Basic Keynesian Model Keynesian Cross Diagram

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# Basic Keynesian Model Keynesian Cross Diagram - PowerPoint PPT Presentation

Basic Keynesian Model Keynesian Cross Diagram. Measuring the macroeconomy. GNPpm = GDP – factor incomes from abroad + factor incomes of foreigners NetNPpm = GNPpm - Depreciation

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Basic KeynesianModel

Keynesian Cross Diagram

Measuringthemacroeconomy
• GNPpm = GDP – factor incomesfromabroad + factor incomes of foreigners
• NetNPpm = GNPpm - Depreciation
• NNP at factor costs = Net NationalProduct – Net indirecttaxes + Subsidies (NNP=net nationalproduct at factor costs)
• NI (NationalIncome) = NNPcf
• Personal DispousableIncome (PDI = Familyincome = NI – Directtaxes + Transfers - Profits + Undistributedprofits
• Personal DisposableIncome (PDI = Familyincome )= ConsumptionSpending+ Savings
• Consumerpriceindex: the CPI measuresthepriceincrease of a merketbasketfogoodsrepresentative of thepurchases of a typicalhousehold
• TheUnemploymentrate: Theunemployed are peoplewhowanttowork and are activelylookingforjobsbuthavenotyetfoundone. Theunemploymentrateisequaltothenumber of unemployedpeopledividedbythe total labor force.
Key concepts
• GDP composition
• The demand of goods and services
• The equilibrium

EXPENDITURE (FLOW OF EXPENDITURE)

MARKET

GOODS &

SERVICES

MONETARY FLOW

HOUSEHOLDS

FIRMS

(CONSUMPTION)

(PRODUCTION)

FACTORES DE

PRODUCCION

INCOMES –WAGES ((FLOW OF INCOMES)

REAL FLOW

FACTORS

The circular flow of economicactivity

GOODS AND SERVICES

Demandvaries, production

Productionvaries, incomevaries

Incomevaries, demandvaries

National income identity
• Production is equal to income. Then:
• This last equation states that savings should be sufficient for financing the investment spending, the budget deficit and the trade deficit. In other words, increases in budget or trade deficits unless accompanied by an equal increase in savings will lead to the crowding out of investment
Short-runmacroeconomicmodels
• Keynesianmodel (Endogenous variable: Income)
• Fixedprices
• Pureexchangeeconomy. No money
• IS-LM Model (Endogenous variables: income-interest rate)
• Fixedprices
• Monetaryeconomy
• Open economywithout capital flows
• IS-LM with capital mobility (Mundell-Fleming) (Endogenous variables: Income-interestrates)
• Fixedprices
• Monetary economy
• Open economywithcapital flows
• Aggregate supply and demand model (Endogenous variables: Prices-Income). AS-AD diagram
• Sticky prices
• Monetary economy
• Dynamic AS-AD model (endogenous variables: inflation rates and income)
Keynesianmodel: assumptions
• Government sector:

(0<t<1)

• Budget deficit (BS) isdefinedbythedifferencebetweentaxes and thesum of government purchases (G) and transfers (TR).
• Open Economy: net export is a decreasing function of national income. The coefficient m, is the marginal propensity to import.
• No money
• Fixedprices: no inflationnordeflation
Keynesianmodel
• In thismodel a macroeconomicequilibriumisreachedwhen actual ouput Y, isequaltointendedspending. Hence, thelevel of theaggregatedemand determines theincomelevel.
• Consumptionspending (C),
• Investmentspending (I),
• Governmentpurchases, G,
• Investmentspending, I.
• Therefore Y+Q-X isequalto:

and

Being X and Q, export and import, respectively.

Keynesianmodel
• Equations:
• Susbtracting (7) - (8), s:
Keynesianmodel
• Ecuaciones del modelo:
• Substituting (4) in (3)
Simple keynesianmodel
• Substituting (5), (6), (9) y (10) in (2)
Keynesianmodel
• Equations are now:
• Substituting (11) into (1) :
Keynesianmodel
• In compact form:
• ¿Qué dice aquí?
• Theequilibriumlevel of incomeisdeterminedbythemultiplier and bytheautonomousexpenditurecomponent.
• Anyincrease in autonomousspendingoranyincrease in themultiplierwillchangenationalincome.
• Proof:
Keynesianmodel
• dAo:
• Interpretation
• Anychange in autonomousconsumptionspending, autonomousinvestmentspending, marginal propensityto consume out of disposable personal income , ttransfers, governmentpurchasesorautonomous net exportwillincreaseautonomousspending .
• Ontheotherhand, anychange in t, m or c willchangethemultipliervalue
Check
• By using the last equation
• we can check that

Types of changes in theexogenous variables

• Exogenous variables in themodel can besplittedintotwogroups: a) variables dependingontheindividual’sdecisions: (c, I, m); variables determinedbyauthorities (Governmentor Central Bank):G, TR, XN, t. Changes in G, TR, XN and t are fiscal and trade policy variables. Changes in this variables are policy shocks.
• Sincechangesin G, TR y t, will lead changes in budget surplus, they are defined as fiscal policyinstruments.
• Changes in tariffsor in theexchangerate in ordertochangeNXo, are tradepolicyinstruments.
Expansionary vs. Contractionarypolicies
• If as a result of anykind of policy shock incomeincreases, thispolicyisexpansionary. The so-calledcontractionarypolicies lead incomedecreases.
• Forinstance,
• Increase in G : Fiscal policyexpansionary
• A taxcut: Fiscal policyexpansionary
• Decrease in TR: Fiscal policycontractionary
• A cut in tariffs: Tradepolicycontractionary
• A decreaase in the marginal propensityto consume (NO policy)
Themodel

HORIZONTAL AXIS:

INCOME (Y)

VERTICAL AXIS:

Renta,Y

45º LINE: EQUILIBRIUM CONDITION Y=DA

45o LINE

SLOPE= 1

Y1

INCOME,Y

Y1

45o LINE

Ao

Y

THE EQUILIBRIUM

45o LINE

E

EQUILIBRIUM:

Y = DA

AUTONOMOUS SPENDING

Y

E’

Y1

E

Yo

45º

Yo

Y1

A1

Ao

INCOME,Y

HIGHLIGHTS
• C and I will decrease in recessions
• Howver, Government could increase G (government purchases):
• Government intervention vs. laissez faire-laissez-passer.
• Key argument: multipliereffect.

From this model, what are the recipes for the crisis

Multiplier effect
• For simplicity suppose that we are in a closed economy, and suppose that Government increases the government purchases.
• The increase in government purchases by 1 euro changes intended spending by 1 euro and income in 1 euro. After tax, 1-t euros will be disposable for consumption . Therefore, the consumption spending will increase in c(1-t) euros, so the intended spending goes up and income will also increase in c(1-t).
• This new increase in income, will lead a new increase in consumption spending of ….
• The sum of the initial effects and the rest of induced effects determines that the multiplier will be higher than 1.
Fiscal policy and Budget surplus

How an increase in G would affect the budget deficit?

How an increase in G would affect the budget deficit?

• Taking differences
• The increase in income from the increase in government purchases is , dY=αdG then:

E’

Y1

Yo

E

45º

Yo

Y1

An increase in the Government purchases

A1=C0+I0+G1+cTRo+NXo

Ao=C0+I0+G0+cTRo+NXo

Income,Y

E’

Y1

Yo

E

45º

Yo

Y1

An Increase in the Transfers

A1=C0+I0+G0+cTR1+NXo

Ao=C0+I0+G0+cTRo+NXo

INCOME,Y

E

Yo

45º

Y1

An increase in the tax rate