Keynesian formula
Encyclopedia
The Keynesian formula is an economic theory developed by the British economist
John Maynard Keynes
. Keynes argued that the level of output and employment in the economy was determined by aggregate demand
or effective demand
. In a reversal of Say's Law
, Keynes in essence argued that "man creates his own supply," up to the limit set by full employment
. Adherents of the Austrian
and Monetarist
and schools of economic thought are critical of this theory.
which means:
Consumption
+ Investment
+ Government Spending
+ Export
s − Import
s = Gross Domestic Product
aggregate consumption is total personal consumption expenditure, i.e., the purchase of currently produced goods and services out of income, out of savings (net worth), or from borrowed funds. It refers to that part of disposable income (income after taxes paid and payments received) that does not go to saving.
and economics
, related to saving or deferring consumption
. An asset
is usually purchased, or equivalently a deposit is made in a bank, in hopes of getting a future return or interest from it. Literally, the word means the "action of putting something in to somewhere else" (perhaps originally related to a person's garment or 'vestment
').
purchases, which can be financed by seigniorage
, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product.
John Maynard Keynes was one of the first economists to advocate government deficit spending
as part of a fiscal policy
to cure an economic contraction. In Keynesian economics, increased government spending is thought to raise aggregate demand and increase consumption.
, transported from one country to another country in a legitimate fashion, typically for use in trade. Export is an important part of international trade
. Its counterpart is import.
Export goods or services are provided to foreign consumers by domestic producers. Export of commercial quantities of goods normally requires involvement of the Customs authorities in both the country of export and the country of import.
by foreign producers
. Import of commercial quantities of goods normally requires involvement of the Customs
authorities in both the country of import and the country of export.
, causing it to rise and, thus resulting in the aggregate demand curve shifting outwards. Alternatively, if there was a decrease in the mentioned factors, the result will be a fall in aggregate demand, thus causing and inward shift in the aggregate demand curve.
The Keynesian Formula can be used to track changes in aggregate demand, gross domestic product and what consequence that will have on the price level
(inflation
). This formula is a tool for analysing macroeconomic performance.
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
. Keynes argued that the level of output and employment in the economy was determined by aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
or effective demand
Effective demand
In economics, effective demand in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market...
. In a reversal of Say's Law
Say's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...
, Keynes in essence argued that "man creates his own supply," up to the limit set by full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
. Adherents of the Austrian
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
and Monetarist
Monetarism
Monetarism is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over...
and schools of economic thought are critical of this theory.
Composition of the Keynesian Formula
In scientific notation, the Keynesian Formula consists of the following make-up:which means:
Consumption
Consumption (economics)
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
+ Investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
+ Government Spending
Government spending
Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...
+ Export
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...
s − Import
Import
The term import is derived from the conceptual meaning as to bring in the goods and services into the port of a country. The buyer of such goods and services is referred to an "importer" who is based in the country of import whereas the overseas based seller is referred to as an "exporter". Thus...
s = Gross Domestic Product
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
Consumption
In Keynesian economicsKeynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
aggregate consumption is total personal consumption expenditure, i.e., the purchase of currently produced goods and services out of income, out of savings (net worth), or from borrowed funds. It refers to that part of disposable income (income after taxes paid and payments received) that does not go to saving.
Investment
Investment is a term with several closely related meanings in business management, financeFinance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
and economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, related to saving or deferring consumption
Consumption (economics)
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
. An asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
is usually purchased, or equivalently a deposit is made in a bank, in hopes of getting a future return or interest from it. Literally, the word means the "action of putting something in to somewhere else" (perhaps originally related to a person's garment or 'vestment
Vestment
Vestments are liturgical garments and articles associated primarily with the Christian religion, especially among Latin Rite and other Catholics, Eastern Orthodox, Anglicans, and Lutherans...
').
Government Spending
Government spending or government expenditure consists of governmentGovernment
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
purchases, which can be financed by seigniorage
Seigniorage
Seigniorage can have the following two meanings:* Seigniorage derived from specie—metal coins, is a tax, added to the total price of a coin , that a customer of the mint had to pay to the mint, and that was sent to the sovereign of the political area.* Seigniorage derived from notes is more...
, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product.
John Maynard Keynes was one of the first economists to advocate government deficit spending
Deficit spending
Deficit spending is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit," the opposite of budget surplus....
as part of a fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
to cure an economic contraction. In Keynesian economics, increased government spending is thought to raise aggregate demand and increase consumption.
Exports
In economics, an export is any good or commodityCommodity
In economics, a commodity is the generic term for any marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services....
, transported from one country to another country in a legitimate fashion, typically for use in trade. Export is an important part of international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
. Its counterpart is import.
Export goods or services are provided to foreign consumers by domestic producers. Export of commercial quantities of goods normally requires involvement of the Customs authorities in both the country of export and the country of import.
Imports
In economics, an import is any good or commodity, brought into one country from another country in a legitimate fashion, typically for use in trade. Import goods or services are provided to domestic consumersConsumer
Consumer is a broad label for any individuals or households that use goods generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary.-Economics and marketing:...
by foreign producers
Production, costs, and pricing
The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
. Import of commercial quantities of goods normally requires involvement of the Customs
Customs
Customs is an authority or agency in a country responsible for collecting and safeguarding customs duties and for controlling the flow of goods including animals, transports, personal effects and hazardous items in and out of a country...
authorities in both the country of import and the country of export.
Economic Consequences
If the rate of consumption, investment, government spending and/or exports increases, there will be an overall increase in gross domestic product. This will have a resulting effect on aggregate demandAggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
, causing it to rise and, thus resulting in the aggregate demand curve shifting outwards. Alternatively, if there was a decrease in the mentioned factors, the result will be a fall in aggregate demand, thus causing and inward shift in the aggregate demand curve.
The Keynesian Formula can be used to track changes in aggregate demand, gross domestic product and what consequence that will have on the price level
Price level
A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set...
(inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
). This formula is a tool for analysing macroeconomic performance.
See also
- Aggregate demandAggregate demandIn macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
- Aggregate supplyAggregate supplyIn economics, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period...
- John Maynard KeynesJohn Maynard KeynesJohn Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
- Keynesian economicsKeynesian economicsKeynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
- Supply-side economicsSupply-side economicsSupply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing...