Draw a 45-degree, income-expenditure diagram (KW p. 284), Aplia Chapter 11 PS II
(due Tuesday, November 1, 9:PM)
I’ll have office hours today, 2-4, and Wednesday 9:30-11:30.
We have a new Greenspan!
the inculcation of the incomprehensible into the
indifferent by the incompetent.” – John Maynard Keynes
“Knowledge is power.
Study hard, be evil.” – I don’t know who said this, but it sounds like an
economist to me.
Good and Bad Macroeconomic Equilibrium
What if savings is too big so that we have no equilibrium but instead have general gluts of
everything, including labor?
Fear not, if savings is big, then the price of savings, the interest rate, will be low, and this will
encourage investment demand to grow.
You know, like Say’s Law.
But sometimes we see the economy fall apart, what’s up with that?
What if what Malthus thought was not an equilibrium really was one, just a bad one?
Failure of AD sometimes.
What if the economy is in equilibrium in the short run with AS= AD, but at the wrong level?
AS = AD, but where unemployment is very high.
This was Keynes’s
main focus because he was writing during the Great Depression.
AS = AD, but where unemployment is very low.
Need a very good understanding of consumption to see why we might get “bad equilibria.”
In Macro Equilibrium, the following must hold:
Production = Spending (like in “circle flow” diagrams)
AS = AD
Y = C + Id + G + (X-Im)
(Now, subtract (C + T) from both sides of the above.)
(Y-T)-C = Id + (G-T) + (X-Im)
Savings = (Y-T) - C = Disposable Income – C
S = Id + (G-T) + (X-Im)
Id = S + (T-G) + (Im-X) = S + (Government Surplus) + (International Capital Flows)
Investment is financed by private savings, government surpluses, and trade deficits (which
represent foreigners investing in the US)
Government deficits (G>T) use of private savings that could otherwise have gone to finance
S + T + X = Id + G + X
Leakages = Injections
If we are not in macro equilibrium:
AS does not equal AD
Leakages to not equal Injections
If AS > AD
Leakages > Injections
Production > Spending
Inventories will rise, and firms will respond by cutting back production
If AS < AD
Leakages < Injections
Production < Spending
Inventories will fall, and firms will respond by raising production
Keynes Tries to Model the Economy
Consumption is 2/3rds of AD, so must model it carefully.