The Keynesian Model of Income Determination

Question 1

What is the Keynesian Model primarily used to explain?

Answer 1

How national income (output) is determined and why it fluctuates.

Question 2

What are the key assumptions of the Keynesian model?

Answer 2

Fixed prices, unemployed resources, goods market only, closed economy, firms supply what is demanded.

Question 3

What determines output in the Keynesian model?

Answer 3

Demand — the model is demand-driven

Question 4

What is the role of government in the Keynesian model?

Answer 4

To intervene via fiscal policy to stabilize the economy during demand deficiencies.

Question 5

What is the consumption function in its basic form

Answer 5

C=bY, where b is the marginal propensity to consume (MPC).

Question 6

How do you calculate the MPC?

Answer 6

MPC=ΔC/ΔY

Question 7

What is the savings function derived from the consumption function?

Answer 7

S=(1−b)Y, where (1−b) is the marginal propensity to save (MPS)

Question 8

What does the investment function look like in the simple Keynesian model?

Answer 8

Investment (I) is assumed autonomous: I=constant

Question 9

What is the full form of the consumption function including autonomous spending?

Answer 9

-
C= C +bY

Question 10

What is the formula for Aggregate Expenditure (AE)?

Answer 10

AE=C+I

Question 11

Substituting the functions, what is the AE formula?

Answer 11

-
AE= C+bY+I

Question 12

What defines the equilibrium level of national income in the model?

Answer 12

Y=AE

Question 13

Solving for equilibrium, what is the formula?

Answer 13

Y= C+b(TR-T)+I+G
—-
1-b

Question 14

What is the Keynesian multiplier formula?

Answer 14

k= 1
—–
1-b
​

Question 15

If MPC = 0.75, what is the value of the multiplier?

Answer 15

1−0.75
=4

Question 16

Why is the multiplier greater than 1?

Answer 16

Because increased income leads to induced consumption which further increases income

Question 17

How does an initial increase in investment affect income?

Answer 17

It leads to a multiplied increase in national income via consumption feedback loops.

Question 18

How is disposable income (Yd) defined with government included?

Answer 18

Yd =Y+TR−T, where TR = transfers, T = taxes.

Question 19

How is the consumption function revised with government?

Answer 19

C=a+b(Y−T)

Question 20

What is the new AE formula including government?

Answer 20

A= C +b⋅TR+I+G

Question 21

How is the equilibrium income calculated with government?

Answer 21

-
Y= C +I+G+bTR
—————-
1−b(1−t)

Question 22

What is the formula for net exports (NX)?

Answer 22

NX=X−mY, where X = exports, mY = imports

Question 23

What is the revised AE function with foreign trade included?

Answer 23

-
AE= C+bY+I+G+X−mY

Question 24

What is the equilibrium income formula with trade?

Answer 24

–
AE
Y= ————-
1−b+m

Question 25

How does government spending affect income?

Answer 25

1 ΔY=ΔG× ----------- 1−b(1−t)

Question 26

How do transfer payments affect income?

Answer 26

1 ΔY=b×ΔTR× ------------ 1−b(1−t)