Question

Part B. 2. (10%) In the space provided below, discuss the following macroeconomics diagram. Your discussion should consist of complete sentences organized into complete paragraphs. Give at least one of the names for the model shown, explain the situation to which the model best applies, provide a possible scenario for what is happening in the diagram, and describe the change in equilibrium. Y = PAE Expenditure line PAE = 960 + 0.8Y Expenditure line PAE = 950 + 0.8Y Planned aggregate expenditure (PAE) A decline in autonomous aggregate expenditure shifts the expenditure line down 0 960 i Recessionary gap 4750 4800 Output (Y)

Answer 1

The graph describes the Keynesian Cross model.

In this model, planned aggregate expenditure (PAE) and output (Y) are shown along vertical & horizontal axes, respectively. Equilibrium is at intersection of PAE and 450 line where at all points located on the 450 line represents equality between PAE and Y.

Initial equilibrium is at point E with vertical intercept of PAE being 960 and equilibrium output being 4800 which is the full-employment output. When autonomous aggregate expenditure decreases by 10 units, PAE shifts downward by 10 units with new vertical intercept being 950, so new equilibrium is at point F, and new equilibrium output being 4750 which is less than the full-employment output. At this level firms are unable to sell their entire production, which leads to unplanned inventory accumulation.

This situation may arise if any autonomous component of PAE, viz. autonomous consumption, investment, government spending or net exports decrease by 10 units.

In this case, Recessionary gap = 4800 - 4750 = 50

So, a 10-unit decrease in autonomous aggregate expenditure decreases output by 50 units.

Spending multiplier = 50/10 = 5