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Assignment 9: Keynesian Economics and the Expenditure Model

Module Summary:

Because the Keynesian view of economic growth relies on government spending, it is

useful to have a model which relates aggregate spending with aggregate incomes. The

expenditure model illustrates this relationship and gives us a tool to determine how much

income will be produced by various levels of output (expenditure).

The expenditure graph will visually illustrate how a change in spending will change real

disposable income, which is the goal of Keynesian economics. The expenditure model

also illustrates the power of the spending multiplier to enhance changes in spending.

Discussion Board Question:

Why do Keynesian economists rely on high levels of consumption for their policies to

work?

Section 1 – Essay Questions: Please answer each essay question completely and to the best of your ability. Please answer using complete sentences.

1. Explain what happens to the government’s ability to influence the government through changes

in spending as people decide to save more money? ___________________________________________________________________________________________

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2. Explain how the MPC is related to the spending multiplier. ___________________________________________________________________________________________

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Round of

Spending

Income Spending Savings

1 $5,000

2

3

4

5

Section 2 – The Spending Multiplier: Our economy has the ability to multiply initial spending through the circular flow. Complete the exercises below to better understand the multiplier process.

1. Calculate the spending multiplier for the following.

a. MPC = .5 → Spending Multiplier = ____________________

b. MPC = .75 → Spending Multiplier = ____________________

c. MPC = .9 → Spending Multiplier = ____________________

d. MPC = .95 → Spending Multiplier = ____________________

e. MPS = .2 → Spending Multiplier = ____________________

2. Suppose the government decides to spend $5,000 on a new public works project. Given the MPC in the

economy is .75, complete the table below and answer the corresponding questions.

a. What is the spending multiplier for the economy describd above?______________

b. What is the total amount of spending created by the public works project? ______________

c. What is the total amount of savings created by the public works project? ______________

3. Suppose you are facing a recessionary gap of $10,000,000 currently in your economy. How much would

you increase/decrease government spending to close the gap completely if the MPC in your economy is

.9? ___________________

4. Suppose your economy is currently producing $10,000,000 above its long-run potential. As an economic

advisor, you are concerned about inflation so you decide to slow down the economy. How much would

you increase/decrease government spending to return the economy to equilibrium if the MPC in your

economy is .9? ___________________

Real Aggregate

Expenditure

AE = Y

$50,000 $65,000

(Y P )

AE 1

$50,000

Real Aggregate

Income

$10,000

Real Aggregate

Expenditure

AE = Y

$100,000$60,000

(Y P )

AE 1

$100,000

Real Aggregate

Income

$25,000

Section 3 – Using Keynesian Economics and the Expenditure Model: In this section are examples of how Keynesian economics is applied. Complete the exercises below to reinforce your knowledge on this

subject.

1. Use the graph below to answer the following questions. (Hint: You must calculate the MPC first from the

slope of the aggregate expenditure line)

a. What is the MPC for this economy? _____________

b. Is the economy facing an expansionary or recessionary gap? _____________

c. How much is the gap? _____________

d. What is the multiplier in this economy? _____________

e. What is the change in government spending needed to return to equilibrium? _____________

2. Use the graph below to answer the following questions. (Hint: You must calculate the MPC first from the

slope of the aggregate expenditure line)

a. What is the MPC for this economy? _____________

b. Is the economy facing an expansionary or recessionary gap? _____________

c. How much is the gap? _____________

d. What is the multiplier in this economy? _____________

e. What is the change in government spending needed to return to equilibrium? _____________