Question

Following the Keynesian school of thought, explain how output affects capital accumulation by following the two-step procedure (namely, derivation of the relationships between output and investment, and between investment and capital accumulation).

Answer 1

Under the Keynesian economic theory, the aggregate investment expenditure is a key component or determinant of the aggregate demand or AD, and an increase in aggregate investment expenditure would lead to a rise in the AD in the goods market, holding everything else constant. An increase in the AD in the goods market would lead to an increase in the real output or GDP and the overall price level of goods and services in the goods market and the economy, again holding everything else constant. This would also eventually increase the overall production of goods and services and the aggregate supply or AS in the goods market and the economy as the firms or companies expand their business investment on capital assets and factors or inputs of production. As the real output or GDP increases due to the expansionary positive impact of the aggregate investment expenditure on AD and the subsequent eventual increase in AS, it would subsequently lead to capital accumulation in the economy through the multiplier effect of this initial output or income increase. An increase in the real output or income would lead to an increase in the real purchasing power of the consumers or buyers thereby inducing higher consumer demand for goods and services in the economy eventually leading to an increase in the aggregate consumption expenditure on goods and services in the economy, holding everything else as constant. It would also induce or encourage firms or companies to increase the production of goods and services in accordance with an increase in consumer demand for goods and services and the aggregate consumption expenditure in the economy. Therefore, this would induce further capital accumulation as the firms and companies would increase investment in various capital assets and other productive resources or factors or inputs of production. Hence, based on the Keynesian perspective, an expansion of the aggregate investment expenditure by firms and companies is the key to subsequently enhance the capital accumulation in the economy by capitalizing on the multiplier effect of the aggregate output or income increase impelled by the erstwhile increase in the investment level.