Simple Keynesian Model

http://apeconomics.ncee.netUnit 3 : MacroeconomicsNational Council on Economic Education

Simple Keynesian Model

Planned aggregate expenditure = C + I + G + NX

45 degree line: all points where production (real GDP) = aggregate expenditure

Equilibrium occurs where planned aggregate expenditure equals production


Equilibrium and Disequilibrium in theKeynesian Model


Saving and Dissaving


Increase in Investment

Investment increases from I to I1.Output increases from Y to Y1.


Investment Demand

Interest rate decreases from r to r1.

Investment increases from I to I1.


Different Elasticities of Investment Demand

Decrease of interest rates from r to r1.

With IA, investment increases from I to I2.

With IB, investment increases from I to I1.

IA is more elastic than IB.


Aggregate Demand

An increase in price from P to P1 results in

a decrease in real GDP from Y to Y1


Shifts in Aggregate Demand

A decrease in expected future income, in government expenditures, in the money supply or an increase in taxes will cause the AD to shift from AD to AD1.

An increase in expected future income, in government expenditures or in the money supply, or a decrease in taxes will cause the AD to shift from AD to AD2.


Aggregate Supply

Y* represents potential real GDP. It is full-employment output.

SRAS is the short-run aggregate supply curve.


Aggregate Supply

1. Potential GDP increases from Y* to Y*1. The LRAS shifts to LRAS1 and the short-run aggregate supply curve shifts to SRAS1.

2. Decrease in resource prices will shift the SRAS to SRAS1. A decrease in the money wage rate does not change the LRAS.


Aggregate Supply and Aggregate Demand


Change in Aggregate Demand


From the Short Run to the Long Run

Initially the economy is at Y*, potential GDP and P.

Aggregate demand increases from AD to AD1 and the economy moves to Y1 and P1.

The final equilibrium is Y* and P2.


Long-Run Aggregate Supply and Production Possibilities Curves

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Simple Keynesian Model