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Slides Created By Kevin Brady and Eric Chiang

Interactive Examples. Keynesian Macroeconomics. Begin. To navigate, please click the appropriate green buttons. (Do not use the arrows on your keyboard). Material from this presentation can be found in: Chapter 18. Slides Created By Kevin Brady and Eric Chiang. CoreEconomics, 2e.

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Slides Created By Kevin Brady and Eric Chiang

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  1. Interactive Examples Keynesian Macroeconomics Begin To navigate, please click the appropriategreenbuttons. (Do not use the arrows on your keyboard) Material from this presentation can be found in: Chapter 18 Slides Created By Kevin Brady and Eric Chiang CoreEconomics, 2e

  2. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) The Keynesian Model focuses on the relationship between Aggregate Expenditures (AE) in the economy and Income (Y) in the economy. Recall that AE = C + I + G + (X-M), where: 10000 8000 6000 C = Consumption I = Investment G = Government Spending (X-M) = Net Exports 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back

  3. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE By tracing out all of the points where Income is equal to Aggregate Expenditures, we can show the Y = AE line. 10000 8000 For example, notice that when AE = $4,000, Y also equals $4,000. 6000 Question: In this graph, when AE = $10,000, what does Y equal? 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  4. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE By tracing out all of the points where Income is equal to Aggregate Expenditures, we can show the Y = AE line. 10000 8000 For example, notice that when AE = $4,000, Y also equals $4,000. 6000 Question: In this graph, when AE = $10,000, what does Y equal? 4000 2000 Answer = $10,000 2000 4000 6000 8000 10000 Income (Y) Back

  5. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Let’s assume for a moment that the aggregate expenditures in our economy are made up of only consumption (C). In other words, there is no investment, no government spending, and no trade. 10000 8000 C 6000 We can add a line that traces out the amount of consumption for various income levels. 4000 2000 Question: When income is $2,000 how much are consumers spending in this economy? 2000 4000 6000 8000 10000 Income (Y) Back Answer

  6. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Question: When income is $2,000, what do consumers spend in this economy? 10000 Answer: $3,000 8000 C 6000 4000 3000 2000 2000 4000 6000 8000 10000 Income (Y) Back

  7. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Question: When income is $2,000, what do consumers spend in this economy? 10000 Answer: $3,000 8000 C Question: How is it possible that income in the economy is only $2,000, while consumer spending is $3,000? 6000 4000 3000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  8. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Question: When income is $2,000, what do consumers spend in this economy? 10000 Answer: $3,000 8000 C Question: How is it possible that income in the economy is only $2,000, while consumer spending is $3,000? 6000 4000 3000 Answer: Just like many college students, consumers in the entire economy can borrow to spend more than they are currently earning! 2000 2000 4000 6000 8000 10000 Income (Y) Back

  9. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE On the other hand, it is possible for spending in the economy as a whole to be less than income. 10000 8000 C Question: How much saving is there in the economy when income is $8,000? 6000 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  10. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE On the other hand, it is possible for spending in the economy as a whole to be less than income. 10000 8000 C Question: How much saving is there in the economy when income is $8,000? 6000 Answer: When income is $8,000, spending in the economy is only $6,000. This implies there is $2,000 in savings. 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back

  11. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Question: On this graph, when is the economy in equilibrium? In other words, at what level of income are aggregate expenditures equal to income? 10000 8000 C 6000 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  12. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Question: On this graph, when is the economy in equilibrium? In other words, at what level of income are aggregate expenditures equal to income? 10000 8000 C Answer: Recall that we are ignoring investment, government spending, and trade for now. Thus, consumption represents all aggregate expenditures. 6000 4000 This means that when the consumption line crosses the Y = AE line, we have the answer to our question! 2000 This occurs at an income level of $4,000. 2000 4000 6000 8000 10000 Income (Y) Back

  13. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Let us now add investment to our economy. Suppose businesses spend $1,000 on investment no matter what the income level is in the economy. 10000 8000 C Question: How can we show this in our model? 6000 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  14. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Let us now add investment to our economy. Suppose businesses spend $1,000 on investment no matter what the income level is in the economy. 10000 AE = C+Io 8000 C Question: How can we show this in our model? 6000 Answer: By adding $1,000 to consumption for every possible income level, we arrive at a new AE curve labeled “AE = C + Io” 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back

  15. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Question: What is the new equilibrium in this economy? 10000 AE = C+Io 8000 C 6000 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  16. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Question: What is the new equilibrium in this economy? 10000 AE = C+Io Answer: The new equilibrium is where the AE = C+Io line crosses the Y = AE line. 8000 C 6000 The new equilibrium is $6,000 in income and $6,000 in aggregate expenditures. 4000 Did you notice something remarkable here? 2000 2000 4000 6000 8000 10000 Income (Y) Back

  17. Interactive Examples Keynesian Macroeconomics Next Aggregate Expenditures (AE) Y = AE Did you notice something remarkable here? 10000 AE = C+Io To see what is remarkable, let’s take a step backwards. With only consumption in the model, the equilibrium income level in the economy was $4,000. 8000 C 6000 When we added investment spending of $1,000, the new equilibrium income level in the economy was $6,000. 4000 2000 An increase in investment spending of $1,000 led to a $2,000 increase in income in the economy!!! 2000 4000 6000 8000 10000 Income (Y) Back

  18. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE This remarkable phenomena is known as the multiplier effect, which in essence shows that added spending can change equilibrium income in the economy by more than the additional spending. 10000 AE = C+Io 8000 C 6000 Question: Why does this happen? 4000 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  19. Interactive Examples Keynesian Macroeconomics Next Answer: Because one person’s spending becomes another person’s income, part of which that person then spends, which then becomes another person’s income, part of which they spend, and so on and so forth. This process allows us to calculate the spending multiplier, which tells us how many more times income will change in the economy for each extra dollar in spending. In our example, the spending multiplier was 2, because a $1,000 increase in investment spending resulted in a $2,000 increase in income in the economy. Back

  20. Interactive Examples Keynesian Macroeconomics Question: What is the general formula for the spending multiplier? Back Answer

  21. Interactive Examples Keynesian Macroeconomics Next Question: What is the general formula for the spending multiplier? The spending multiplier depends on how much each person spends of their additional income. The spending multiplier (k) is found by computing 1 / (1 – MPC), where MPC is the marginal propensity to consume. The MPC is the change in consumption associated with a given change in income. Back

  22. Interactive Examples Keynesian Macroeconomics Question: If spending in the economy rises $90 for the next $100 earned in income, what is the MPC? What is k? Back Answer

  23. Interactive Examples Keynesian Macroeconomics Next Answer: The MPC would be $90 / $100, or .90. Since k = 1 / (1 – MPC), we find that k = 1 / (1 - .90) = 10 Back

  24. Interactive Examples Keynesian Macroeconomics Question: If businesses decide to invest an additional $50, and the marginal propensity to consume is .80, by how much will income in the economy grow? Back Answer

  25. Interactive Examples Keynesian Macroeconomics Next Answer: Since the MPC is .8, we know the spending multiplier is 1 / (1 - .8), which is 5. To find the change in income, take change in spending and multiply it by the spending multiplier. In this case, $50 * 5 = $250. Income will rise by $250 in the economy. Back

  26. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Y = AE Recall that aggregate expenditures in a modern economy also depend on government spending (G) and net exports (X-M). We can add these components in the same way we added investment. As we did for investment, let’s assume the level of G is the same at each income level. 10000 AE = C+Io 8000 C 6000 4000 Question: If government spending is $2,000, what is the new equilibrium income level in the economy? 2000 2000 4000 6000 8000 10000 Income (Y) Back Answer

  27. Interactive Examples Keynesian Macroeconomics Aggregate Expenditures (AE) Answer: We can add $2,000 to our C+Io line for each income level to get a new AE line, namely C + Io + Go. Y = AE AE = C+Io+Go 10000 AE = C+Io 8000 C The new equilibrium income in the economy is $10,000. 6000 Remember that we can also use this framework to analyze changes in net exports. 4000 2000 Also remember that the multiplier effect also occurs in reverse: a cut in spending will lead to a larger drop in equilibrium income! 2000 4000 6000 8000 10000 Income (Y) Start Over Back

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