Explain how equilibrium is determined in the Keynesian Income Expenditure.
Keynesians are economists that believe everything should not be considered under market forces as there is no guarantee that the economy will achieve a full employment level of GDP. They believe that the government intervention is only solution and this can be done in the form of deficit financing (i.e. difference between government spending and tax generated). If government spending is more then the taxes then the difference is the deficit finance. This results in injection and employment of GDP.
An income is in equilibrium where aggregate expenditure equals the output. If the aggregate expenditure is greater then output firms will have to use more factors of production to meet the conditions. This would result in an increase in GDP.
If aggregate expenditure is less then the output, firms will reduce production and use of factors of production would reduce. This would decrease the GDP and the employment of resources.
Expenditure 45 Degree C+ I + G + (X-M)
Expenditure = Income
The 45 degree diagram above is a often referred to as the Keynesians 45 degree diagram, the diagram measures money GDP on the horizontal axis and the aggregate expenditure on the vertical axis. The intersection between the 45 degree line and the
C + I + G + (X-M) line show the point at which aggregate expenditure equals national income (GDP). It determines the level of output to be produced in an economy.
Aggregate 45 Q1
In the graph above the movement from line Q to Q1 may be due to and increase in consumption and investment, this may be due to consumer and entrepreneur’s decision about being optimistic about future conditions for example boom/growth. Aggregate expenditure would rise and output would increase, resulting in an increase in GDP.
The downward movement of Q to Q2 might be due to an expectation of recession or a slump in the economy the expenditure would fall thus output will also fall.
These movements in the C + I + G + (X-M) line might also be influenced by business optimism, expansionary and contractionary policies, interest rates, changes in technology and capital costs, changes in consumer demands, tax rates, decrease in domestic prices for goods, availability of credit, increase or decrease in the buying power and government subsidies.
C= Consumer Spending
G= Government Spending
Q = C+ I + G + (X-M)
Q1= C+ I + G + (X-M) 1
Q2 = C+ I + G + (X-M) 2