Economics For Managers
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Chapter 13 : Consumption and Investment Function
Consumption And Investment Function
Aggregate Supply And Aggregate Demand
The Keynesian Aggregate Supply Function
Aggregate Demand
Simple Equilibrium Without Government
Intervention
Equilibrium with Large-Scale Unemployment
Economy With Government Intervention - Three
Sector Model
Recessionary Situation
Inflationary Situation
Equilibrium In An Economy With Government
Intervention
Four Sector Model
Chapter Summary
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An economy can reach equilibrium without government
intervention, with government intervention, and with trade. Consumption is
important to determine the aggregate demand in an economy. According to the
Engel's Law, the amount spent on food and other necessities falls as the income
rises. A country's consumption expenditures rise as incomes rise. The Keynesian
theory explains how consumption and investment can help the economy reach
equilibrium.
Savings and investment can also help the economy reach an equilibrium. An
increase in savings leads to a decrease in national product whereas an increase
in investment demand leads to an increase in national product. When savings
equal investments, the economy reaches its equilibrium point. Keynes believed
that government intervention can reduce the level of unemployment. |
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When the economy has high unemployment levels,
the government can take fiscal measures to reduce unemployment.
Government can increase aggregate demand during recessions by
increasing its spending or decreasing the tax rate. An increase in
aggregate demand will have a multiplier effect on the economy.
Government spending will create employment opportunities in the
economy and this in turn will increase the disposable income and
consumption in the economy.
Government has to increase taxes to fund the spending. However, an
increase in taxes will reduce the purchasing power of the people and
consumption will suffer. Thus, during a recession, government
spending should increase without an increase in taxes. Government
can increase spending during recessions by borrowing.
During period of high inflation, government has to reduce spending.
The inflationary gap can be reduced by imposing higher taxes.
Imposition of higher taxes reduces the disposable income of the
people and consequently consumption. Taxes can be imposed in two
forms: lumpsum and proportional.
IN THE FOUR SECTOR MODEL, AN ECONOMY REACHES AN EQUILIBRIUM WHEN Y=C+I+G+(X-M).
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