Transcript John Maynard Keynes The General Theory A workout with the basic macroeconomic magnitudes in a mixed economy.

John Maynard Keynes
The General Theory
A workout
with the basic
macroeconomic
magnitudes
in a
mixed economy
A MACROECONOMIC IDENTITY
Y=C+S+T
INCOME IS THE SUM OF:
THE PART YOU SPEND,
THE PART YOU DON’T SPEND,
THE PART YOU NEVER SAW
(because the government took it as taxes).
MACROECONOMIC EQUILIBRIUM
INCOME = EXPENDITURES
Y=E
Y=C+I+G
C+S+T=C+I+G
S+T=I+G
Note that I is “given”; G and T are policy variables;
and C (and therefore S) depend directly on Y.
E
S, I
C+I+G
C+I
C
Y
S+T
S
I+G
I
Y
E
S, I
C+I+G
C+I
C
Y
S+T
S
I+G
I
Y
E
S, I
C+I+G
Y
S+T
I+G
Y
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
IS NORWAY IN EQUILIBRIUM?
Y = 180 = 120 + 36 + 24?
C = 120
S = 60
T=0
I = 36
G = 24
NORWAY IS IN EQUILIBRIUM.
Y = 180 = 180 = E
C = 120
S = 60
T=0
I = 36
G = 24
People are producing and
consuming 120. They’re
producing but not
consuming another 60.
They save the 60, which is
borrowed partly by the
private sector (36) and
partly by the government
(24). These borrowers then
take command over the
unconsumed 60.
E
S, I
C+I+G
Y
S+T
I+G
Y
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
S + T = 60
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
T=0
I = 36
G = 24
S + T = 60
IS NORWAY IN EQUILIBRIUM?
Y = 180
C = 120
S = 60
S + T = 60
T=0
I = 36
G = 24
I + G = 60
NORWAY IS IN EQUILIBRIUM
Y = 180
C = 120
S = 60
S + T = 60
T=0
I = 36
G = 24
I + G = 60
E
S, I
C+I+G
Y
S+T
I+G
Y
IS EASWAY IN EQUILIBRIUM?
Y = 120
C = 84
S = 30
T=6
I = 17
G =10
IS EASWAY IN EQUILIBRIUM?
Y = 120
C = 84
S = 30
T=6
I = 17
G =10
IS EASWAY IN EQUILIBRIUM?
Y = 120
C = 84
S = 30
T=6
I = 17
G =10
IS EASWAY IN EQUILIBRIUM?
Y = 120 = 84 + 17 + 10?
C = 84
S = 30
T=6
I = 17
G =10
EASWAY ISN’T IN EQUILIBRIUM.
Y = 120 > 111 = E
C = 84
S = 30
T=6
I = 17
G =10
E
S, I
EXCESS
INVENTORIES
C+I+G
Y
S+T
I+G
Y
IS SOUWAY IN EQUILIBRIUM?
Y=
C = 150
S = 45
T=3
I = 24
G =30
IS SOUWAY IN EQUILIBRIUM?
Y=
C = 150
S = 45
T=3
I = 24
G =30
IS SOUWAY IN EQUILIBRIUM?
Y = 198
C = 150
S = 45
T=3
I = 24
G =30
IS SOUWAY IN EQUILIBRIUM?
Y = 198
C = 150
S = 45
T=3
I = 24
G =30
IS SOUWAY IN EQUILIBRIUM?
Y = 198 = 150 + 24 + 30?
C = 150
S = 45
T=3
I = 24
G =30
SOUWAY ISN’T IN EQUILIBRIUM.
Y = 198 < 204 = E
C = 150
S = 45
T=3
I = 24
G =30
E
C+I+G
DEFICIENCY OF
INVENTORIES
S, I
Y
S+T
I+G
Y
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y = C + 46 + 20
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y = C + 46 + 20
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y = C+46+20=C+38+28?
C=
S = 46
T = 20
I = 38
G =28
WESWAY IS IN EQUILIBRIUM
Y = C + 66 = C + 66 = E
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
S + T = 66
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
T = 20
I = 38
G =28
S + T = 66
IS WESWAY IN EQUILIBRIUM?
Y=
C=
S = 46
S + T = 66
T = 20
I = 38
G =28
I + G = 66
WESWAY IS IN EQUILIBRIUM.
Y=
C=
S = 46
S + T = 66
T = 20
I = 38
G =28
I + G = 66
E
S, I
C+I+G
Y
S+T
I+G
Y
MACROECONOMIC EQUILIBRIUM
INCOME = EXPENDITURES
Y=E
Y=C+I+G
C+S+T=C+I+G
S+T=I+G
John Maynard Keynes
The General Theory
Can you write the
equation describing
consumption
behavior if you know
two point on that
equation?
In 2000 Prophetess Mary earned a fairly good income, partly
by making predictions about the outcome of the Bush-Gore
race for the presidency. She earned about $15,000 that year,
out of which she spent about $12,500. She knew that in 2001,
with no election to stimulate her business, her income might
fall to $10,000, out of which she would spend $9,500. On the
basis of these data (and assuming no taxes), calculate
Prophetess Mary’s marginal propensity to consume.
Unfortunately, Prophetess Mary’s Bush-Gore predictions
turned out to be exactly wrong (Poor Mary; Poor Gore!), and
her business dried up completely. Her income dropped
(temporarily) to zero in 2001. How much do you think she
spent on consumption goods while making no income at all?
9. During this election year, Prophetess Mary is
earning a fairly good income, partly by making
predictions about the outcome of the Bush-Gore
race for the presidency. She will earn about
$15,000 this year, out of which she’ll spend about
$12,500. Next year, with no election to stimulate
her business, her income may fall to $10,000, out
of which she may spend $9,500. On the basis of
these data (and assuming no taxes), we can
calculate that Prophetess Mary’s marginal
propensity to consume (MPC) is
A. 0.85.
B. 0.75.
C. 0.80.
D. 0.60.
C
12,500
9,500
C = a+bY
3,000
5,000
10,000 15,000
Y
MPC = b = slope = 3,000 / 5,000 = 0.60
9. During this election year, Prophetess Mary is
earning a fairly good income, partly by making
predictions about the outcome of the Bush-Gore
race for the presidency. She will earn about
$15,000 this year, out of which she’ll spend about
$12,500. Next year, with no election to stimulate
her business, her income may fall to $10,000, out
of which she may spend $9,500. On the basis of
these data (and assuming no taxes), we can
calculate that Prophetess Mary’s marginal
propensity to consume (MPC) is
A. 0.85.
B. 0.75.
C. 0.80.
D. 0.60.
10. But suppose Prophetess Mary’s Bush-Gore
predictions turn out to be exactly wrong, and her
business dries up completely. Even with her
income dropping (temporarily, she hopes) to zero
in 2001, she will engage in consumption spending
(symbolized by “a”) in the amount of
A. $2,500.
B. $3,000.
C. $3,500.
D. $4,000.
C
C = a+bY
12,500
9,500
3,000
MPC = b = slope = 0.60
5,000
a = 3,500
10,000 15,000
C = a + bY
9,500 = a + 0.6 (10,000)
a = 9,500 – 6,000
a = 3,500
Y
10. But suppose Prophetess Mary’s Bush-Gore
predictions turn out to be exactly wrong, and her
business dries up completely. Even with her
income dropping (temporarily, she hopes) to zero
in 2001, she will engage in consumption spending
(symbolized by “a”) in the amount of
A. $2,500.
B. $3,000.
C. $3,500.
D. $4,000.
John Maynard Keynes
The General Theory
Can you work
through the Study
Problem in Keynesian
Economics posted as
a handout?
ECON 2030 STUDY PROBLEM:
KEYNESIAN MACROECONOMICS
Y=C+I+G
The equality between Y (which
represents income and measures
output) and C+I+G (which
represents total expenditures, or
aggregate demand), is the
(Keynesian) equilibrium condition.
ECON 2030 STUDY PROBLEM:
KEYNESIAN MACROECONOMICS
C=a+bY
This simple linear equation shows
the general form of the relationship
between income and consumer
spending. It describes consumer
behavior. Note that a>0; 0<b< 1.
ECON 2030 STUDY PROBLEM:
KEYNESIAN MACROECONOMICS
Y=C+S
In the absence of taxation, this
equation is an identity which defines
savings. That is, saving (S) is defined
as that part of income not spent on
consumption goods (Y-C). With
taxation, we would write Y=C+S+T.
Here’s a particular Macroeconomy:
C=100+0.8Y
This is a specific
consumption equation
that describes the
consumer behavior in
some particular
economy during some
particular period of
time.
Here’s a particular Macroeconomy:
C=100+0.8Y This magnitude
represents the current
I=50
level of investment,
which is based on the
prevailing state of
business confidence.
(Keynes would mention
something about
“animal spirits” here.)
Here’s a particular Macroeconomy:
C=100+0.8Y These magnitudes
represent the current
I=50
levels of government
spending and taxation.
G=60; T=0
Query: How is the
government financing
G if T is 0?
Here’s a particular Macroeconomy:
C=100+0.8Y This is the fullemployment level of
I=50
income--the level of
income that reflects an
G=60; T=0
absence of (cyclical)
unemployment and
Yfe=1,300
corresponds to a wage
rate that clears the
labor market.
Here’s a particular Macroeconomy:
C=100+0.8Y Answer the following
questions based on
I=50
these data and your
understanding of the
G=60; T=0
Keynesian framework.
Yfe=1,300
What are these data telling us?
What is the MPC?
MPC stands for Marginal Propensity
to Consume and is symbolized by
“b” in the equation C=a+bY. In this
economy, then, MPC=b=0.8. When
people get a raise, they increase
their spending on consumption
goods by 80% of the raise.
What are these data telling us?
What is the MPS?
MPS stands for Marginal Propensity
to Save and is symbolized by “1-b”
in the equation S=-a+(1-b)Y. In
this economy, then, MPS=1-b=0.2.
When people get a raise, they
increase their saving by 20% of the
raise.
What are these data telling us?
What is the significance of the "100"
in the equation C=100+0.8Y?
The 100 is the level of consumption
spending that corresponds to an
income of zero. With no income, this
spending would also represent
"dissaving."
And now for some calculations:
What is the investment multiplier and
the government-spending multiplier?
The spending multiplier (whether it’s
investors or the government doing the
spending) is the 1/(1-b) in the
equations:
Y= 1/(1-b) I and Y= 1/(1-b) G
And now for some calculations:
What is the investment multiplier and
the government-spending multiplier?
1/(1-b) = 1/(1-0.8) = 1/0.2 = 5.
So, when investors or the government
increase their spending by, say, 10,
there will be a spiraling up of both
income and expenditures in the
amount of 50.
And now for some calculations:
What saving equation corresponds to
this particular consumption equation?
Consumption is given by C=100+0.8Y.
Savings is given by S=-100+0.2Y.
Just change the sign of the intercept
term and use the MPS instead of the
MPC as the coefficient of Y.
Note that MPC+MPS=1.
And now for some calculations:
At what level of income does savings
equal zero?
Savings is given by S=-100+0.2Y.
Just write S=-100+0.2Y=0 and solve
for Y.
0.2Y = 100
Y = 500
S
S=-100+0.2Y
At Y=500, S=0
Y
And now for some calculations:
How much is aggregate demand when
income is 1,100?
Consumption is the only component of
aggregate demand that depends on
income:
C=100+0.8Y = 100+0.8(1100) = 980.
C+I+G = 980+50+60=1,090.
So, when Y=1,100, C+I+G is 1,090.
And now for some calculations:
Is the economy in equilibrium at this
level of income?
No. Y = 1,100; C+I+G is 1,090.
The equilibrium condition is not met.
Further, with spending less than output
(as measured by income), inventories
are piling up, and the economy will be
spiraling down.
And now for some graphics:
Sketch the aggregate demand curve
and the 45o line and locate Y=1100
and Y=1300 (relative to equilibrium
income).
What is the equilibrium level of
income?
E
Y=E=C+I+G
C+I+G
C+I
C
1,050
1,100
Y = 100 + 0.8Y + 50 + 60
Y – 0.8Y = 210
0.2Y = 210
Y = 1,050
Y
1,300
And now for some stimulant
packages and policy prescription.
Suppose that government spending is
increased by 30.
What does this do to the equilibrium
level of income?
Y= 1/(1-b) G
Y= 1/(1-0.8) 30 = 5(30) = 150
C+I+G’
E
C+I
C
1,050
Y
1,200
1,300
An increase in G of 30 will increase the
equilibrium level of Y by 150.
The new Yeq will be 1,050 + 150 = 1,200.
And now for some stimulant
packages and policy prescription.
How much more government spending
is required to drive the economy to
full employment?
After the increase of 30, income
settles in at 1,200. Full employment is
1,300, so we need another Y of 100.
And now for some stimulant
packages and policy prescription.
How much more government spending
is required to drive the economy to
full employment?
Y= 1/(1-b) G
100= 1/(1-0.8) G
100= 5G;
G = 100/5 = 20
C+I+G’
E
C+I
C
1,050
Y
1,200
1,300
To increase Y by another 100, the
government can increase G by another 20.
A Postscript.
What assumptions about wage rates
and prices do all your calculations and
graphics presuppose?
We assume that wage rates and prices are
"sticky downwards"--and for simplicity, we
assume that they do not change at all.
If they did actually change quickly enough
to clear the markets for goods and for labor,
then there would be no lapses from full
employment to theorize about.
John Maynard Keynes
The General Theory
A workout with the
basic
macroeconomic
magnitudes