| | | | | | | Curiosity 4.1: What about Unwanted Investment in Inventories? | | | | | | | | | | Keynes specified each of the four demands consumption demand, investment demand, government demand, and export demand as that which a sector of the economy consumers, business firms, the government, or foreigners would want to purchase during any year. "Investment in inventories," introduced in chapter 2, does not reflect desired demand and so is not included in these demand categories. Inventory investment is merely an accounting device, utilized by the national accounts statisticians to allow the adding up of demands to produce a measure of national output by reconciling what demanders bought with what producers made. | | | | | |
| | | | | vide better insight into the operation of the economy and how it might respond to policy. Much of the historical development of the Keynesian approach has taken the form of investigating in detail the economic forces that determine demand in one of these sectors and then seeing the implications that this analysis has for the operation of the economy as a whole. | | | | | | | | | One of the simplest of Keynes's insights is that the level of consumption demand is affected by the level of income. As income increases, so does consumption, but not by as much because income earners save some income and set some aside to pay taxes. Economists usually capture this relationship by specifying that consumption is a function of after-tax (or disposable) income. As disposable income increases by, say, a thousand dollars, consumption demand increases by some fraction of the thousand dollars, say by $800. This fraction (0.8 in this example) is called the the marginal propensity to consume (MPC). The MPC tells us what fraction of an additional dollar of disposable income will be spent on consumption. The fraction not spent on consumption is called the marginal propensity to save. This consumption function, as it is known, is a major ingredient in the Keynesian explanation of the determination of income. Much more complicated variants of the consumption function have been developed, involving additional explanatory variables, but this simple version suffices to illustrate the Keynesian approach. The other categories of aggregate demand also have functions explaining their levels, but for now we ignore these functions and assume the categories are fixed at constant levels. | | | | | | | | | 4.2
Determining National Income | | | | | | | | | Keynes believed that natural forces operating in the economy cause the level of aggregate supply of domestically produced goods and services (AS), also known as national income, to move in order to meet the level of aggregate demand for goods and services (AD). What are these forces? | | | | | | | | | Suppose that aggregate demand exceeds national income/output, a situation referred to as excess aggregate demand. In this case, the output produced by the economy is not enough to satisfy all the aggregate demand, so that firms producing and selling goods should experience | | | | |
