Key Points

Ex-ante refers to the planned or intended values of variables like consumption and investment. Ex-post refers to the actual or realized values of these variables after a period.

Aggregate Demand (AD) is the total planned expenditure on final goods and services in an economy. In a two-sector model, its components are planned consumption (C) and planned investment (I), so AD = C + I.

The consumption function shows the relationship between consumption and income, given by the equation C = C̄ + cY. It has two parts: autonomous consumption (C̄) and induced consumption (cY).

Autonomous consumption is the minimum level of consumption that occurs even when national income is zero. It is independent of the level of income.

MPC (denoted by c) is the ratio of the change in consumption to the change in income (ΔC/ΔY). It represents the proportion of additional income that is spent on consumption and its value is between 0 and 1.

MPS (denoted by s) is the ratio of the change in savings to the change in income (ΔS/ΔY). It represents the proportion of additional income that is saved.

The sum of the Marginal Propensity to Consume and the Marginal Propensity to Save is always equal to one. This is expressed as MPC + MPS = 1, or c + s = 1.

In the Keynesian model, investment is assumed to be autonomous, meaning it does not depend on the level of income. It is represented as a constant value, I = Ī.

The economy is in equilibrium when planned aggregate supply (Y) equals planned aggregate demand (AD). The equilibrium condition is Y = AD, which means Y = C + I.

Under the assumption of fixed prices and excess capacity, the aggregate supply is perfectly elastic. It is graphically represented by a 45-degree line from the origin, where at any point, Income = Aggregate Supply.

The multiplier shows that an initial change in autonomous spending (like investment) leads to a much larger final change in the equilibrium level of national income.

The value of the investment multiplier (k) is determined by the MPC. The formula is k = 1 / (1 - MPC) or k = 1 / MPS.

The Paradox of Thrift states that if all people in an economy try to save more, the total savings of the economy may not increase and could even decrease. This is because increased saving reduces consumption, aggregate demand, and ultimately income.

This is the level of income where all factors of production are fully employed. The equilibrium level of income may be less than, equal to, or greater than the full employment level.

Deficient demand occurs when the equilibrium level of aggregate demand is less than the aggregate supply at the full employment level. This situation leads to unemployment and is also known as a deflationary gap.

Excess demand occurs when the equilibrium level of aggregate demand is more than the aggregate supply at the full employment level. This situation leads to a rise in the general price level and is also known as an inflationary gap.