Keynesian Aggregate Expenditure Model Two Quotations: Company Term Paper

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Keynesian Aggregate Expenditure Model

Two Quotations:

Company profits grew strongly in the June quarter putting another question mark over the extent of the predicted economic slowdown..."

However the central bank acknowledged that the weaker data for capital spending intentions are at this point the only clear evidence of an impending slowdown"

These two quotations regarding the same economic scenario seem to pose the question to consumers and economists alike -- why a predicted economic slowdown, if company profits are growing strongly? Why place so much fear in the data regarding capital spending intentions on the part of consumers? Why turn to the tools macroeconomics has long focused on, that of monetary policy, which the central bank controls, and fiscal policy, which the federal government controls, to shift the current state of economic equilibrium, as described above? (Schenk, 1997, "Synthesis")

The answer lies in the Keynesian aggregate expenditure model. This model is the generic term for several graphical models used to analysis the basic components of Keynesian economics and to identify Keynesian equilibrium as the intersection of the aggregate expenditures line and "the 45-degree line." The 45-degree line in this case is that of company profits, although it can encompass "differences among the specific models are based on which sectors are included," including "household, business, government, and foreign" spending "and whether expenditures are induced or autonomous," or if they can be controlled like government spending or fiscal policy, or in this case, not controlled.

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(Amos Web, 2004) state of Keynesian equilibrium, according to the Keynesian model, "in the goods market may be graphically depicted by showing income (Y) and aggregate expenditure (AE), where AE appears on the vertical axis and Y is on the horizontal axis. Equilibrium is depicted as the point where aggregate expenditures (AE) equal income (Y) or, where the AE function crosses the 45-degree line." However, if expenditures upon the part of consumers are going down, this equilibrium is not likely to last for long." (Macroeconomic Equilibrium, 2004)

In other words, if consumers are spending less, it is unlikely that companies will continue to spend more and thus the companies will have to let workers go to make up for the decrease in consumer demand. The Keynesian model of aggregate demand was introduced in the 1930's as an answer to the worldwide great depression that the global economy found itself spiraling into after years of boom and financial speculation. Keynes departed from his predecessors when he "rejected the view of Adam Smith that, left alone, a market system generally functions well," namely that the "invisible hand" works when consumer confidence is low." (Schenk, 1997, "Activism")

An important reason for the "pessimistic views" of Keynes "was his assumption about prices." A simple income-expenditure microeconomics model suggests the market for goods and services contracts, supply responds. This assumes that prices will remain prices constant. "Assuming fixed….....

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