"Keynesians in the White House" Economics Case study
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The document discusses the case study 'Keynesians in the White House' by Nikhil Gupta, focusing on President Kennedy's tax cut proposal aimed at increasing consumer spending and aggregate demand, based on Keynesian economic theory. It explains the four components of aggregate demand—consumption, investment, government spending, and net exports—and their impact on the economy, as well as the role of fiscal policy in regulating economic activity through changes in taxation and spending. Additionally, it explores how expansionary and contractionary fiscal policies shift the aggregate demand curve and their implications for budget deficits and surpluses.
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"Keynesians in the White House" Economics Case study
- 1. A Presentation on Case study “Keynesians in The White House” By Nikhil Gupta
- 2. Introduction • This Case deals about Kennedy's Proposal of Tax cut which will increase the Consumer Spending, Expand Aggregate Demand, and increase the country’s Production and Employment. • The Proposal of Kennedy’s Economic Advisers, James and Robert is based on John Maynard Keynes General Theory. • The Advisers proposed cutting taxes, they were putting Keynes idea into action. • This Case is based on usage of Fiscal Policy in controlling Aggregate Demand.
- 3. What is Aggregate Demand? Aggregate Demand is an economic measurement of the sum of all final goods and services produced in an economy, expressed as the total amount of money exchanged for those goods and services. Since aggregate demand is measured through market values, it only represents total output at a given price level, and does not necessarily represent quality or standard of living. COMPONENTS OF AGGREGATE DEMAND • It is helpful to keep in mind that aggregate demand for an economy is divided into four components: consumption, investment, government spending, and net exports. Changes in any of these components will cause the aggregate demand curve to shift. • Consumption(C) • Investment(I) • Government Spending(G) • Net Exports(X-M) Aggregate Demand(AD)= C+I+G+(X-M)
- 4. CONSUMPTION This is made by households, and sometimes Consumption accounts for the larger portion of aggregate demand. An increase in consumption shifts the AD curve to the right. FACTORS THAT AFFECT CONSUMPTION CONSUMER CONFIDENCE If consumers are confident about their future income, job stability, and the economy is growing and stable, spending is likely to increase. However, any job insecurity and uncertainty over income is likely to delay spending. An increase in consumer confidence shifts AD to the right. INTEREST RATES Lower interest rates tend to increase consumption because larger goods are usually purchased on credit and if interest rates are low, then its cheaper to borrow. Consumers mostly borrow to buy houses, which is one of the biggest purchases and lower interest rates means lower mortgage payments, so households can spend more on other goods. Some Economists argue that lower interest rates also make saving less attractive, but there is no real evidence. So, lower interest rates increase Aggregate Demand. CONSUMER DEBT If a consumer has a lot of debt, he is unlikely to buy more since he would have to pay his debt off first. Low consumer debt increases consumption and aggregate demand. WEALTH Wealth are assets held by a household, such as property or stocks. An increase in property is likely increase to consumption.
- 5. INVESTMENT Investment, second of the four components of Aggregate Demand, is spending by firms on capital, not households. Investment is the most volatile component of AD. An increase in investment shifts AD to the right in the short run and helps improve the quality and quantity of factors of production in the long run. FACTORS THAT AFFECT INVESTMENT: INTEREST RATES Firms borrow from banks to make large capital intensive purchases, and if the interest rate decreases, it becomes cheaper for firms to invest and provides incentive for firms to take risk. BUSINESS CONFIDENCE If firms are confident about the economy and its future growth, they are more likely to invest in capital, new projects and buildings/machinery. INVESTMENT POLICY If governments provide incentives such as tax breaks, subsidies, loans at lower interest rates then investment can increase. However, corruption and bureaucracy deters investment. NATIONAL INCOME As firms increase output, they would need to invest in new machines. This relationship is known as The Accelerator. The assumption behind the accelerator is that firms will want to maintain a fixed capital to output ratio, meaning that if a factory uses one machine to produce 1000 goods, and the firms needs to produce 3000 goods more, then the firm will buy 3 more machines.
- 6. GOVERNMENT SPENDING Government spending forms a large total of aggregate demand, and an increase in government spending shifts aggregate demand to the right. Government spending is categorized into transfer payments and capital spending. Transfer payments include pensions and unemployment benefits and capital spending is on things like roads, schools and hospitals. Governments spend to increase the consumption of health services, education and to re-distribute income. They may also spend to increase aggregate demand. NET EXPORTS Imports are foreign goods bought by consumers domestically, and exports are domestic goods bought abroad. Net exports is the difference between exports and imports, and this component can be net imports too, if imports are greater than exports. An increase in net exports shifts aggregate demand to the right. The exchange rate and trade policy affects net exports.
- 7. Fiscal policy • Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. • It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. • These two policies are used in various combinations to direct a country's economic goals. • Before the Great Depression, which lasted from Sept. 4, 1929 to the late 1930s or early 1940s, the government's approach to the economy was laissez-faire. • Following World War II, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles, inflation and the cost of money. • By using a mix of monetary and fiscal policies governments will control economic phenomena.
- 8. How Fiscal Policy Relates to the AD-AS Model • When setting FISCAL POLICY, the government can take an active role in changing its spending or the level of Taxation. These actions lead to an increase or decrease in aggregate demand, which is reflected in the shift of the Aggregate Demand (AD) curve to the right or left respectively . • Expansionary policy shifts the Aggregate Demand curve to the right, while contractionary policy shifts it to the left.
- 9. • Expansionary Fiscal Policy is used to kick-start the economy during a recession. It boosts aggregate demand, which in turn increases output and employment in the economy. In pursuing expansionary policy, the government increases spending, reduces taxes, or does a combination of the two. Since government spending is one of the components of aggregate demand, an increase in government spending will shift the demand curve to the right. A reduction in taxes will leave more disposable income and cause consumption and savings to increase, also shifting the aggregate demand curve to the right. An increase in government spending combined with a reduction in taxes will, unsurprisingly, also shift the AD curve to the right. The extent of the shift in the AD curve due to government spending depends on the size of the spending multiplier, while the shift in the AD curve in response to tax cuts depends on the size of the tax multiplier. If government spending exceeds tax revenues, expansionary policy will lead to a budget deficit. • A Contractionary Fiscal Policy is implemented when there is demand- pull inflation. It can also be used to pay off unwanted debt. In pursuing contractionary fiscal policy the government can decrease its spending, raise taxes, or pursue a combination of the two. Contractionary fiscal policy shifts the AD curve to the left. If tax revenues exceed government spending, this type of policy will lead to a budget surplus.
- 10. References • www.investopedia.com • www.boundless.com • www.intelligenteconomist.com
- 11. Thank you