keynesian circular-flow analysis (labor-based macroeconomics)
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Keynesian Circular-Flow Analysis (Labor-Based Macroeconomics). The Inherent Instability of a Wholly Private Economy (according to John Maynard Keynes). Roger W. Garrison 2010. The Keynesian Vision. - PowerPoint PPT PresentationTRANSCRIPT
Keynesian Circular-Flow Analysis(Labor-Based Macroeconomics)
The Inherent Instability of a Wholly Private Economy(according to John Maynard Keynes)
Roger W. Garrison 2010
Keynes’s vision of the economy suggests a circular-flow framework—in which earning and spending are brought into balance by changes in the level of employment.
The Keynesian Vision
Graphically, the circular flow appears as the Keynesian cross, the cross’s intersection identifying the particular state of the economy in which income and expenditures are in balance.
The Income-Expenditure Framework
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
LABOR AND OTHERFACTOR SERVICES
INCOME
THECIRCULAR-FLOW
FRAMEWORK
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
LABOR AND OTHERFACTOR SERVICES
INCOME
GOODS ANDSERRVICES
EXPENDITURES
Let the speed of rotation indicate the strength (fast) or weakness (slow) of
the economy.
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
INCOME
EXPENDITURES
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
In Keynesian equilibrium,INCOME equals EXPENDITURES.
Y = EY = C + I + G
What counts as income?
RENTS
WAGES
INTEREST
PROFITS
What counts as Spending?
SPENDING BY CONSUMERS
SPENDING BY BUSINESSES
SPENDING BY GOVERNMENT
C + I + G Y
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
INCOME
EXPENDITURES
For a wholly private economy,
Y = C + I
In Keynesian equilibrium,INCOME equals EXPENDITURES.
45o
E = Y
EX
PE
ND
ITU
RE
S
INCOME
The circular character of the flow suggests an equality of left-half flow and right-half flow---as represented by a forty-five degree line passing through the origin.
EXPENDITURES, which constitute the left half of the circular flow, is represented on the vertical axis.
INCOME, which constitutes the right half of the circular flow, is represented on the horizontal axis.
The economy is in a Keynesian equilibrium somewhere along the 45o line—the line itself identifying all possible income-expenditure equilibrium points.
As taught at all levels, the consumption function is an essential component of the Keynesian framework. The presumed stability of this function underlies Keynesian thinking.
EX
PE
ND
ITU
RE
S
INCOME
CONSUMPTION
INVESTMENT
INCOME
C = a + bY
C + I
45oa
b
1
Consumption and Investment (as well as Government Spending) are portrayed as additive components of total spending. The three components are distinguished largely in terms of their stability characteristics: stable (C ), unstable (I), and stabilizing (G).
A wholly private macroeconomy achieves an income-expenditure equilibrium when Y = C + I. Note that income itself (rather than prices, wages, or the interest rate) is the equilibrating variable.
Investment depends neither on (current) income nor on the rate of interest. It depends only on profit expectations, which themselves are not well-anchored in economic reality.
Keynes would say the investors are moved by the “animal spirits.”
Labor income (Y = WN) is fully representative of total income, such that changes in labor income stand in direct proportion to changes in total income.
Yfe
Full employment implies that the economy is operating on its production possibility frontier, the PPF itself being defined in terms of sustainable output levels of consumption and investment goods.
EX
PE
ND
ITU
RE
S
INCOME
C = a + bY
N
W
S
D
C + I
INVESTMENT
CO
NS
UM
PTI
ON
In Keynesian macroeconomics, full employment implies that the labor market clears at the going wage rate, the going wage itself having emerged during a period in which the economy was experiencing no macroeconomic problems.
LABOR INCOME
According to Keynes, it is only by “accident or design” that the economy is actually performing at its full-employment potential.
We assume here that, initially, full employment conditions prevail—if only by accident.
ΔY
According to Keynes, a collapse of investment activity (the collapse being attributed to a waning of “animal spirits”) is the primary cause economic downturns. In response to reduced investment and hence reduced employment opportunities, the economy spirals downward into recession and possibly into deep depression.
E < Y
EX
PE
ND
ITU
RE
S
INCOME
N
W
S
D
EXCESS INVENTORIESC + I
C = a + bY
ΔI
Note that the going wage keeps “going”—even after the market conditions that gave rise to it are gone.
Yfe
E = Y
INCOME
CONSUMPTION
INVESTMENT
ΔC
CONSUMPTION
INVESTMENT
INCOME
EX
PE
ND
ITU
RE
S
INCOME
N
S
D
W
C = a + bY
C + I
In the Keynesian construction, prices and the wage rate are sticky downward.
But note that they’re not stuck too high. They’re stuck just right. The going wage rate will clear the labor market once again—as soon as spending and hence labor demand recover to their full-employment levels.
A further loss of confidence on the part of the business community will send the economy even further from its full-employment potential.
Yfe
Recovery may be self-initiating. Waning animal spirits may become waxing animal spirits. In due time, a pressing need to maintain or replace depreciating capital may account for the lower turning point of a bust-and-recovery sequence.
(Keynes, of course, preferred not to wait it out. He advocated make-work projects, deficit spending, and monetary stimulation to get the economy turned around.)
EX
PE
ND
ITU
RE
S
INCOME
C = a + bYC + I
N
S
D
W
Yfe
DEFICIENCY OF INVENTORIES
INCOME
CONSUMPTION
INVESTMENT
Yfe
Recovery may continue as further investment activity drives labor-demand back to its full-employment level...
EX
PE
ND
ITU
RE
S
INCOME
C + I
C = a + bY
N
S
D
W
but there is nothing about “animal spirits” that will bring the recovery process to an end at full employment.
Over-optimism may push the economy beyond its full-employment level.
Recovery may continue as further investment activity drives labor-demand back to its full-employment level...
EX
PE
ND
ITU
RE
S
INCOME
C + I
C = a + bY
N
S
D
W
From full-employment onward, there is upward pressure on both prices and wage rates. And since prices and wage rates are not sticky upwards, the economy experiences a spiraling inflation.
The equilibrium points in the labor market traced out during the recovery and inflationary spiral constitute the so-called L-shaped supply curve.
Yfe
BUSINESSORGANIZATIONS
WORKERS
FACTOROWNERS
CONSUMERS
INCOME
EXPENDITURES
Dealing with the inherent instability of the economy, according to Keynes, requires policy activism. Well-gauged and well-timed fiscal policy (changes in government spending and the level
of taxation) can counter the recessionary and inflationary forces that are deeply rooted in capitalism.
Keynesian Circular-Flow Analysis(Labor-Based Macroeconomics)
The Inherent Instability of a Wholly Private Economy(according to John Maynard Keynes)
Roger W. Garrison 2010