The Keynesian model distinguishes between actual, potential, and equilibrium GDP. It assumes a closed economy with three sectors - consumption (C), investment (I), and government spending (G). Consumption depends on disposable income and is modeled by the consumption function C = a + bYd, where a is autonomous consumption and bYd is induced consumption. The savings function is S = Yd - C. Equilibrium occurs when aggregate demand (C + I + G) equals actual output (Y). The government expenditure multiplier and tax multiplier can be derived from this model.
The Keynesian model distinguishes between actual, potential, and equilibrium GDP. It assumes a closed economy with three sectors - consumption (C), investment (I), and government spending (G). Consumption depends on disposable income and is modeled by the consumption function C = a + bYd, where a is autonomous consumption and bYd is induced consumption. The savings function is S = Yd - C. Equilibrium occurs when aggregate demand (C + I + G) equals actual output (Y). The government expenditure multiplier and tax multiplier can be derived from this model.
The Keynesian model distinguishes between actual, potential, and equilibrium GDP. It assumes a closed economy with three sectors - consumption (C), investment (I), and government spending (G). Consumption depends on disposable income and is modeled by the consumption function C = a + bYd, where a is autonomous consumption and bYd is induced consumption. The savings function is S = Yd - C. Equilibrium occurs when aggregate demand (C + I + G) equals actual output (Y). The government expenditure multiplier and tax multiplier can be derived from this model.
The Keynesian model distinguishes between actual, potential, and equilibrium GDP. It assumes a closed economy with three sectors - consumption (C), investment (I), and government spending (G). Consumption depends on disposable income and is modeled by the consumption function C = a + bYd, where a is autonomous consumption and bYd is induced consumption. The savings function is S = Yd - C. Equilibrium occurs when aggregate demand (C + I + G) equals actual output (Y). The government expenditure multiplier and tax multiplier can be derived from this model.
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Simple Keynesian Model of Income
Determination
Prof Prarthana Banerjee
The Keynesian model
The Keynesian model distinguishes:
•Actual GDP -- what GDP happens to be right now • Potential GDP -- full employment GDP •Equilibrium GDP -- a level of GDP at which there are no forces tending to change the level of GDP. •Price is constant •Closed economy with or without government. •Economy consisting of goods market. No money market. Overview In a 3 sector economy = C(Yd)+I+G • Desired aggregate demand is the sum of consumption (C), investment (I), government spending (G) • Consumption mainly depends on disposable income C = f(Yd) • (the Keynesian consumption function): C = a + b Yd • Consumption function
• Concept: C = a + b Yd there are two components to consumption a represents autonomous consumption this is the amount that people will spend independent of their current level of income (depends on other things besides income) bYd is the induced consumption. b represents the marginal propensity to consume Savings function S= Yd- C So, S = -a + (1 – b)Yd (1-b) is known as the marginal propensity to save. MPC = ΔC/ΔY MPS = ΔS/ΔY • Since all disposable income is either consumed or saved…. MPC + MPS = 1 Consumption and Savings function • We can also graph the consumption and savings functions: S C C = 500 + 0.9 Yd
0.9 S = -500 + 0.1
0 Yd
500 - 0.1 500 0 Yd Yd Savings function S = -a + (1 - b) Yd Let s = 1 – b And so, we have the savings function: S = -a + s Yd Example: Let a = 500, b = 0.9, In this case: C = 500 + 0.9 Yd S = -500 + 0.1 Yd You Do: Let a = 1000, b = 0.95 • Find the consumption and savings functions. Also write the MPC and MPS. I
More autonomous components
• Investment: I= I • Government spending: G = G • Taxes: T = T • Lumpsum tax Government Expenditure - II • To assume G is fixed, or given, at all levels of Y means we have an Government expenditure fucntion like this: G
G=G
Y Y C + I +G • Equilibrium when planned expenditures = actual expenditures, or aggregate demand (C + I + G) = aggregate output (Y). C+I + G = a + bY + I + G C, I, G
C = a + bY
I+G=I+G
Y Y YC+I+G • Suppose output greater than expected (A) or less than expected (B).
C+I + G= a + bY + I + G C, I
Unplanned fall in excess inventories inventories
B Y A Y Government Expenditure Multiplier • If C = a + b(Y - T) • YC+I+G • Ya + bY -bT + I + G • Y = a/(1 - b) -bT/(1 - b) + I/(1 - b) + G/(1 - b) • We can solve for dY/dG by taking the derivative, in the process of which all values on right = 0 except for G, such that • dY/dG = 1/(1 - b) = govt. expend. multiplier Taxation Multiplier • If C = a + b(Y - T) • YC+I+G • Ya + bY -bT + I + G • Y = a/(1 - b) -bT/(1 - b) + I/(1 - b) + G/(1 - b) • We can solve for dY/dT by taking the derivative, in the process of which all values on right = 0 except for T, such that • dY/dT = -b/(1 - b) = govt. taxation multiplier Balanced Budget Multiplier • So if govt. expenditure multiplier = 1/(1-b) • and, govt taxation multiplier = -b(1-b) • then we can see just how much a balanced budget would stimulate the economy • Where G = T, the effects added together are:
1/(1-b) + [-b(1-b)] = (1 - b)/(1 - b) = 1
Trade multiplier • Open economy multiplier= 1/(mps+mpi) • mpi is marginal propensity to import.
• Paradox of thrift: The paradox of thrift states
that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving. You do 1. If C= 100+0.6Y, find that value of mps 2. If C= 40 +0.8Yd, I=60, G=10, Tax= 5. calculate equilibrium national income 3. Derive government expenditure multiplier for a 3sector economy 4. Derive balanced budget multiplier in SKM. Practice • C= 100+0.75Yd, I=200, G=T=100 • Find equilibrium level of income and calculate government expenditure multiplier and tax multiplier. • If full employment level of income is 1600, how much government expenditure should be increased to attain full employment? End
