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    Economic Consumption: Mastering Economic Consumption, Your Path to Informed Decision-Making
    Economic Consumption: Mastering Economic Consumption, Your Path to Informed Decision-Making
    Economic Consumption: Mastering Economic Consumption, Your Path to Informed Decision-Making
    Ebook647 pages7 hours

    Economic Consumption: Mastering Economic Consumption, Your Path to Informed Decision-Making

    By Fouad Sabry

    ()

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    About this ebook

    What is Economic Consumption


    The act of satisfying one's immediate needs and desires through the utilization of available resources is known as consumption. It stands in contrast to investing, which can be defined as making expenditures with the intention of acquiring future revenue. Consumption is a fundamental notion in economics, in addition to being researched in a wide variety of other fields within the social sciences.


    How you will benefit


    (I) Insights, and validations about the following topics:


    Chapter 1: Consumption (economics)


    Chapter 2: Keynesian economics


    Chapter 3: Macroeconomics


    Chapter 4: IS-LM model


    Chapter 5: Consumer choice


    Chapter 6: Aggregate demand


    Chapter 7: Normal good


    Chapter 8: Marginal propensity to consume


    Chapter 9: Law of demand


    Chapter 10: Consumption function


    Chapter 11: Revealed preference


    Chapter 12: Goods


    Chapter 13: Average propensity to consume


    Chapter 14: Permanent income hypothesis


    Chapter 15: Consumption smoothing


    Chapter 16: Multiplier (economics)


    Chapter 17: Keynesian cross


    Chapter 18: Absolute income hypothesis


    Chapter 19: Random walk model of consumption


    Chapter 20: Preference (economics)


    Chapter 21: Index of economics articles


    (II) Answering the public top questions about economic consumption.


    (III) Real world examples for the usage of economic consumption in many fields.


    (IV) Rich glossary featuring over 1200 terms to unlock a comprehensive understanding of economic consumption


    Who this book is for


    Professionals, undergraduate and graduate students, enthusiasts, hobbyists, and those who want to go beyond basic knowledge or information for any kind of economic consumption.

    LanguageEnglish
    PublisherOne Billion Knowledgeable
    Release dateNov 6, 2023
    Economic Consumption: Mastering Economic Consumption, Your Path to Informed Decision-Making

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      Economic Consumption - Fouad Sabry

      Chapter 1: Consumption (economics)

      Consumption is the utilization of resources to meet present needs and desires. Consumption is a central concept in economics and is also a subject of study in numerous other social sciences.

      People buying home electronics at a shopping mall in Jakarta, Indonesia

      Various economic schools define consumption differently. Consumption, according to mainstream economists, consists only of the final purchase of newly produced goods and services by individuals for immediate use. Other types of expenditure, such as fixed investment, intermediate consumption, and government spending, are placed in separate categories (see consumer choice). Other economists define consumption as the sum of all economic activity that does not involve the design, production, and marketing of goods and services (e.g., the selection, adoption, use, disposal and recycling of goods and services).

      The Keynesian consumption function is also known as the absolute income hypothesis because it bases consumption solely on current income and disregards the possibility of future income (or lack of). This assumption's criticism led to the development of the permanent income hypothesis by Milton Friedman and the life cycle hypothesis by Franco Modigliani.

      Recent theoretical approaches based on behavioural economics imply that a number of behavioral principles can serve as microeconomic foundations for a behaviourally-based aggregate consumption function.

      Aggregate demand includes aggregate consumption.

      Consumption is partially defined in relation to production. In the tradition of the New Home Economics, also known as the Columbia School of Household Economics, commercial consumption must be analyzed in the context of household production. The opportunity cost of time influences the price of home-made substitutes and, consequently, the demand for commercial goods and services.

      Consumption can also be measured in a variety of ways, including energy metrics in energy economics.

      This equation defines the Gross Domestic Product (GDP):

      {\displaystyle Y=C+G+I+NX}

      Where C stands for consumption.

      Where G stands for total government spending.

      (including compensation)

      Where I stands for Investments.

      Where NX stands for net exports.

      Exports minus imports equals net exports.

      In the majority of nations, consumption is the largest contributor to GDP. It typically ranges between 45 percent and 85 percent of GDP.

      Consumer choice is a theory in microeconomics that assumes people are rational consumers who decide what combinations of goods to purchase based on their utility function (which goods provide the most use/happiness) and their budget constraint (which combinations of goods they can afford to buy).

      In the theory of national accounts, consumption in macroeconomics is not limited to the amount of money spent by households on goods and services from businesses. But also government expenditures intended to provide citizens with items they would otherwise have to purchase themselves. This includes aspects such as healthcare.

      {\displaystyle C=C_{0}+c*Y_{d}}

      Where C_{0} stands for autonomous consumption which is minimal consumption of household that is achieved always, by either decreasing household savings or borrowing money.

      c is marginal propensity to consume where {\displaystyle c\in [0,1]} and it reveals how much of household income is spent on consumption.

      Y_{d} is the disposable income of the household.

      Economic expansion is positively correlated with electric energy consumption.

      As electric energy is one of the most essential economic inputs, it is one of the most important sources of pollution.

      Electric energy is required for the production of goods and the provision of consumer services.

      Positive statistically significant correlation exists between electrical energy consumption and economic growth.

      Electricity consumption mirrors economic expansion.

      With the gradual improvement in people's material status, Likewise, electric energy consumption is gradually growing.

      In Iran, for example, Since 1970, electricity consumption has increased alongside economic expansion.

      But as nations continue to develop and optimize their production, this effect is diminishing, by acquiring more energy-efficient machinery.

      Or by transferring parts of their production to foreign nations where the cost of electrical energy is smaller.

      Energy consumption per capita-Iran (Cro)

      Economists study the most significant factors affecting consumption, which include:

      Income: According to economists, income is the most influential factor on consumption. Consequently, consumption functions frequently emphasize this variable. Keynes evaluates total income, The consumer's real income and purchasing power would change as a result of price fluctuations. If the consumer's expectations for future prices change, it can affect his current consumption decisions.

      Consumer assets and wealth include cash, bank deposits, and securities, as well as physical assets such as stocks of durable goods or real estate such as houses, land, etc. These variables can affect consumption; if the aforementioned assets are sufficiently liquid, they will remain in reserve and can be used in the event of an emergency.

      Consumer credits: The expansion of the consumer's credit and his credit transactions can permit the consumer to use his future income now. Consequently, it can result in greater consumption expenditures than if the only purchasing power was current income.

      Interest rate: Interest rate fluctuations can influence household consumption decisions. A rise in interest rates increases people's savings and, as a result, decreases their expenditures on goods and services.

      The absolute consumption costs of a household increase as the number of family members rises. However, as the number of households increases, the consumption of certain goods will rise at a slower rate than the number of households. Due to the phenomenon of the economy of scale, this occurs.

      Different social groups exhibit varying levels of household consumption. For instance, the consumption patterns of employers and employees differ. The smaller the gap between groups in a society, the more homogeneous the society's consumption pattern.

      Consumer preference is one of the most influential determinants of consumption patterns. This factor can influence other variables, such as income and price levels, to some extent. Alternatively, the culture of a society has a significant influence on the tastes of consumers.

      Different geographical regions exhibit distinct consumption patterns. This pattern, for instance, varies between urban and rural areas, densely populated and sparsely populated areas, economically active and inactive areas, etc.

      John Maynard Keynes introduced consumption theories in 1936, and economists such as Friedman, Dusenberry, and Modigliani refined them. Long ago, the relationship between consumption and income was a fundamental concept in macroeconomic analysis.

      In 1936, Keynes introduced the consumption function in his General Theory. He believed that numerous factors influence consumption decisions, but that real income is the most significant factor in the short term. The Absolute Income Hypothesis states that a consumer's spending on consumption goods and services is proportional to his current disposable income.

      In 1949, James Dusenbery proposed this model. This theory is founded on two hypotheses: 1- Consumption patterns are not independent of one another. In other words, two individuals with the same income but different positions within the income distribution will have distinct consumption patterns. In reality, one compares oneself to others, and one's position among individuals and groups in society has a significant impact on one's consumption; therefore, a person only feels an improvement in his consumption situation if his average consumption increases relative to the average level of society. This occurrence is known as the Demonstration Effect. 2- Consumer behavior cannot be reversed over time. This implies that when income declines, consumer spending remains constant. After becoming accustomed to a certain level of consumption, a person resists and is unwilling to reduce that level of consumption. This occurrence is known as the ratchet effect.

      John Rae conceived the model of intertemporal consumption in the 1830s, and Irving Fisher expanded on it in the 1930s in his book Theory of interest. This model describes the distribution of consumption throughout the life span. In the fundamental model with two periods, such as young and old age,.

      {\displaystyle S_{1}=Y_{1}-C_{1}}

      And then

      {\displaystyle C_{2}=Y_{2}+S_{1}\times (1+r)}

      Where C is the consumption in a given year.

      Where Y is the income received in a given year.

      Where S are saving from a given year.

      Where r is the interest rate.

      Indexes 1 and 2 correspond to periods 1 and 2.

      This model can be expanded to represent every year of an individual's life.

      Milton Friedman developed the permanent income hypothesis in the 1950s in his book A theory of the Consumption Function.

      This theory divides income into two components: Y_{t} is transitory income and Y_{p} is permanent income, such that {\displaystyle Y=Y_{t}+Y_{p}} .

      Variations in the two factors have distinct effects on consumption.

      If Y_{p} changes then consumption changes accordingly by {\displaystyle \alpha \times Y_{p}} , where \alpha is known as the marginal propensity to consume.

      If we expect a portion of income to be saved or invested, we will need a larger budget, then \alpha \in (0,1) , otherwise {\displaystyle \alpha =1} .

      On the contrary, if Y_{t} changes (for example as a result of winning the lottery), Then, this income increase is distributed over the remaining years of life.

      For example, Winning $1,000 with the expectation of surviving 10 more years will result in a $100 increase in annual consumption.

      The life-cycle hypothesis was first published in 1966 by Franco Modigliani. It describes how individuals make consumption decisions based on their past, present, and future income as they tend to distribute their consumption over their lifetime. It is, in its fundamental form:

      {\displaystyle C=1/T\times W+1/T\times (R\times Y)}

      Where C is the consumption in given year.

      Where T is the number of years the individual is going to live for.

      Where R is for how many more years will the individual be working.

      Where Y is the average wage the individual will be paid over his or her remaining work time

      And W is the wealth he has already accumulated in his or her life.

      Spending the Kids' Inheritance (originally the title of a book on the subject by Annie Hulley) and the acronyms SKI and SKI'ing refer to the increasing number of older people in Western society who are spending their money on travel, cars, and property, as opposed to previous generations who tended to leave their money to their children. According to a 2017 study conducted in the United States, twenty percent of married people consider leaving an inheritance a priority, while thirty-four percent do not. And approximately one-tenth of unmarried Americans (14 percent) plan to use their retirement funds to improve their quality of life, as opposed to leaving it as an inheritance to their children. In addition, 28 percent of married Americans have already downsized or plan to do so after retirement.

      Die Broke is a similar concept (from the book Die Broke: A Radical Four-Part Financial Plan by Stephen Pollan and Mark Levine).

      {End Chapter 1}

      Chapter 2: Keynesian economics

      Keynesian economics (The Keynesian theories and models (named after the British economist John Maynard Keynes) explain how aggregate demand (the sum of all purchases) has a major impact on GDP and inflation.

      When compared to the classical economics that came before his book, which focused on aggregate supply, Keynes's approach was radical.

      There is much debate over how to make sense of Keynes's writings, and his influence can be seen in a variety of economic philosophies.

      The neoclassical synthesis, of which Keynesian economics was a part, was the dominant macroeconomic framework in the industrialized world from the latter stages of the Great Depression through World War II and the subsequent period of economic growth (1945–1973). It was created to aid economists in their analysis of the Great Depression and similar events in the future. After the 1970s oil shock and subsequent stagflation, it lost some of its sway.

      The field of study known as macroeconomics looks at the big picture of an economy. The general level of prices, the interest rate, the number of people actively employed, and real income (or equivalently, real output) are all significant macroeconomic variables.

      In the classical tradition of partial equilibrium theory, individual markets were isolated from one another so that equilibrium conditions for each market could be stated in terms of a single equation. This approach had a unified mathematical foundation thanks to Fleming Jenkin and Alfred Marshall's work on supply and demand curves; the Lausanne School extended this work to general equilibrium theory.

      Both the Quantity theory of money, which states that the price level is determined by the quantity of money in circulation, and the classical theory of interest rates are important pieces of the macroeconomics puzzle. Applying marginalist principles from the 19th century to the labor market was what Keynes called the first postulate of classical economics, and it stated that the wage is equal to the marginal product (see The General Theory). All three of the classical theory's pillars were targets for replacement by Keynes.

      Keynes's work was part of an ongoing debate within economics over the existence and nature of general gluts before the Great Depression crystallized and energized it. Many of the theoretical ideas Keynes proposed (effective demand, the multiplier, the paradox of thrift) and many of the policies he advocated (notably government deficit spending at times of low private investment or consumption) had been advanced by authors in the 19th and early 20th centuries. (For instance, in 1892, J. M. Robertson brought up the paradox of thrift.) Keynes's originality lay in his development of a comprehensive theory of these that found favor with the economic establishment.

      John Law, Thomas Malthus, the Birmingham School led by Thomas Attwood, and American economists William Trufant Foster and Waddill Catchings were all thought leaders in the 1920s and 1930s who influenced the development of Keynesian economics. Underconsumptionists, like Keynes after them, advocated economic interventionism and were concerned with the failure of aggregate demand to reach potential output, which they labeled underconsumption (focusing on the demand side) rather than overproduction (focusing on the supply side). Underconsumption (which Keynes spelled under-consumption) was a topic Keynes addressed in the General Theory, specifically in Section IV of Chapter 22 and Section VII of Chapter 23.

      The Stockholm school developed many ideas in the 1930s before and apart from Keynes; these were detailed in an article published in 1937 in response to the 1936 General Theory.

      Keynes's first contribution to economic theory, A Tract on Monetary Reform (1923), takes a classical approach but includes some ideas that would later be central to his General Theory. In particular, he examined the effects of hyperinflation on European economies to highlight the role of the opportunity cost of holding money (which he associated with inflation rather than interest).

      Mainstream economic thought at the time Keynes wrote the General Theory held that the economy would eventually return to a state of general equilibrium; specifically, that everything produced would be consumed once the appropriate price was found, as the needs of consumers are always greater than the capacity of producers to satisfy those needs. Say's law, which states that people create goods with the intention of using them themselves or selling them to fund further production, reflects this view. The premise of this argument is that in the presence of a surplus, the price of the goods or services in question would inevitably fall until they were consumed.

      Against the backdrop of high and persistent unemployment during the Great Depression, Keynes argued that periods of high unemployment were to be expected, especially when the economy was contracting in size, and that there was no guarantee that the goods that individuals produced would be met with adequate effective demand. In his view, the economy needed government intervention in the form of spending to put more disposable income into the hands of the working population so that full employment could be maintained. Thus, according to Keynesian theory, the economy operates below its potential output and growth rate if a large number of individuals and firms take microeconomic-level actions such as not investing savings in the goods and services produced by the economy.

      Before Keynes, classical economists used the term general glut to describe a scenario in which aggregate demand for goods and services did not meet supply, although there was debate among them as to whether or not such a scenario was even possible. According to Keynes, the overreaction of producers and the laying off of workers when a glut occurs leads to a fall in demand and exacerbates the problem. Since Keynesians consider the amplitude of the business cycle to be among the most serious economic problems, they advocate for an active stabilization policy to address this issue. According to the theory, elevated levels of government spending can stimulate economic activity, decrease unemployment, and prevent deflation.

      With the slogan reduce levels of unemployment to normal within one year by utilising the stagnant labour force in vast schemes of national development, the Liberal Party campaigned for votes in the 1929 General Election.

      The respending mechanism used by the multiplier in Kahn's paper is standard fare in modern textbooks. As Samuelson explains it,:

      Let's say I decide to construct a $1,000 woodshed using unemployed labor.

      My woodworkers and lumberjacks will each see an increase in income of $1,000.

      Assuming everyone has a marginal willingness to buy of 0.6, They have decided to buy new consumer items costing $666.67.

      The manufacturers of these items will now receive higher compensation.

      In return, they'll shell out $444.44.

      Thus an endless chain of secondary consumption respending  is set in motion by my primary  investment of $1000.

      The main route through which the multiplier has influenced Keynesian theory is via Samuelson's treatment, which closely follows Joan Robinson's account from 1937. Compared to Kahn's paper and especially Keynes' book, it's very different.

      He gives no reason why initial consumption or subsequent investment respending shouldn't have exactly the same effects, but he still calls the initial spending investment and the respending that creates jobs consumption, echoing Kahn faithfully. It was written by Henry Hazlitt, who saw Keynes as just as guilty as Kahn and Samuelson, that.

      Keynes uses the term investment to mean any increase in spending, regardless of its intended use, when discussing the multiplier, as well as most of the time. In this context, investment has a Pickwickian or Keynesian meaning.

      Kahn envisioned monetary transactions as a hand-to-hand transfer of funds, developing work opportunities in each stage, until it came to rest in a cul-de-sac  (Hansen's term was leakage); the only culs-de-sac  he acknowledged were imports and hoarding, Nonetheless, he cautioned that price increases could dampen the multiplier effect.

      Personal financial planning was something Jens Warming realized was important, considering it a leak p. While acknowledging on p. that it could potentially be invested 217.

      According to the textbook multiplier, increasing government spending is all that's needed to improve people's standard of living. It's more challenging in Kahn's article. According to him, the first outlay of money can't just be a redirection of funds from some other purpose; it has to be an increase in total expenditure, which is contrary to the classical theory that says spending can't exceed the economy's income or output. While Kahn does acknowledge that this may arise if the revenue is raised through taxation (see page 174), he argues that other available means have no such consequences and thus rejects the claim that the effect of public works is at the expense of expenditure elsewhere. He gives the possibility of borrowing from banks as a possible source of the needed funds.

      It is always possible for banks to front the government money for roads without disrupting investment through traditional channels.

      Assuming banks can freely create resources to meet any demand is central to this argument. However, Kahn argues that...

      In all honesty, such a supposition is unnecessary.

      Because it will be shown in due time that, pari passu  with the building of roads, The cost of the roads is met by a steady flow of money from a variety of sources.

      The demonstration relies on Mr Meade's relation (due to James Meade) asserting that the total amount of money that disappears into culs-de-sac  is equal to the original outlay, a fact that should bring relief and consolation to those who are worried about the financial sources, as Kahn puts it (p. 189).

      Hawtrey had previously proposed a respending multiplier in a 1928 Treasury memorandum (with imports as the only leakage), but he abandoned the idea in later writings. The concept itself was centuries old. Since some Dutch mercantilists assumed there would be no leakage of imported goods, they reasoned that military spending could be multiplied infinitely.

      If enough money were kept in the country, the war could continue indefinitely. For if money is consumed, all that has happened is that it has changed hands, and that can happen forever.

      Keynes was becoming a strong public advocate of capital development as a public measure to reduce unemployment as the 1929 election neared. Conservative Chancellor Winston Churchill disagreed:

      That State borrowing and State expenditure can create very little additional employment and no permanent additional employment is the orthodox Treasury dogma.

      Keynes quickly spotted a problem with the Treasury's analysis. During his 1930 cross-examination of Treasury Second Secretary Sir Richard Hopkins before the Macmillan Committee on Finance and Industry, Hopkins was asked whether it would be a misunderstanding of the Treasury view to say that they hold to the first proposition, referring to the idea that schemes of capital development are of no use for reducing unemployment. Hopkins remarked in response, The first suggestion goes far beyond the mark. The first hypothesis would make it sound like we adhere to some kind of inflexible dogma, right?

      In his seminal work, The General Theory of Employment, Interest, and Money (1936), Keynes put forth the ideas that would later form the foundation of Keynesian economics (1936). During the Great Depression, when unemployment reached 25% in the US and even 33% in some countries, it was written. It's mostly theoretical, with some satire and social commentary thrown in for flavor. The book's publication sparked heated discussions about the direction of economic thought.

      Keynes begins the General Theory  with a summary of the classical theory of employment, which he summarizes in the adage Supply creates its own demand, Say's Law.

      Although he explained his theory using examples from an Anglo-Saxon laissez-faire economy, he also noted that, Additionally, unlike a free market policy, his theory could be easily adapted to totalitarian states..

      The term savings refers to the amount of money that is not spent on daily needs, while consumption describes the amount of money that is spent on non-durable goods. In this sense, hoarding (the accumulation of income as cash) and the purchase of long-lasting goods are both types of saving. The General Theory's simplified liquidity preference model denies the possibility of net hoarding or a demand to hoard.

      Keynes's alternative to the classical theory of unemployment as a result of excessive wages is based on the interplay between saving and investment, which he rejects. Keynes argues that unemployment occurs when business owners' incentives to invest are lower than the general public's propensity to save. Income is capped at a point where the desire to save is not greater than the incentive to invest, so that the two are in equilibrium.

      Optimistic expectations of future profits interact with the material conditions of production to create an incentive to invest; However, after receiving these benefits, the incentive is no longer tied to monetary gain, but rather to the interest rate r.

      Keynes designates its value as a function of r  as the schedule of the marginal efficiency of capital.

      The term saving refers to any monetary resource that is set aside rather than spent, and:

      When total income rises, consumers tend to spend a smaller percentage of that sum on goods and services, according to the prevailing psychological law..

      The importance of this psychological law to Keynes's own thought development is emphasized.

      Determination of income according to the General Theory

      The money supply was an important factor in Keynes's analysis of the real economy. One of the novel aspects of his work is the importance he ascribed to it, which influenced the politically antagonistic monetarist school.

      Liquidity preferences are affected by money supply, what is the demand function that maps onto the quantity of currency in circulation.

      According to the current economic climate, it lays out the target cash balance that consumers will strive to maintain.

      In Keynes's first (and simplest) account – that of Chapter 13 – liquidity preference is determined solely by the interest rate r—which is seen as the earnings forgone by holding wealth in liquid form: hence liquidity preference can be written L(r ) and in equilibrium must equal the externally fixed money supply M̂.

      Money supply, As shown, income is determined by a combination of saving and investment, where interest rate (left) is plotted against money supply (right) in the top graph.

      M̂  determines the ruling interest rate r̂  through the liquidity preference function.

      The rate of interest determines the level of investment Î  through the schedule of the marginal efficiency of capital, in the lower graph as a blue line.

      The red curves in the same diagram show what the propensities to save are for different incomes Y ; and the income Ŷ  corresponding to the equilibrium state of the economy must be the one for which the implied level of saving at the established interest rate is equal to Î.

      Keynes's more involved liquidity preference theory (discussed in Chapter 15) adds another layer of complexity to the analysis by making the demand for money contingent not only on the interest rate but also on income. John Hicks is responsible for the full integration of Keynes's second liquidity preference doctrine with the rest of his theory. below is a model of the IS-LM.

      While it is clear that Keynes disagrees with the classical explanation of unemployment based on wage rigidity, the impact of the wage rate on unemployment in his system is unclear. He chooses his units so that the rate established through collective bargaining never comes up separately from the wages themselves. It's implied in the numbers he uses wage units to express, but not in the numbers he uses money to express. This makes it unclear whether and how his findings change for a given wage rate, as well as his own thoughts on the matter.

      According to Keynes's theory, a rise in the money supply reduces interest rates and raises the amount of investment that can be made profitably, leading to a rise in both individual income and the national income as a whole.

      Despite the fact that Keynes's name is commonly linked to fiscal rather than monetary policies, these are only mentioned briefly (and often satirically) in the General Theory. Before he develops the relevant theory, he makes a passing reference to increased public works as an example of something that brings employment through the multiplier, but he does not expand on this when he gets to the theory.

      The author reveals later in the chapter that:

      In that it had both pyramid-building and the search for the precious metals, the fruits of which did not go bad even in abundance because they could not serve the needs of man by being consumed, Ancient Egypt was doubly fortunate and likely owed much of its legendary wealth to this. The emo music and Gothic cathedrals of the Middle Ages. Two pyramids are better than one, as are two funeral masses, but two trains between London and York are just as inefficient as one.

      However, when constructing the theory, he does not return to his implied recommendation to participate in public works, even if they are not fully justified from their direct benefits. However, he tells us later that.

      In the system in which we currently reside, our ultimate goal may be to identify those factors that can be managed or controlled on purpose by a governing body.

      and this seems to be anticipating a book rather than a section of the General Theory.

      Keynes–Samuelson cross

      Keynes' most significant departure from the classical outlook was his view of saving and investment.

      The Keynesian cross by Paul Samuelson serves as a useful metaphor for this concept.

      The horizontal axis denotes total income and the purple curve shows C (Y ), the tendency to consume, whose complement S (Y ) is the propensity to save: the sum of these two functions is equal to total income, which is shown by the broken line at 45°.

      The horizontal blue line I (r ) is the schedule of the marginal efficiency of capital whose value is independent of Y.

      Interest rate determines marginal efficiency of capital schedule, the rate of interest that a new investment will incur.

      Investment is positive and increases as interest rates fall if the productive sector is able to borrow money at a rate lower than the marginal efficiency of capital at the given level of technology and capital intensity, given the declining rate of return on investment.

      Investment equals zero if interest rates are higher than the point at which capital is no longer cost effective.

      Aggregate demand, which Keynes defines as the sum of consumer and capital expenditure demands, is what this means, separate curves are plotted.

      Total income must equal aggregate demand, so equilibrium income must be determined by the point where the aggregate demand curve crosses the 45° line.

      This is the same horizontal position as the intersection of I (r ) with S (Y ).

      The equation I (r ) = S (Y ) had been accepted by the classics, who had previously thought of it in terms of the interest rate and the condition of equilibrium between the supply and demand for investment funds (see the classical theory of interest).

      But to the extent that they had any understanding of aggregate demand, they had seen the demand for investment as being given by S (Y ), since putting money aside was, in their minds, equivalent to investing in capital equipment, as a result, total income and aggregate demand became an identity, rather than a state of equilibrium.

      This viewpoint is noted by Keynes in Chapter 2, where he finds it in Alfred Marshall's early writings but notes that the doctrine is never stated to-day in this crude form..

      The equation I (r ) = S (Y ) is accepted by Keynes for some or all of the following reasons:

      Given that total income must equal total demand in accordance with the principle of effective demand (Chapter 3).

      The equilibrium hypothesis that these amounts are adequate to satisfy their needs follows from the fact that saving and investment are the same thing (Chapter 6).

      Despite agreeing with the general tenor of the classical theory of the investment funds market, he rejects its final conclusion on the grounds that it is based on a fallacy of circular reasoning (Chapter 14).

      In Chapter 10, Keynes alludes to an earlier paper by Kahn to set the stage for his discussion of the multiplier (see below).

      They are only a little different, he says, between his investment multiplier and Kahn's employment multiplier..

      Therefore, much of the Keynesian literature takes Kahn's multiplier to be an integral part of Keynes's own theory, one that is encouraged by the complexity of Keynes's explanation.

      Kahn's multiplier gives the title (The multiplier model) to the account of Keynesian theory in Samuelson's Economics  and is almost as prominent in Alvin Hansen's Guide to Keynes  and in Joan Robinson's Introduction to the Theory of Employment.

      That there is, as Keynes puts it,.

      It's easy to get confused between the logical theory of the multiplier, which is true indefinitely and instantly, and the effects of a growth in the capital goods industries, which manifest themselves gradually, with a time lag, and only after a certain amount of time has passed.

      and it seems to imply that he's embracing the former theory.

      Keynes' departure from Kahn's multiplier was seen as a. by G. L. S. Shackle.

      A step backwards... For when we consider the Multiplier as a momentary functional relation... we are merely employing the term Multiplier to stand for a different perspective on the marginal propensity to consume.., which G. M. Ambrosi uses to demonstrate the viewpoint of a Keynesian commentator who would have liked Keynes to have written something less'retrograde.' The Chapter 13 model of liquidity preference from which Keynes derived his multiplier entails that all of the impact of a change in investment must be borne by income, so this is indeed the value of his multiplier. But according to his model presented in Chapter 15, a shift in the marginal efficiency of capital schedule affects both interest rates and income, with the exact split depending on the partial derivatives of the liquidity preference function. Keynes did not look into the possibility that his multiplier formula needed adjusting.

      The liquidity trap.

      As a phenomenon, the liquidity trap can make it harder for monetary policies to fight unemployment.

      Economists agree that the interest rate is unlikely to go below a certain floor, typically defined as zero or a slightly negative number. Keynes hypothesized that the limit could be significantly larger than zero, but he didn't give it much weight in his theoretical framework. In his discussion of the General Theory, Dennis Robertson coined the term liquidity trap after realizing the importance of a slightly different concept.

      The economy is in a state of near-vertical liquidity preference curve if, as must happen as the lower limit on r  is approached, then a change in the money supply M̂  makes almost no difference to the equilibrium rate of interest r̂  or, Unless the other curves are steep enough to compensate, to the resulting income Ŷ.

      According to Hicks, The interest rate cannot be lowered any further through monetary policy.

      Extensive research on the liquidity trap has been conducted by Paul Krugman, who claims that this issue plagued the Japanese economy at the turn of the millennium. Later, he explained:

      Private investment spending was still insufficient to pull the economy out of deflation even though short-term interest rates were close to zero and long-term rates were at historical lows. Monetary policy was similarly ineffective under those conditions to what Keynes had predicted. The Bank of Japan's attempts to boost the country's money supply have had no effect other than to increase the country's already large stockpiles of cash.

      IS–LM plot

      When Hicks considered a scenario in which liquidity preference depends on both income and interest rate, Keynes' system became more transparent.

      Keynes's return to classical theory can be seen in his recognition of income as a factor in money demand, and Hicks takes a further step in the same direction by generalizing the propensity to save to take both Y  and r  as arguments.

      In a less classical move, he extrapolates this principle to the capital efficiency distribution.

      Keynes' model is expressed using two equations in the IS-LM model.

      The first, updated to I (Y, r ) = S (Y,r ), communicates the idea of efficient demand.

      Possible Graph Construction on (Y, r ) coordinates and draw a line connecting those points satisfying the equation: this is the IS  curve.

      In the same way we can write the equation of equilibrium between liquidity preference and the money supply as L(Y ,r ) = M̂ and draw a second curve – the LM  curve – connecting points that satisfy it.

      The equilibrium values Ŷ  of total income and r̂  of interest rate are then given by the point of intersection of the two curves.

      If we accept Keynes's initial account, in which the preference for easy access to cash is based solely on the rate of interest r,, then the LM  curve is horizontal.

      According to Joan Robinson's analysis,:

      The attempt by J. R. Hicks to reduce the General Theory to a version of static equilibrium with the formula IS-LM has muddled modern teaching. It will take a long time for the effects of Hicks' teaching to wear off, despite the fact that he has changed his name from J. R. to John.

      After that, Hicks had a relapse.

      Typical intervention strategies under different conditions

      During the Great Depression, Keynes proposed a combination of two policies to stimulate the economy and encourage investment:

      Lowering of Interest Rates (monetary policy), and

      Infrastructure spending by the government (fiscal policy).

      Investments that were previously uneconomic become profitable, and large consumer sales that are typically financed through debt (such as houses, automobiles, and, historically, even appliances like refrigerators) become more affordable if the interest rate at which they can borrow falls. Monetary policy refers to the various methods central banks use to affect the interest rate in countries that have them. Interest rate cuts are considered an example of expansionary monetary policy because they are thought to increase economic activity and thus grow the economy..

      A government can implement expansionary fiscal policy by doing one of three things: a) cutting taxes, b) increasing spending, or c) doing both. Government spending and investment boosts demand for goods and services offered by businesses, thereby increasing the number of jobs available. When government spending exceeds tax collections, the gap is filled by purchasing bonds on the open market. We refer to this as a deficit in our budget. There are two points worth emphasizing right now. First, deficits are not necessary for expansionary fiscal policy, and second, the only thing that can stimulate or depress the economy is a change in net spending. A government with a 10% deficit last year and the same deficit this year would be practicing neutral fiscal policy. In fact, this would be contractionary if the deficit were 10% last year and 5% this year. On the other hand, expansionary fiscal policy would be implemented if the government never ran a deficit but instead ran surpluses of 10% of GDP in both 2017 and 2018.

      However, contrary to some interpretations, Keynesianism does not merely advocate deficit spending; rather, it advocates adjusting fiscal policies in response to cyclical conditions. An example of a counter-cyclical policy is deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns, and tax increases to cool the economy and prevent inflation when demand-side growth is robust.

      FDR's belief that a lack of consumer spending contributed to the Great Depression was influenced by Keynes's ideas. After the United States fell back into recession in the depths of the Depression as a result of fiscal contraction in 1937, Roosevelt began to adopt some Keynesian economic policies. However, many argue that the outbreak of World War II—which gave the global economy a jolt, eliminated uncertainty, and compelled the rebuilding of destroyed capital—is the true success of Keynesian policy. After World War II, social-democratic Europe and the United States both adopted Keynesian ideas to varying degrees.

      The Keynesian defense of deficit spending stood in stark contrast to the classical and neoclassical economic evaluation of government spending. They conceded that government spending would stimulate industry. These institutions reasoned that there was no reason to expect the benefits of government spending to outweigh the costs of the crowding out of private investment. For starters, a deficit increases the supply of government bonds, which lowers their market price and encourages high interest rates, making it more difficult for businesses to finance fixed investment. As a result, any attempt to boost the economy would have the opposite effect intended.

      In response, Keynesians argue that this type of fiscal policy is only warranted when unemployment rates remain persistently high and are higher than the rate of inflation that does not cause unemployment to rise (NAIRU). In such a scenario, crowding is to a minimum. In addition, fiscal stimulus can crowd in private investment by expanding businesses' addressable markets for their output, thereby boosting cash flow, profits, and morale. Keynes believed that because of this accelerator effect, the government and business could work together rather than against each other.

      Second, as the stimulus takes effect, GDP rises, boosting saving and thereby facilitating the expansion of

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