Permanent Income Hypothesis of Consumption

The Permanent Income Hypothesis of Consumption The permanent income hypothesis is an alternative theory of consumption (although in many ways it is very similar to the life-cycle hypothesis) developed by Milton Friedman. Like the life-cycle hypothesis, Friedman proposes that consumption depends on the long-run average of income, but the permanent income hypothesis offers a different… Continue reading Permanent Income Hypothesis of Consumption

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Conditions for Equilibrium in the Keynesian Model

Conditions for Equilibrium in the Simple Keynesian Model The simple Keynesian model hypothesised that equilibrium required aggregate supply (output, Y) to be equal to aggregate demand (E). Y = E Assuming that the economy is closed with no imports or exports, aggregate demand (E) consists of three components: consumption (C), investment (I), and government purchases (G).… Continue reading Conditions for Equilibrium in the Keynesian Model

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Government Spending and Taxes

Government Spending and Taxes Like investment, government spending is not considered to be directly influenced by the level of income, but rather by the decision-making of politicians, who may or may not take economic factors in their budget decisions. For now, we will leave government spending as G. To simplify things, we will assume that the government… Continue reading Government Spending and Taxes

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Foundations of the Keynesian Revolution

Lecture Notes for Topic 5: Keynesian Macroeconomics (I) Readings: Froyen Ch. 5 (8th Ed. Ch. 6) I. The Foundations of the Keynesian Revolution The Great Depression of the 1930s and the enormous long-term persistency of high unemployment and low output could not be explained by the classical model. In the classical framework, recessions were possible… Continue reading Foundations of the Keynesian Revolution

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Determining Equilibrium Income

Determining Equilibrium Income (or Output) Recall that equilibrium is where aggregate demand and aggregate supply are equal: Y = C + I + G Y is the endogenous variable we are trying to calculate. I and G, as well as T, are determined exogenously, as well as the autonomous part of consumption, a. The other component of consumption is income-induced expenditure which is dependent on the level… Continue reading Determining Equilibrium Income

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The Components of Aggregate Demand

The Components of Aggregate Demand Again, assume a closed economy with no imports or exports. Consumption: Unlike classical loanable funds theory which argued that interest rates drove savings and consumption, Keynes argued that consumer expenditures was a stable function of disposable income, where disposable income (YD) is the difference between national income and taxes (Y – T).… Continue reading The Components of Aggregate Demand

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Expanding the economy by a tax cut

Tax Policy Suppose the government chooses to expand the economy by a tax cut. On the demand side, a tax-cut could stimulate consumer demand. However, if the government sells bonds to finance the tax cut, the interest rate will adjust to ensure that the level of AD remains unchanged. The increased demand for loanable funds… Continue reading Expanding the economy by a tax cut

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The Quantity Theory of Money

The Quantity Theory of Money There are two main versions of the classical quantity theory of money—Fisher’s quantity theory and the Cambridge quantity theory. Both models are similar and draw basically the same conclusions, but the techniques and analysis are a bit different. One of the oldest economic theories still in use today, the quantity… Continue reading The Quantity Theory of Money

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