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By the end of this section, you will be able to:
  • Explain real GDP, recessionary gaps, and inflationary gaps
  • Recognize the Keynesian AD/AS model
  • Identify the determining factors of both consumption expenditure and investment expenditure
  • Analyze the factors that determine government spending and net exports

The Keynesian perspective focuses on aggregate demand. The idea is simple: firms produce output only if they expect it to sell. Thus, while the availability of the factors of production determines a nation’s potential GDP    , the amount of goods and services actually being sold, known as real GDP    , depends on how much demand exists across the economy. This point is illustrated in [link] .

The keynesian ad/as model

Keynesian view of the AD/AS model shows that with a horizontal AS, a decrease in demand leads to a decrease in output, but no decrease in prices.
The Keynesian View of the AD/AS Model uses an SRAS curve, which is horizontal at levels of output below potential and vertical at potential output. Thus, when beginning from potential output, any decrease in AD affects only output, but not prices; any increase in AD affects only prices, not output.

Keynes argued that, for reasons we explain shortly, aggregate demand is not stable—that it can change unexpectedly. Suppose the economy starts where AD intersects SRAS at P 0 and Yp. Because Yp is potential output, the economy is at full employment. Because AD is volatile, it can easily fall. Thus, even if we start at Yp, if AD falls, then we find ourselves in what Keynes termed a recessionary gap    . The economy is in equilibrium but with less than full employment, as shown at Y 1 in the [link] . Keynes believed that the economy would tend to stay in a recessionary gap, with its attendant unemployment, for a significant period of time.

In the same way (though not shown in the figure), if AD increases, the economy could experience an inflationary gap    , where demand is attempting to push the economy past potential output. As a consequence, the economy experiences inflation. The key policy implication for either situation is that government needs to step in and close the gap, increasing spending during recessions and decreasing spending during booms to return aggregate demand to match potential output.

Recall from The Aggregate Supply-Aggregate Demand Model that aggregate demand is total spending, economy-wide, on domestic goods and services. (Aggregate demand (AD) is actually what economists call total planned expenditure. Read the appendix on The Expenditure-Output Model for more on this.) You may also remember that aggregate demand is the sum of four components: consumption expenditure, investment expenditure, government spending, and spending on net exports (exports minus imports). In the following sections, we will examine each component through the Keynesian perspective.

What determines consumption expenditure?

Consumption expenditure is spending by households and individuals on durable goods, nondurable goods, and services. Durable goods are things that last and provide value over time, such as automobiles. Nondurable goods are things like groceries—once you consume them, they are gone. Recall from The Macroeconomic Perspective that services are intangible things consumers buy, like healthcare or entertainment.

Questions & Answers

what is price surveillance?
Berry Reply
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aza Reply
what is elasticity of demand?
Rita Reply
Causes of economic growth
pierre Reply
What is elasticity of demand
What are the causes of economic growth
economic growth, establishment of industry, encourage of investor's, farm productivities, creation of institutions, construction of good road etc
elasticity of demand can be said to be the responsiveness of demand to a change in prices
impact of collusion in the economy referring to inefficiencies illustrated by means of graph
nondumiso Reply
The Factor price will determine the choice of techniques to produce.Expantiate
what is elasticity of demand?
Etta Reply
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Institution involved in money market
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Economic is the study of scarcity
Economics is the study of a lot of things. It is split up into two areas of study, Microeconomics and Macroeconomics. Microeconomics is the study of an individual's choices in the economy and Macroeconomics is the study of the economy as a whole.
Economics is a science that studies human scarcity
What is Equilibrium price?
Equilibrium is the market clearing price. The point at which quantity demanded equals quantity supplied. The point at which the supply and demand curves intersect.
Equilibrium price*
Refers to the study of how producers use limited resources to satisfy human unlimited wants
why is economics important
Derrick Reply
What will you do as a consumer if you are not at equilibrium?
chukwu Reply
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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