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Keynesian Economics and IS-LM Analysis (I)
Terms in this set (10)
What is planned spending?
Planned spending, saving or investment refers to the intended actions of households and firms → example: a person may intend to save €1000 over the year to put towards paying for a wedding next year
What is actual spending?
Actual spending, saving or investment refers to the realized outcome resulting from actions of households and firms → example: plans for saving for the wedding may be compromised by the need to spend money on repairing a house damaged by a flood.
What does Keynes suggest about planned and actual outcomes?
Keynes suggested that there was no reason why national income would coincide with full employment → sticky wages and prices: the economy could be at a position where the level of demand in the economy is insufficient to bring full employment.
How does Keynesian explain the deviations in the business cycle?
What causes downturns in economic activity?
- Downturns in economic activity occur because firms fail to sell all the goods and services that they planned to sell
→ if customers are not buying as many goods and services, firms will not need to produce as many and so cut back production
→ if production is cut back then firms do not need as many workers
→ unemployment rises
→ the affected workers see a fall in their incomes and so cut back their spending which exacerbates the problem.
How does Keynes say the government can influence demand in the economy?
Keynes argued that governments can use the tools of fiscal and monetary policy, and in particular fiscal policy, to influence demand in the economy and reduce inflationary and inflationary gaps
→ combinations of changes in tax and government spending can be used as levers to manage demand and bring the economy into equilibrium at a point nearer to full employment output.
What is the multiplier effect?
The multiplier effect refers to the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending.
Multiplier effect explained?
When consumer spending rises, the firms that produce these consumer goods hire more people and experience higher profits .
• The higher earnings and profits stimulate consumer spending once again, and so on. • Thus, higher demand leads to higher income, which in turn leads to even higher demand.
• The total impact on the quantity of goods and services demand can be much larger than the initial impulse from higher government spending.
• The multiplier effect can be strengthened by response of investment to higher levels of demand.
What is MPC and the MPS?
The marginal propensity to consume (MPC) is the fraction of extra income that a household consumes rather than saves.
• The marginal propensity to save (MPS) is the fraction of extra income that a household saves rather than consumes.
Equation for the multiplier?
𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 𝑘 = 1/ 1 − 𝑀𝑃C or k= 2/MPS
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