economy is closed, then we can realize another very important simplifying relationship,
GDP = DI
where DI is disposable income. It sounds pretty ridiculous that gross domestic product is equal to everyone's take home pay, but thi
equation will come in handy later. Also note this relationship will change a bit later, so keep an eye open. Furthermore, there will be three ways the
material can be presented: 1) graphical form, 2) tabular form, and 3) in the form of equations. Make sure you can do all three versions once we go
If one of Keynes' major insights was the possibility that prices and wages are sticky, a second was that the level of consumption spending of household