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    Keynesian Model of National Income

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    niloy
    The Keynesian cross model describes how total spending determines national income in the short run. It assumes that planned expenditure (PE) equals actual expenditure (AE) at equilibrium. PE is the sum of consumption, investment, and government spending. AE is simply national income (Y). The point where PE and AE intersect is the equilibrium level of income. If income is above or below equilibrium, inventory adjustments bring it back in line. An increase in government spending shifts the PE curve up, raising equilibrium income by a multiplier determined by the marginal propensity to consume.

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    Keynesian Model of National Income

    Uploaded by

    niloy
    84 views13 pages
    The Keynesian cross model describes how total spending determines national income in the short run. It assumes that planned expenditure (PE) equals actual expenditure (AE) at equilibrium. PE is the sum of consumption, investment, and government spending. AE is simply national income (Y). The point where PE and AE intersect is the equilibrium level of income. If income is above or below equilibrium, inventory adjustments bring it back in line. An increase in government spending shifts the PE curve up, raising equilibrium income by a multiplier determined by the marginal propensity to consume.

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    Keyneysian model

    Original Title

    Keynesian Macroeconomics

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    The Keynesian cross model describes how total spending determines national income in the short run. It assumes that planned expenditure (PE) equals actual expenditure (AE) at equilibrium. PE is the sum of consumption, investment, and government spending. AE is simply national income (Y). The point where PE and AE intersect is the equilibrium level of income. If income is above or below equilibrium, inventory adjustments bring it back in line. An increase in government spending shifts the PE curve up, raising equilibrium income by a multiplier determined by the marginal propensity to consume.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    84 views13 pages

    Keynesian Model of National Income

    Uploaded by

    niloy
    The Keynesian cross model describes how total spending determines national income in the short run. It assumes that planned expenditure (PE) equals actual expenditure (AE) at equilibrium. PE is the sum of consumption, investment, and government spending. AE is simply national income (Y). The point where PE and AE intersect is the equilibrium level of income. If income is above or below equilibrium, inventory adjustments bring it back in line. An increase in government spending shifts the PE curve up, raising equilibrium income by a multiplier determined by the marginal propensity to consume.

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    Keynesian Model of National Income

    Central idea of Keynesian cross


    In The General Theory Keynes proposed that an economy’s
    total income was, in the short run, determined largely by the
    spending plans of households, businesses, and government.
    The more people want to spend, the more goods and services
    firms can sell. The more firms can sell, the more output they
    will choose to produce and the more workers they will choose
    to hire. So ultimately output / GDP/ Income rises.
    Planned or desired expenditure and Actual
    expenditure

    • Planned expenditure: (Desired expenditure) (PE)


    Planned expenditure is the amount households, firms, and the
    government would like to spend on goods and services
    • Actual expenditure (AE)
    Actual expenditure is the amount households, firms, and the
    government spend on goods and services.
    Developing the Keynesian model of national
    income
    •   Assuming that the economy is closed, so that net exports are zero, we
    write planned expenditure PE as the sum of consumption C, planned
    investment I, and government purchases G:

    PE=C+I+G
    we add the consumption function,
    C=C(Y-T)
    And the investment function: I = , We also have G = and T =
    Combining these five equations we have
    ••   PE =C(Y-)++……. (6)
    • C= +MPC (Y-) PE = +MPC (Y-) + +
    • PE = +MPC.Y –MPC. + +
    • PE = ( - MPC. + +) + MPC.Y……… (7)
    • planned expenditure as a function of the level of income.

    • PE Planned expenditure function is linear and upward sloping

    • Slope of PE function is MPC.

    • Y (Income /GDP /Output)


    The Economy in Equilibrium

    Keynesian cross is the assumption that the economy is in equilibrium


    when actual expenditure equals planned expenditure. when people’s
    plans have been realized, they have no reason to change.

    Actual Expenditure = Planned Expenditure


    Y = PE
    45 degree line that passes through point of origin is the graph of Actual
    expenditure line. Equation for AE : Y=C+I+G
    Graph of short- run equilibrium
    Q1. Explain Keynesian cross in diagram.
    • PE and Actual Expenditure
    AE

    • E Planned expenditure
    •
    • E= Keynesian cross
    • 45o
    • 0 YE Y (Income/GDP/Output)
    The Adjustment to Equilibrium in the Keynesian Cross
    Q2. How does adjustment in inventory investment help attain equilibrium in
    SR?
    • PE & AE
    • AE
    • A
    • PE
    planned drop in inventory E B

    F unplanned inventory
    accumulation = AB =positive inventory
    • G investment. FG= Negative inventory I.

    • 0 Y1 YE Y2 Y(Income /GDP/Output)

    •
    • If firms are producing at level Y1, then planned expenditure PE falls
    short of production, and firms accumulate inventories. This inventory
    accumulation induces firms to decrease production. Similarly, if firms
    are producing at level Y2, then planned expenditure PE exceeds
    production, and firms run down their inventories. This fall in
    inventories induces firms to increase production. In both cases, the
    firms’ decisions drive the economy toward equilibrium.
    Q3. Derive expression for government
    purchase multiplier
    • An increase in government purchase of ΔG immediately raises
    planned spending line by ΔG and, therefore, the economy moves
    into new Keynesian cross. The equilibrium income also increases.

    • The planned-expenditure schedule shifts upward by ΔG. The


    equilibrium of the economy moves from point A to point B.
    Graph of G multiplier
    • Actual & planned Actual Expenditure

    expenditure
    B New PE line
    Original PE Line
    △G A
    △Y = Increase in equilibrium income
    45
    0 Y1 Y2 Income/GDP/Output
    •Increase
      in income in 1st round = △G (Increase in planned G)
    Increase in income in 2nd round = MPC × △G
    Increase in income in 3rd round = MPC (MPC × △G) = MPC2× △G
    And the process continues………..
    Total change in Income = Summation of change in income in all rounds
    △Y= △G + MPC × △G + MPC2×△G + MPC3× △G +………
    = [ 1+ MPC + MPC2+ MPC3+........... ]
    △Y / △G = [ 1+MPC+MPC2+……..]
    = = = G multiplier =
    • Since the value of MPC lies between 0 and 1. The value of G multiplier is
    always greater than ‘1’.

    • Suppose the value of G multiplier = 2.5, Give its economic interpretation.


    • If Govt increases its purchase by 1 $ , equilibrium income rises by 2.5 dollars
    (MORE than 1 dollar).

    • Important conclusion: Greater the value of MPC the larger the value of G
    multiplier.
    • Verify this result using your own choice of MPC values.
    • AE & PE MPC=0.3 MPC=0.7
    • PE line is flatter New PE Line AE & PE PE line is steeper
    • Old PE line

    • Y1 Y2 Income 0 Y1 Y2 Income

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