The Simple Keynesian Model

In The TE-TP Framework

Deriving a Total Expenditures (TE) Curve

TE = C + I + G
TE = Total Expenditure
C = Consumption
I = Investment
G = Government purchases
Consumption
Disposable Income
& then… Consumption
Real GDP

However, as real GDP rises, consumption rises by a smaller amount. For example, if Real GDP rises by
$100, consumption may rise by $80. Above shows consumption as an upward-sloping curve. Notice that
as Real GDP rises from Q1 to Q2, consumption rises from $7 trillion to $7.5 trillion.
Investment & Government Purchases
Total Expenditures
 What Will Shift the TE Curve?
The TE curve in the TE–TP framework plays the same role as the AD
curve in the AD–AS framework. Both the AD curve and the TE curve shift
with a change in C, I, or G.

For example:

Increase in C… TE curve shifts upward

Decrease in I… TE curve shifts downward

THE THREE STATES OF THE ECONOMY IN
THE TE–TP FRAMEWORK

TE < TP
Disequilibrium
TE > TP

TE = TP Equilibrium
Moving from Disequilibrium to Equilibrium
CASE 1: TE < TP Assume that business firms hold an optimum
inventory level of $300 billion worth of goods, that the firms produce $11
trillion worth of goods and services, and that the three sectors of the
economy buy $10.8 trillion worth of goods and services. In this case,
producers produce more than individuals buy (TE < TP). The difference is
added to inventories, and inventory levels rise unexpectedly to $500 billion,
which is $200 billion more than the $300 billion that firms see as optimal.
This unexpected rise in inventories signals to firms that they have
overproduced. Consequently, they cut back on the quantity of goods
they are producing. The cutback in production causes Real GDP to fall,
bringing Real GDP closer to the (lower) output level that the three sectors
of the economy are willing and able to buy. Ultimately, TP will equal TE.
CASE 2: TE > TP Assume that business firms hold their optimum inventory
level ($300 billion worth of goods), that they produce $10.4 trillion worth
of goods, and that members of the three sectors buy $10.6 trillion worth
of goods. How can individuals buy more than businesses produce? Firms
make up the difference out of inventory. In our example, inventory levels
fall from $300 billion to $100 billion because individuals purchase $200
billion more of goods than firms produced (to be sold). This is why firms
maintain inventories in the first place: to be able to meet an unexpected
increase in sales. The unexpected fall in inventories signals to firms that
they have under produced. Consequently, they increase the quantity of
goods they produce. The rise in production causes Real GDP to rise, in
the process bringing Real GDP closer to the (higher) real output that the
three sectors are willing and able to buy. Ultimately, TP will equal TE.
 The Theme of the Simple Keynesian Model
In terms of TE and TP, the essence of the simple Keynesian model can be
summed up in five statements:
1. The price level is constant until Natural Real GDP is reached.
2. The TE curve shifts if there are changes in C, I, or G.
3. According to Keynes, the economy could be in equilibrium and in a
recessionary gap too.
4. The private sector may not be able to get the economy out of a recessionary
gap. In other words, the private sector (households and businesses) may not
be able to increase C.
5. The government may have a management role to play in the economy.
According to Keynes, government may have to raise TE enough to stimulate
the economy to move it out of the recessionary gap and to its Natural Real
GDP level.
The Simple Keynesian Model in the TE–TP
Framework
The purpose of the simple Keynesian model
is to explain changes in Real GDP. In (a) the
model is presented as a flowchart. Real
GDP is determined by total expenditures
(TE ) and total product (TP ). Total
expenditures (TE ) depend on C,
consumption; I, investment; and G,
government purchases. In (b) is a
diagrammatic exposition of the model in the
TE2TP framework.