Chapter 7: The Real Expenditure Model
A Simple Keynesian MacroEconomic Model Driven by Aggregate Demand
This lecture covers Chapter 7 of the MMT Textbook by Mitchell, Wray and Watts.
Final Exam Questions
1. Explain how the aggregate demand determines the GNP, and clearly differentiate this Keynesian Demand Side perspective from the Supply Side view embodies in RBC models according to which the factors of production Labor and Capital determine the GNP.
2. Consider a situation where Aggregate Demand is insufficient to generate full employment. Suppose the Government increases its demand for good. Show how this will eventually lead to an increase in the GNP. Explain the role of inventory adjustment in this process.
3. Explain how the multiplier works -- a small increase in government demand leads to a much larger increase in total aggregate demand eventually.
RED UNDERLINE is not clear
According to Keynes, total output depends on demand, demand determine the output, firm produce on the basis of expected AD. Production proceed generates employment mostly firm work on reserve capacity (increase supply when demand rises) and they do quantity adjustment when demand rises and prices remain constant. On the other side, there is RBC model or supply side model according to which production is determined by available factors of production and firms have supply constraints so in order to increase output firms will increase prices and economy always works at full employment level. The problem is not the demand because according to Say’s law supply creates its own demand. in Keynesian model if AD is less this leads to decrease in production this leads to unemployment. More or less correct
When government increase spending or starts a new project, this creates new employment opportunities. In the economy production increases, firms start production to fulfill government’s demand so it will start hiring more people, as a result employment will increase. Also income of people rises and they increase consumption, their demand increases and this leads to further increase in production. Firms do production on the basis of expectations about AD which they think satisfy the AD and inventories play an important role in it. If their expected AD is less than the actual AD, inventories run out this give signal to increase production but if expected AD is more than actual aggregate demand then inventories pile up and give signal to stop production, by this process equilibrium is achieved. Inventories pay an important role in Keynesian quantity adjustment model.correct
When ever there is change in AD due to autonomous component: G+I+C0+X this leads to multiple change in AD. When G increases è Agg Dem Increases è Production increases due to which employment increases more generation of income so real GDP increases and when income increases this leads to additional consumption, this leads to addition AD and increase in production and this process goes as a cycle. If a lot of cycles are repeated then this gives multiple effect. Multiplayer effect = 1/(1-c)
example; If tax=0 imports=0 (Closed economy) C=0.9Y , C0=0
AD= C+I, I=50, At Equilibrium AS=AD
C+I = Y What is Equilibrium when I=50?
50 + 0.9 Y = Y
Y* = 50/0.1 = 50 * 10= 500
Multiplier = 1/(1-MPC)=10
Increase of 10 units of Investment will add 100 units of Aggregate Demand. Y* = 60 * 10 = 600 Multiple Round Process.Description is correct, but algebraic part was not worked out. The sequence and how the infinite series sums to the multiplier is missing -- 75% correct.
MMT07 Basic Keynesian Macroeconomics — Demand Driven model of Macro Economy