{"id":526,"date":"2015-05-06T03:58:27","date_gmt":"2015-05-06T03:58:27","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterymacro1xngcxmaster\/?post_type=chapter&p=526"},"modified":"2016-07-11T19:41:45","modified_gmt":"2016-07-11T19:41:45","slug":"aggregate-demand-in-keynesian-analysis","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-hccc-macroeconomics\/chapter\/aggregate-demand-in-keynesian-analysis\/","title":{"raw":"Reading: Aggregate Demand in Keynesian Analysis","rendered":"Reading: Aggregate Demand in Keynesian Analysis"},"content":{"raw":"

Aggregate Demand in Keynesian Analysis<\/h2>\r\nThe Keynesian perspective focuses on aggregate demand. The idea is simple: firms produce output only if they expect it to sell. Thus, while the availability of the factors of production determines a nation\u2019s potential GDP<\/em>, the amount of goods and services actually being sold, known as real GDP<\/em>, depends on how much demand exists across the economy. This point is illustrated in Figure\u00a011.3.\r\n
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\r\n\r\n[caption id=\"attachment_4516\" align=\"aligncenter\" width=\"390\"]\"Keynesian<\/a> Figure 11.3. <\/strong>The Keynesian AS\u2013AD Model. The Keynesian View of the AS\u2013AD Model uses an AS curve, which is horizontal at levels of output below potential and vertical at potential output. Thus, when beginning from potential output, any decrease in AD affects only output, but not prices; any increase in AD affects only prices, not output.[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\n

Keynes argued that, for reasons we explain shortly, aggregate demand is not stable\u2014that it can change unexpectedly. Suppose the economy starts where AD intersects AS at P0<\/sub> and Yp. Because Yp is potential output, the economy is at full employment. Because AD is volatile, it can easily fall. Thus, even if we start at Yp, if AD falls, then we find ourselves in what Keynes termed a\u00a0recessionary gap<\/em>. The economy is in equilibrium but with less than full employment, as shown at Y1\u00a0<\/sub>in the Figure\u00a011.3. Keynes believed that the economy would tend to stay in a recessionary gap, with its attendant unemployment, for a significant period of time.<\/p>\r\n\r\n<\/div>\r\nIn the same way (though not shown in the figure), if AD increases, the economy could experience an\u00a0inflationary gap<\/em><\/a>, where demand is attempting to push the economy past potential output. As a consequence, the economy experiences inflation. The key policy implication for either situation is that government needs to step in and fill the gap, increasing spending during recessions and decreasing spending during booms to return aggregate demand to match potential output.\r\n\r\nRecall from The Aggregate Supply-Aggregate Demand Model that aggregate demand<\/em><\/a> is total spending, economy-wide, on domestic goods and services. (Aggregate demand (AD) is actually what economists call total planned expenditure. You'll read more about this in the next outcome\u00a0on The Expenditure-Output Model<\/a>.)\u00a0You may also remember that aggregate demand is the sum of four components: consumption expenditure, investment expenditure, government spending, and spending on net exports (exports minus imports). In the following sections, we will examine each component through the Keynesian perspective.\r\n

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What Determines Consumption Expenditure?<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nConsumption expenditure is spending by households and individuals on durable goods, nondurable goods, and services. Durable goods are things that last and provide value over time, such as automobiles. Nondurable goods are things like groceries\u2014once you consume them, they are gone. Recall from The Macroeconomic Perspective that services<\/em><\/a> are intangible things consumers buy, like healthcare or entertainment.\r\n\r\nKeynes identified three factors that affect consumption:\r\n
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