John Maynard Keynes - Essay Example

John Maynard Keynes’ Aggregate Expenditure Model The aggregate expenditure model of John Maynard Keynes concentrates on the correlation between aggregate expenditure and income. Keynes applied the income-expenditure approach to explain that real GDP’s equilibrium level may not signify real GDP’s normal level (Tucker 2008). In the income-expenditure framework, real GDP’s equilibrium level is real GDP’s level that is in agreement with the existing aggregate expenditure level (Tucker 2008).

*picture taken from Tucker (2008, p. 224) The above diagram is the income-expenditure model of real GDP’s equilibrium formulated by Keynes. If the existing aggregate expenditure level is not adequate to acquire the whole supplied real GDP, output will be reduced until real GDP level is equivalent to the aggregate expenditure level (Morton 2003). Thus, according to Tucker (2008), if the existing aggregate expenditure level is not adequate to acquire real GDP’s normal level, then the real GDP’s equilibrium level will fall at some point below the normal level.

If the falling of prices is prevented, then to prevent too much inventory accumulations supplies should cut back the supplied quantity, even though they would be eager to provide bigger volumes at the existing market prices (Morton 2003). This scenario is a case of equilibrium merely in the quite narrow logic that the ‘quantity actually supplied of final goods and services is equal to the quantity demanded’ (Truett & Truett 1998, 71). The multiplier theory determines an exact correlation between the rate of investment and aggregate income, given the slight tendency to consume (Morton 2003).

Keynes coined the term ‘investment multiplier’ to refer to that internal factor innate in the economic system which transmits, incorporates, and absorbs an outside ‘shock’ (Truett & Truett 1998, 72). Per se, it is a marker of the expected employment instability from certain instability in investment (Truett & Truett 1998). The consequent concerns from the point of view of policymaking involve, primarily, how long is the readjustment period of the markets to an equilibrium condition. It is difficult to visualize that prices will remain static suitably, but it is practical to predict that they will not fine-tune immediately (Tucker 2008).

A subsequent concern is the extent and feature of the social disadvantages of automatic unemployment during the phase of readjustment and the potential policy alternatives and their matching costs to mitigate this unemployment. A boost in aggregate demand, for instance, being caused by a boost in government spending could get rid of this automatic unemployment (Tucker 2008); however, this will have other consequences to the economy in due course (Morton 2003). If the structure of the market is viewed to be the predicament, as stated by Morton (2003), the government could embark on any attempts to boost the competitiveness of the markets.

Another, certainly severe, scenario actually suggested by Keynes is that following a decline in aggregate demand, the curves of aggregate supply and aggregate demand do not cross at any positive level of aggregate price (Tucker 2008). The aggregate expenditure model of Keynes may also be applied to explain in a more understandable way the more newly introduced theories in macroeconomics including models of dynamic path adjustment that involve discussions of the effect of imprecise predictions and lack of information (Truett & Truett 1998).

According to Tucker (2008), such paradigms of defective market organization usually embody a combination of classical and Keynesian perspectives. References Morton, J. Advanced Placement Economics: Macroeconomics: Student Activities. New York: National Council on Economic Education, 2003. Truett, J. & D. Truett. “The Aggregate Demand/Supply Model: A Premature Requiem?” American Economist 42.1 (1998): 71+ Tucker, I. Macroeconomics for Today. Mason, OH: South-Western College Pub, 2008.