Page 69 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes No doubt that the Keynesian economics is built on the classical economics but it still differs
drastically from the latter in terms of assumptions, presentation of tools of analysis and policy
measures. Keynes possessed great intuitive power of economic analysis. Undoubtedly, the
Keynesian analysis has significantly influenced policy matters in the capitalist economies of the
world.
In this unit, you are going to learn about the basic concepts of aggregate demand and supply in
the economy along with the major concepts of Keynesian Theory of Income and Employment.

4.1 Keynesian Theory of Income, Output and Employment

Historically, the Keynesian model follows the classical model. The basic difference between the
two is:

The classical held that unemployment cannot exist. Even if there is any unemployment, it is self
correcting. The complete flexibility in real variable-wage, price level and rate of interest-ensures
full employment level.

Keynes believed that it is the 'aggregate demand', not wages, price level and rate of interest,
which determine unemployment. Keynes also believed that government can step in to influence
the level of output and employment.

4.1.1 Concepts

Planned Output (Income)

It is also called 'aggregate supply'. It is the value of final goods and services planned to be
produced in an economy during a period. Assuming a closed economy without government, the
value of planned output is nothing but national income.

Planned Aggregate Expenditure (AE)

It is the value of final goods and services planned to be purchased by people in an economy
during a given period. The expenditure is classified into consumption spending (C) and investment
spending (I). This is on the assumption that the economy is a closed economy without government.
It means there is no government expenditure (G), no exports (X), no imports (M). In an open
economy with government AE is the sum of C,I,G and net exports.

Planned Consumption Spending

The main factors determining consumption spending are:
1. Household's Income: It is held that as income of the households rises, people do spend a
proportion of the income on consumption. Higher the income higher the consumption
spending.
2. Household's Wealth: Higher the amount of wealth a household possesses higher is the
expected flow of future income. Higher the expected flow higher the spending on
consumption.
3. Interest Rate: Interest paid is the cost of borrowing. People do borrow to spend on
consumption. Lower the rate of interest lower the cost of borrowing. This stimulates
spending. The higher rate of interest discourages spending.

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