The Keynesian Cross

The Keynesian Cross

The Keynesian Cross Chapter 9 Appendix McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved. The Keynesian Cross The Keynesian cross focuses on the relationship of total spending to the value of output, with no explicit distinction between price levels and real output Aggregate expenditure: The rate of total expenditure desired at alternative levels of income, ceteris paribus 9A-2 The Consumption Shortfall Say the consumption function is: C a bYD $100 0.75YD With full employment output of $3 trillion, consumption at full employment is CF $100 0.75 $3, 000 billion $2,350 billion 9A-3 The Consumption Shortfall ZF $3000 Expenditure Total output 2350

CF 2000 Output not purchased by consumers 1500 1000 Consumption function (C= $100 + 0.75YD) 500 YF 45 0 1000 2000 3000 Income (Output) 9A-4 Non-consumer Spending Investors, governments, and net export buyers add to consumer spending to equal aggregate expenditure Aggregate expenditure still might not reach

full employment 9A-5 Aggregate Expenditure At Income (output) of Consumers Desire to Spend $ 500 $ 475 $ 150 $ 200 $ 50 $ 875 1,000 850 150 200 50 1,250

1,500 1,225 150 200 50 1,625 2,000 1,600 150 200 50 2,000 2,500 1,975 150 200 50 2,375

3,000 2,350 150 200 50 2,750 3,500 2,725 150 200 50 3,125 + Investors Desire to Spend + Governments Desire to Spend

+ Net Export Spending = Aggregate Expenditure 9A-6 Aggregate Expenditure Y = AE 3500 YF g EXPENDITURE 3000 Aggregate expenditure (AE = C + I + G + (X M)) f 2500 e 2000 d

Consumer spending (C= $100 + 0.75Y) c 1500 1000 b a 500 Investment spending = $150 Government spending = $200 $500 $1000 $1500 $2000 $2500 $3000 $3500 Net exports = $50 INCOME (OUTPUT) 9A-7 A Recessionary Gap

In this case, we end up with less aggregate expenditure ($2,750 billion) than the value of full-employment output Recessionary gap: The amount by which aggregate spending at full employment falls short of full-employment output 9A-8 Recessionary Gap Expenditure $3500 3000 2750 2500 Output at YF g Recessionary gap f Equilibrium 2000 1500 1250 1000 E e ex t a

reg g g A AE = Y ditu n e p Desired spending at YF re 500 45 0 $500 Y1 1000 YE 1500 2000 YF 2500 3000

Income (Output) 9A-9 A Single Equilibrium Expenditure equilibrium: The rate of output at which desired spending equals the value of output The point where the AE and 45 degree lines meet Producers have no incentive to change the rate of output, since are selling all they produce 9A-10 Expenditure Equilibrium $3500 AE = Y Expenditure 3000 2500 Equilibrium 2000 1500 1000 Ag re u t i

end p x ee t a g gre E 500 YE 45 0 $500 1000 1500 2000 2500 3000 Income (Output) 9A-11 Expenditure Equilibrium At Income (output) of

Consumers Desire to Spend $ 500 $ 475 $ 150 $ 200 $ 50 $ 875 1,000 850 150 200 50 1,250 1,500 1,225 150 200

50 1,625 2,000 1,600 150 200 50 2,000 2,500 1,975 150 200 50 2,375 3,000 2,350 150 200

50 2,750 3,500 2,725 150 200 50 3,125 + Investors Desire to Spend + Governments Desire to Spend + Net Export Spending Aggregate

= Expenditure 9A-12 Macro Failure Market participants spending desires could also exceed the economys full-employment potential Inflationary gap: The amount by which aggregate spending at full employment exceeds full-employment output 9A-13 Two Paths to the Same Conclusion Both the Keynesian cross and the AD/AS framework lead to the same conclusion about macro instability The former focuses on total spending, the product of output and prices The latter distinguishes separate effects of macro instability on prices and real output 9A-14 The Keynesian Cross End of Chapter 9 Appendix McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

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