Aggregate Expenditure - Keynesian Economics

Keynesian Economics

Keynesian Economics believes, contrary to the classical thought that the Wages, Prices and interest rates are not flexible and hence violating Say's Law, which provided the foundation for the maxim that "supply creates its own demand". Keynes believed that the economy was subject to Sticky Prices and thus the economy was not in a state of perpetual equilibrium and also operated at an under-employment equilibrium.

Keynesian economics calls for a government intervention and is called demand side economics as it believes that aggregate demand and not the aggregate supply determines the GDP because of the difference between the Aggregate Supply and Planned expenditure in an economy.Hence Keynes believed that the government played an important role in the determination on the Aggregate Expenditure in an economy and was thus included Government Expenditure in the Aggregate Expenditure Function.

Hence,

Where,

• C = Household Consumption Expenditure
• I = Investment (Planned)
• G = Government Expenditure
• NX= Net Exports ( Exports - Imports )

Keynesian economics preaches that in times of a recession, the government must undertake the expenditure to compensate for the lack in the components of Household expenditure (C) and private investment (I) so as to ensure that the demand is maintained in the markets. This also leads to the Keynesian Multiplier which suggests that every dollar spent on investment creates a multiplier effect and leads to an increased expenditure of more than one dollar.