Economic Fluctuations in the Simple Keynesian Model

In the previous chapter we explored the Keynesian conception of unemployment equilibrium in a simplified model that focuses only on incomes and expenditures, leaving out many real-world complications. In the model, production is determined by "autonomous spending" together with a multiplier. The most important application of this equilibrium concept and the multiplier is not to understand the equilibrium at a particular time. Rather, it is really to understand economic change.

After all, the economic system never really stays in one place for very long. The Great Depression, the event that got Keynes thinking about income-expenditure models, is a good example -- it was a rapid change in economic conditions, a "Great Crash!" And we can equally well point to periods of dynamic growth, booms, in twentieth-century economic history.

From the first, macroeconomists have aimed to understand these changes in the economic system. The generation of the 1930's thought of them as "business cycles," and that term is often still used. Some modern economists are less certain that these movements are cyclical, and so we will reserve judgment on that, and use the term "economic fluctuations."

Keynes' thinking was that economic fluctuations could be caused by changes in the autonomous components of expenditure, and he put particular stress on saving and investment. We will follow that line of thought. Net exports can also have important impacts, so we will also allow for imbalances in international trade and changes in the international trade situation. Accordingly, this chapter will consider

• Consumption and Saving
• Changing consumption
• Changing investment
• International Trade Imbalance

1. The consumption function: Consumption depends on income but increases less than proportionately when income increases.
2. We have equilibrium when total spending equals total income, i.e. Y=C+I+G+NX
3. The model can be illustrated by a diagram that plots income and the components of expenditure.

A Drop in Consumption