Transcript Keynesian Cross

Chapter 11 Homework
• Number 1: Lauren
• Number 4: Travis
• Number 8: Stephanie
• Number 14: Nicole
• Alternate: Kelly
Chapter 12 homework (due Monday)
• Numbers 5, 10, 13, and 15
Appendix for
Chapter 12
The Keynesian
Cross
The Keynesian Cross
• The Keynesian Cross is a model of the
economy that focuses on the relationship
between aggregate demand and income
to determine equilibrium.
Consumption
• The relationship between income and
consumption is given by the consumption
function:
C  c0  cy
Where:
c0 represents autonomous consumption,
consumption that is independent of income.
c′ is the marginal propensity to consume.
y is income.
Figure A12.1 The Consumption Function
The 45-Degree Line
• We gain additional insight into the
consumption function when we compare it
to a 45-degree reference line.

At all points along this line, consumption and
income are equal.
Figure A12.2(a) The 45-degree Line and
the Consumption Function
Figure A12.2(b) The 45-degree Line and
the Consumption Function
Investment
• The investment function shows the
relationship between planned investment
and income in the economy:
I  i0
• Investment is independent of income.
Figure A12.3 Adding the Investment
Function to Aggregate Demand
The Aggregate Demand Function in a
World with Government and Trade
• To complete the model, we assume that
both government spending and net exports are
exogenous.

That is, they are determined by outside factors.
G  g0 and X  M   x  m0
The Aggregate Demand Function in a
World with Government and Trade (cont’d)
• We can now add all of the components of
aggregate demand to get the overall aggregate
demand function.
Figure A12.4
Adding Government Expenditures and Net
Exports to the Aggregate Demand Function
The Keynesian Cross and
Overall Macroeconomic Equilibrium
• The 45-degree line is interpreted as the
aggregate supply function for the economy.

Everywhere along that line, total production equals
total demand.
• Equilibrium occurs where the aggregate
demand function intersects the aggregate
supply function.

The Keynesian Cross
Figure A12.5 Equilibrium in the
Keynesian Cross Model
The Keynesian Cross and Overall
Macroeconomic Equilibrium (cont’d)
• Suppose that net exports increase.

The aggregate demand function would shift up.

Aggregate demand now exceeds aggregate supply,
so inventories fall.

As inventories fall, firms increase output.

Increased production leads to increased income and
consumption.

Real GDP ultimately increases by a
multiplied amount.
Figure A12.6
The Impact of an Increase in Net Exports
Can we do it? (number 5)
• If the consumption function is $100+0.5y, the
investment function =$80, the government
spending function = $200, and the net export
function = $10, what would be the amount of
aggregate expenditures be if income were
$1000, $2000, and $3000?
• AE=C+I+G+(X-M)
• 890
• 1390
• 1890
Chapter 12 Appendix Homework
• Numbers 1, 2, and 6
Chapter 13
Fiscal Policy
The Goals of Fiscal Policy
• Intentional use of the government’s power
to tax and spend to alter AD and quickly
achieve the full employment level of
output.
• Goals are to correct either:

An underperforming economy, or

An overheating economy.
Expansionary Fiscal Policy
• Increased government spending
• Decreased taxes

To increase AD and real GDP.
Figure 13.1 Curing the Underperforming
Economy with Expansionary Fiscal Policy
Expansionary Fiscal Policy
• As a result:

AD increases.
• If increases by the “right amount”, full employment
level of output will be met

Price level increases.

Unemployment rate falls.
• Real GDP increases
The Multiplier Principle
• Changes in any component of AD will
lead to a magnified change in the level
of real income in the economy.

Gives policy makers a tool to determine the
correct change in AD needed to close a
recessionary or expansionary gap.