1. Keynesian Income Determination

2. Overview nKeynesian Income Determination Models u Private sector n Consumption demand n Investment Demand n Supply & demand for money u Public Sector n Government expenditure n Government taxes n Monetary policy manipulation of money supply u International n imports, exports, net exports

3. Private Sector nSimple model u Consumption & Aggregate Demand u Savings & Investment nConsumption is consumption of "household" nSavings u in C&F, savings = savings of consumers out of unspent income u but most savings = retained business profits nInvestment: by business thru profits & borrowed $

4. Consumption function = C = f(Y) [=c(y)in C&F] u where Y = income u and dC/dY > 0, i.e., C rises as Y rises Consumption Household income C = f(Y)

5. Consumption function = C = f(Y) [=c(y)in C&F] u where Y = income u and dC/dY > 0, i.e., C rises as Y rises Consumption Household income C = f(Y) ?

6. Linear Version nWe will only deal with linear versions of the consumption function because it makes things simpler C = a + bY Consumption Aggregate Income = Y CC YY dC/dY = b

7. Manipulate nSuppose the marginal propensity to consume rises. What happens to the function? Under what circumstances would "a" rise? Or fall? C = a + bY Consumption Aggregate Income = Y CC YY dC/dY = b

8. Change in MPC nRise in MPC, b' > b would steepen curve C = a + b' Y Consumption Aggregate Income = Y dC/dY = b C = a + bY

9. Change in "a" nUnder what circumstances would "a" rise? Or fall? Rise: a' > a, fall: a' < a C = a' + bY Consumption Aggregate Income = Y C = a + bY

10. Savings Function - derivation nSavings function = flip side of consumption function, what you don't spend you save nC = a +bY nY = C + S nY = a + bY + S nY - a - bY = S n-a + (1 - b)Y = S nS = -a + (1-b)Y

11. 45 o Line nTo facilitate derivation, and future work

12. Savings Function - derivation graphical C = a + bY S = -a + (1-b)Y Consumption Savings a -a

13. Investment - I nInvestment = "real" investment, i.e., the expenditure of money to buy and employ labor and raw materials and machines to produce commodities, i.e., M - C(MP,L)... P... C' nBuying, employing and accumulating "capital stock" u machines (MP) u inventories of raw materials (MP) u inventories of produced goods (C')

14. Investment - II  "Planned" investment u Planned purchases of inputs & inventory accumulation  "Actual" investment u Actual purchase & accumulation nActual can be different than Planned I u difference is usually unexpected changes in inventories u if actual > planned, firms have excess inventory u if actual < planned, firms have less inventory

15. Investment - III nWe can make various assumptions about determinants of Investment  I = f(  ), investment a function of profits,dI/dp >0 u I = f(Y), investment a function of level of economic activity,dI/dY >0 u I = f(Y t - Y t-1 ), investment a function of growth u I = I, investment assumed fixed for short run n This last is C&F assumption, easiest to start with

16. Fixed Investment nTo assume I is fixed, or given, at all levels of Y means we have an investment function like this: I = I I Y

17. "Equilibrium Level of Y" n"Equilibrium" means same as with supply & demand u any move away will set forces in motion that will return you to equilibrium nGiven expenditures C and I, the equilibrium level of Y will = C +, or total aggregate demand. nGiven investment I and savings S, the equilibrium level of Y will be given by S = I

18. Y  C + I nEquilibrium when planned expenditures = actual expenditures, no unexpected accumulation or dis- accumulation of inventories. I = I C = a + bY C+I = a + bY + I Y C, I YeYe

19. Y  C + I nSuppose output greater than expected (A) or less than expected (B). C+I = a + bY + I Y C, I AB excess inventories Unplanned fall in inventories YeYe

20. S  I nEquilibrium also requires that planned I = planned S I = I S = -a + bY YeYe

21. S  I ? nIf planned I  planned S, then the same mechanism of firms responding to unexpected changes in inventory will return Y to Y e I = I S = -a + (1-b)Y YeYe S, I Y excess inventory Unplanned fall in inventories

22. I = f + gY nLet I = f(Y) and let f(Y) be linear, u e.g., I = f + gY u where f > 0, g > 0 I = f + gY S = -a +(1-b)Y Y S, I

23. Algebraic Solutions nY = C + I u where C = a + bY u where I = I, or I = f + gY u Solve for equilibrium Y nS = I u where S = -a + (1-b)Y u where I = I, or I = f + gY u Solve for equilibrium Y

24. Problems nMost of problems in C&F ask you to solve for equilibrium Y given values of variables nYou can also experiment to see what will happen when various kinds of events occur in the private sector u e.g., business goes on strike, cuts back on I u e.g., a burst of optimism (or demoralization) raises (or lowers) b or a such that the consumption function shifts nTake real numbers and calculate parameters

25. Multiplier - I nContemplation of the previous phenomena, using these tools, especially with numerical examples will lead you to notice that changes in a or I will produce larger changes in Y, the effects will be "multiplied"

26. Is this magic?

27. No! Multiplier - II nAssume I increases, clearly S I I' > but, by how much?

28. Multiplier - III nY = C + I nC = a + bY nI = I nY = a + bY + I, so now substract bY from ea. side nY - bY = a + I, regrouping n(1 - b)Y = a + I, divide both sides by (1-b) nY = a/(1-b) + I/(1-b), take derivative ndY/dI = 1/(1-b), so if b =.75, then dY/dI = 4

29. Multiplier - IV nS = I nS = -a + (1-b)Y nI = I nYou solve for dY/dI nYou solve for dY/da

30. Why? nKeynes developed this conceptual approach to looking at the whole economy because he didn't like the kinds of results generated by the private sector and wanted tools that could help figure out how to intervene nFor example, in Great Depression, faced with stock market crash and industrial unions, business cut way back on investment, results could be analyzed with these tools.

31. Great Depression Business strike =  I C + I C + I' I' < I 19291932

32. So What to Do? nPartly answer will come from widening analysis to include government nPartly answer will come from widening analysis to include financial sector nBoth will provide tools to help government decide how to intervene to restore the earlier (and higher) levels of national output

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