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Keynesian Economics
Keynesian Economics
Keynesian economics is an economic theory of total
spending in the economy and its effects on output
and inflation. Keynesian economics was developed by the
British economist John Maynard Keynes during the 1930s
in an attempt to understand the Great Depression. Keynes
E C O N O M I C DEVELOPMENT advocated for increased government expenditures and
lower taxes to stimulate demand and pull the global
economy out of the depression.
Increase in the prices of goods and services over time.
Increases your cost of living.
Key Terms

Reduces the purchasing power of each unit of currency.

John Maynard Keynes

Father of Keynesian economics.
"The General Theory of Employment, Interest and Money,"
His career spanned academic roles and government

Great Depression
Worldwide economic downturn that began in 1929 and
lasted until about 1939
Caused drastic declines in output,
severe unemployment, and acute deflation in almost
every country of the world.
Key Keynesian Economics focuses on using
01 active government policy to manage
aggregate demand in order to address or
Takeaways prevent economic recessions.

Keynes developed his theories in response to the

Great Depression, and was highly critical of
02 classical economic arguments that natural economic
forces and incentives would be sufficient to help the
economy recover.

Activist fiscal and monetary policy are

03 the primary tools recommended by
Keynesian economists to manage the
economy and fight unemployment.
Keynesian Theory

These models stress the accumulation of

capital. They include Rostow’s (1960)stages
of growth model and the Harrod-Domar
growth model. Growth among countries
using these models could easily diverge. The
models do not explicitly consider the law of
diminishing returns to the capital which can
take effect as growth proceeds. In this sense,
they are not particularly realistic.
Rostow’s Stages of Growth Model

5. Age of mass consumption

4. Drive to maturity

3. Take-off

2. Pre-conditions for take-off

Walt Rostow took a historical
approach in suggesting
1. Traditional society. that developed countries have
tended to pass through five stages
to reach their current degree of
economic development.
Harrod-Domar Model
The Harrod-Domar economic growth model
stresses the importance of savings and
investment as key determinants of growth

The Harrod Domar Growth model is a

growth model and not a growth strategy!

50% 50%

National savings Productivity of capital level

Basic Harrod-Domar model says:
Rate of growth of GDP = Savings ratio /
capital output ratio

Numerical examples:
•If the savings rate is 10% and the capital output
ratio is 2, then a country would grow at 5% per
•If the savings rate is 20% and the capital output Keynesian
ratio is 1.5, then a country would grow at 13.3%
per year.
•If the savings rate is 8% and the capital output
ratio is 4, then the country would grow at 2% per
Based on the model therefore the rate of growth in
an economy can be increased in one of two ways:
Keynesian Model
Distinguish features of a
Keynesian Model

Keynesian Keynesian Keynesian

Model Model Model
Undoubtedly There can be Aggregate
too simple to be equilibrium at demand shocks
realistic. less than full can have large
employment. effects on output.
01 The Keynesian
Aggregate Income Theory
The total of all
incomes in an
economy without Keynes's theory of the
adjustments for
determination of equilibrium
inflation, taxation, or
types of double real GDP, employment, and
counting. prices focuses on the
relationship between
aggregate income and

02 Keynes used
his income‐expenditure
model to argue that the
These are economy's equilibrium level
payments of of output or real GDP may
currency or barter
credits for not correspond to the
necessary inputs natural level of real GDP.
(goods or services).
Keynes' Income‐Expenditure Model

Real GDP can be decomposed into four

component parts: The exception is aggregate expenditures on
consumption. Keynes argues that aggregate
consumption expenditures are determined
primarily by current real national income.
Aggregate expenditures on
consumption Aggregate consumption expenditures equation:

Aggregate consumption= C + mpc (Y)

Investment (I)
regarded Where,
Government (G) as autonomous or C = autonomous consumption expenditure
independent of current Y = level of current real income (=current real GDP)
income. (mpc) = fraction of a change in real income that is
Net exports (NX)
currently consumed
marginal propensity to
Y = AE implies that Model
Aggregate Expenditure
Y = A + mpc (Y)
(1-mpc) Y = A
AE = A + (mcp) Y Y* = m (A)
A = C+I+G+NX m= 1
Y = real national income (1 – mpc) In words, the equilibrium level of
(mpc) = fraction of a change in real GDP, Y*, is equal to the
real income that is currently level of autonomous
consumed expenditure, A, multiplied by m,
the Keynesian multiplier.
Aggregate Expenditure Curves

The upward slope of

these AE curves is due to
the positive value of
the mpc. As real national
income Y rises, so does
The Keynesian condition
the level of aggregate
for the determination of
equilibrium real GDP is
Three different aggregate expenditure that Y = AE. This
curves which have three different equilibrium condition is
denoted in Figure by the
corresponding autonomous diagonal, 45° line, labeled Y =
expenditure: AE1, AE2, AE3 AE.
Aggregate Expenditure Curves
 Level of equilibrium real national income or
GDP = The intersection of the AE curve with
the 45° line.
 The levels of real GDP that correspond to these
intersection points are the equilibrium levels of
real GDP, denoted in Figure as Y 1, Y 2, and Y 3.

• Each AE curve corresponds to a different
equilibrium level for Y.
• Each Y is a multiple of the level of autonomous
aggregate expenditure, A, as was found in the
algebraic determination of the level of
equilibrium real GDP.
Graphical illustration of the
Keynesian theory

The Keynesian theory of the determination o

f equilibrium output and prices makes use of
both the income‐expenditure model and the
aggregate demand‐aggregate supply model,
as shown in Figure .


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