Two Sector Economy January 26, Keynes identified a basic two sector macroeconomic model to determine equilibrium, which comprised of two major sectors, the household and business firms.
After reading this article to learn about: The IS-LM curve model emphasises the interaction between the goods and assets markets. The Keynesian model looks at income determination by arguing that income affects spending, which, in turn, determines output GNP and income GNI.
Hansen add the effects of interest rates on spending, and thus income and the independence of asset markets on income. Higher income raises money demand and thus interest rates. Higher interest rates lower spending and thus income.
Spending, interest rates and income are determined jointly by equilibrium in the goods and assets markets as shown in Fig. Role of Money in the Simple Keynesian System: If money supply increases, the rate of interest falls.
The lower interest rate, in its turn, leads to a rise in autonomous investment and in national income through the autonomous expenditure multiplier.
Interest Rates and Aggregate Demand: Keynes pointed out that business investment demand depends on the interest rale. In his view, an investment project will be carried only if its expected rate of return or marginal efficiency of capital exceeds the cost of borrowing to finance the project so that the net return from the project is positive.
For this reason at a higher interest rate borrowing costfewer projects will be accepted. As a result output income increases from Y0 to K, in part b. The Keynesian Theory of the Interest Rate: The demand for money liquidity preference is the crucial variable in Keynesian theory of money.
Keynes makes two assumptions: At a fixed point in time, an individual has a fixed amount of wealth W which is divided between money M and bonds B: So more money holding implies less bond holding and vice versa. Thus there is only independent portfolio decision, the division of W between M and B.
Therefore, an excess demand for money implies an excess supply of bonds and an excess supply of money implies an excess demand for bonds.
Since the money supply is assumed to be fixed exogenously by the policy of the central bank at M0S, the demand for money plays the key role in determining the rate of interest. The Keynesian Theory of Demand for Money: Keynes discussed and analysed three separate motives for holding money: Since money is a medium of exchange, people hold money for purchasing goods and services or for making any type of payments.
Money bridges the time gap between the receipt of income and its expenditure.
Transactions demand for money varies directly with the volume of transactions which is assumed to depend positively on the level of income. People also hold money to meet unexpected expenditures, known as the precautionary demand for money.
It also depends positively on income. Here we include the precautionary demand under transactions demand and do not treat the former separately.
Finally, people hold money for speculative purposes even if bonds pay interest and money does not. The price of bond is the reciprocal of the rate of interest. Thus if the market rate of interest rises falls the price of an old bond will fall rise and the bondholder will incur a capital loss or make a capital gain.
If an individual holds only money there is no risk and there is no return either. If he buys bonds, he earns interest but faces uncertainty.Question 5. Consider a market with a demand curve of P=Q and a supply curve of P=3+Q.
Calculate Consumer Surplus. (Format: Answers must within of the true value to counted as correct. The number of consumers affects overall, or “aggregate,” demand.
As more buyers enter the market, demand rises. As more buyers enter the market, demand rises. That's true even if prices don't change. Thus, the model predicts that the fiscal spending multiplier is likely to be very large in absolute terms when there is a fixed wage.
Rather than mitigate the presence of ‘expansionary fiscal contraction’, real wage constrained unemployment actually enhances it.
Aggregate Demand, Aggregate Supply,and Business Cycles Aggregate Demand and Business Cycles. Aggregate Supply and Business Cycles. A Look Ahead. Factors That Influence Aggregate Demand Consumption. Investment.
Government Spending. Net Exports Aggregate Expenditures.
|Aggregate demand||Answer AD and the price level:|
The Aggregate Demand Curve Changes in Aggregate Quantity Demanded: Price-Level Effects. The model of demand and supply can be used to show the effect of third-party payers on total spending.
With third-party payers (for example, health insurers), the quantity of services consumed rises, as does spending. An initial change in aggregate demand can have a much greater final impact on the level of equilibrium national income. This is known as the multiplier effect - the multiplier is explained in our short revision video below.