Reconciling the Keynesian Aggregate Expenditure Model with the Aggregate Demand & Aggregate Supply Model

AP Macroeconomics

Where we came from…

Short-run macroeconomic equilibrium occurs when real GDP demanded equals real GDP supplied.

When there’s an increase in aggregate demand, then the new equilibrium is at a higher price level, and a higher level of output.

Visual 3.11, Unit 3 Macroeconomics, National Council on Economic Education, http://apeconomics.ncee.net

Where are we going?

In this lesson, we’ll learn the similarities and differences between the two models so that we can reconcile them with one another.

Refresher: The Simple Keynesian Model

Visual 3.1, Unit 3 Macroeconomics, National Council on Economic Education, http://apeconomics.ncee.net

Remember?

The Keynesian Model is the simplest macro model, and is the starting point from the national income accounting identity (i.e. GDP): GDP = C + I + G + X-M (or GDP = C + I + G + NX)

This model helps us to find the equilibrium income and to understand the relationship among the concepts of income, consumption, and spending

Consumption expenditures do not equal income Why not? Even if people’s income is zero, they can beg

and borrow, and even steal. Another reason is savings.

And remember this?

The Keynesian Model is at the heart of the study of Macroeconomics, helping us to understand the consumption function (c=a+MPC*y, with y being income) and something called the “multiplier process”

This model holds the price level constant, which is not a realistic representation of the economy

The aggregate demand and aggregate supply model (which the price level and output are determined) is the central model for macroeconomic analysis.

Similarities between the two models…

A shift upward in aggregate expenditure is the same as a shift outward in aggregate demand

A shift downward in aggregate expenditure is the same as a shift inward of aggregate demand

Aggregate expenditure on the Keynesian model is aggregate demand on the AD &AS model

Looks at relationships (although income, consumption, and spending)

A shift outward in aggregate demand Is the same as a shift upward in aggregate expenditure

A shift inward of aggregate demand is the same as a shift downward in aggregate expenditure.

Aggregate demand on the AD &AS model is aggregate expenditure on the Keynesian model

Looks at relationships (although between price level and AD &AS)

Keynesian Model AD & AS Model

Differences between the models…Keynesian Model AD & AS Model

AD & AS Model is a variable price model

Vertical axis is price level

The AD & AS model can account for shifts in aggregate supply

The multiplier is not in full strength on the positively sloped and vertical AS curve (i.e. the full ripple effect of an autonomous change in spending on GDP)

The increase in price level diminishes the impact of the multiplier (Why? Because it leaves out consumption)

Fixed (constant) price model

Vertical Axis is aggregate expenditure

The Keynesian model cannot account for shifts in aggregate supply

A shift in aggregate expenditures results in full multiplier effect, and the multiplier can be easily calculated from the graph (how? If we have the numbers, i.e. how much change in consumption and income, we can calculate the MPC, and thus the multiplier)

Compare and Contrast

Create a graphic organizer that depicts these similarities and differences

Graph the similarities and differences! (i.e. those that you can graph – you may need to annotate your graphs for others)

And now…

Some resources:

http://www.reffonomics.com/textbook2/macroeconomics2/keynesianthought/keynesiancross.swf

Works Cited

Economics of Seinfeld. Demand. http://yadayadayadaecon.com/clip/46/

Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers.

Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3rd ed. New York: National Council on Economic Education, 2003. Print.

Reffonomics. www.reffonomics.com.