Question

1. What is the main difference between the Keynesian and Neoclassical approach to macro-equilibrium?

2. What are the corresponding Neoclassical and Keynesian policies to secure full employment equilibrium?

3. What are the components of aggregate spending? What are those components in a private closed economy?

4. What is disposable income?

5. Which is the main determinant of the consumption level? Describe the relationship.

6. What is Keynes’ ‘Fundamental psychological law’?

7. What is the marginal propensity to consume (MPC) and its formula? What is the marginal propensity to save (MPS) and its formula?

8. What is the slope of the consumption function?

9. What are the components and the equation of Keynes’ consumption equation?

10. Which are the main determinants of planned investment according to Keynes?

11. Describe the relationship between planned investment spending and the current income in the Keynes model. What is the shape of the investment curve?

12. Describe the relationship between government spending and the current income in the Keynes model.

13. Explain Keynes’ adjustment mechanism towards macro equilibrium when spending and output are not equal.

14. Define and illustrate graphically both the recessionary and the inflationary gap.

15. What is the condition for general equilibrium at full employment in Keynes’ model?

16. What is the inherent mechanism in Neoclassical theory that secures full employment macro-equilibrium? Does Keynesian theory have the same inherent mechanism?

Answer 1

1. The neoclassical approach assumes that there are few frictions in the market, and prices adjust quickly to the shifts in demand and supply while the quantities don't. Hence prices are assumed to be flexible. In the case of the Keynesian approach, the markets are assumed to have friction in markets which means that the prices are sticky in nature and do change quickly while the quantities in the market change with the change in the demand and supply.

2. The neoclassical believed that the level of potential GDP is determined by the long-run productivity growth, and the economy can get back to its full-employment level of the self-correcting mechanism through the changes in the aggregate demand. Thus teh government in this case tend to keep itself away from the active stabilisation policy.

Keynesians believe that the primary reason for the business cycle fluctuations is the changes in the aggregate demand. So to attempt to reverse the recessionary and inflationary periods is through the fiscal policies where the government must make an active effort by changing the aggregate demand. They believe that the economy does not have a self-corrective mechanism to get back to the full employment level.

3. There are four components of aggregate spending which are consumption expenditure, investments, government expenditure, and the net exports in an economy. However, in the case of private economy, there is no government and also the closed economy implies that there is no external trade. Thus, the components of a private closed economy are consumption expenditure and investment.  

4. Disposable income is the income that one is left with after payment of taxes and social security charges. This income is available with the individuals to be saved or spent as he personally wishes to.