The Keynesian Modell

7/28/2019 The Keynesian Modell

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The Keynesian Model

the possibility of

macroeconomic equilibriumwith unemployment


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Great Depression

From 1929-1941, the United States (and

the world) was in a huge economic

depression, in the U.S. the official

unemployment rate was 25%. This

doesnt count the millions living in the

Hoovervilles the homeless camps named

for the President. Not until the U.S.entered WWII did the economy recover.


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Questioning Neoclassical Theory

Economists and others began to ask thequestion: why isnt the economyrecovering, where is the self-adjusting

mechanism. Neoclassical theory says the economy will

recover in the long run, but how long isthat? One famous economist, JosephSchumpeter said: The short run is longenough to bring about the ruin if a nation.


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John Maynard Keynes

Another famous economist from

Cambridge University in England, he

remarked: In the long run were all dead.

Keynes, writing in the midst of the Great

Depression, criticized neoclassical theory,

and put forward an

alternative way of looking

at the macroeconomy.


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Keynes on

consumption and income

Keynes began with a very simple

proposition: when income goes up,

consumption increases, but not by as

much as income. So:

0


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Keynes on income and savings

If that is true, then it must also be true

(since Yd = C + S) that when income goes

up, savings increases, but not by as much:

0


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the mpc and the mps

C/Yd is called the mpc (marginal

propensity to consume)

S/Yd is called the mps (marginal

propensity to save)


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C/Yd +S/Yd = 1

and mps = 1 b


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:

If Yd = C + S, then


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:

If Yd = C + S, then

Any change in Yd must resolve itself somepart of a change in C and some part a

change in S.


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:

If Yd = C + S, then


change in S.

So,Yd =C +S


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:

If Yd = C + S, then


change in S.

So,Yd =C +S Divide both sides byYd, and we get:


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C/Yd +S/Yd = 1

and mps = 1 b

Proof:

If Yd = C + S, then


change in S.

So,Yd =C +S Divide both sides byYd, and we get:

1 = mpc + mps (from 1 = mpc + mps)


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the consumption function


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mpc = additional consumption from an

additional dollar of disposable income.


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mps = additional saving from an additional

dollar of disposable income.


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So we can think of present consumption

as a function of disposable income:


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So we can think of present consumption

as a function of disposable income:

C = bYd


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autonomous consumption

But is present income the only determinant

of present consumption?


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of present consumption? No. What else?


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of present consumption? No. What else:

accumulated past savings


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access to credit


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access to credit

expectations of future income


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access to credit

expectations of future income

social standards etc.


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Keynesian consumption function

all these and other determinants of

present consumption other than present

disposable income we will call a, or

autonomous consumption; so:

C = a + bYd


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all these and other determinants of

present consumption other than present

disposable income we will call a, or

autonomous consumption; so:

C = a + bYd

This is our consumption function.


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all these and other determinants of presentconsumption other than present disposable

income we will call a, or autonomous

consumption; so:

C = a + bYd

(takes form y = mx + b; linear function; m is

slope and b is y-intercept)

This is our consumption function. We can graph

this in expenditure/output (=income) space.


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45 Degree Line

exp.

Y45

45

0

15

10

5

5 10 15


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

YfY1

a + I

- a

IC > Y

C = Y

C < Y


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C = a + bYd


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C = a + bYd

What is the slope of the consumption

function?


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C = a + bYd


function? b (b = mpc = marginal propensity

to consume =C/Yd = rise/run = slope)


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C = a + bYd


function? b (b = mpc = marginal propensity

to consume =C/Yd = rise/run = slope)

What is the y intercept of the C function?


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savings function

S = -a + (1 - b) Yd


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savings function

S = -a + (1 - b) Yd

What is the y intercept of the savingsfunction?


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savings function

S = -a + (1 - b) Yd

What is the y intercept of the savingsfunction? a (= autonomous savings)


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savings function

S = -a + (1 - b) Yd


What is the slope of the savings function?


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savings function

S = -a + (1 - b) Yd


What is the slope of the savings function?(1 b) ( = mps = marginal propensity to

save =S/Yd = rise/run = slope)


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

S = - a + (1 b) Y

YfY1

a + I

- a

IC > Y

C = Y S = 0

C < Y

S< 0

Dissaving

S > 0


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savings function

When the savings function is below the x-

axis savings is negative, when the savings

function is above the x-axis savings is

positive and when the savings functionintersects the x-axis savings = 0.


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

S = - a + (1 b) Y

YfY1

a + I

- a

IC > Y

C = Y S = 0

C < Y

S< 0

Dissaving

S > 0

f


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Relation of consumption and

savings functions

At all those levels of income where the C func is

above the 45 d line, the savings func is below

the x-axis, meaning C > Yd so S is negative.

And at all those levels of income where the Cfunc is below the 45 d line the savings func is

above the x-axis, meaning C < Yd, so savings

is positive. And at exactly that one and only onelevel of income where the cons func intersects

the 45 d line, the savings func intersects the x-

axis, so C = Yd so savings is zero.


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

S = - a + (1 b) Y

YfY1

a + I

- a

IC > Y

C = Y S = 0

C < Y

S< 0

Dissaving

S > 0


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autonomous investment In Keynes, investment is determined by a

number of factors, most importantly investorexpectations of future conditions.

The important point here, though, is that

investment, unlike consumption and savings,is NOT a function of income. It isautonomous in the same sense asautonomous consumption.

Neither is it a simple function of interest rates,as in the neoclassical model.

The investment function will be horizontal.


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Keynesian Model

Expenditure

Y

45

0

I = I

YfY*Y1

I


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aggregate spending (C+I)

We add the constant amount of

autonomous investment to consumption to

derive the aggregate spending function

(no government, no foreign trade).

The y-intercept of the aggregate spending

function is (a+I), and the slope is b. This is

because the only thing changing whenincome changes is consumption.


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

AS = C + I

S = - a + (1 b) Y

I

YfY*Y1

a + I

- a

I

S i i t t d


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Savings, investment, and

equilbrium

Note that the savings function intersectsthe investment function at the same levelof income as the aggregate spending

function intersects the 45 degree line,indicating that savings = investment at themacroequilibrium.

Note that this macroequilibrium occursbelow the full employment level of output,Yf.

K i M d l


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Keynesian Model

Expenditure

Y

45

C = a + bY

0

a

AS = C + I

S = - a + (1 b) Y

I

YfY*Y1

a + I

- a

I

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