Question

1. What are the components and the equation of Keynes’ consumption equation?

2. Which are the main determinants of planned investment according to Keynes?

3. Describe the relationship between planned investment spending and the current income in the Keynes model. What is the shape of the investment curve?

4. Describe the relationship between government spending and the current income in the Keynes model

Answer 1

1. The Keynesian Consumption function :

C = a + bYd

Where C = Consumption spending

a = Autonomous Consumption

b = Marginal propensity to Consume

Yd = disposable income

2. Main determinants of planned investment According to Keynes :

i) Expectations of future profits : While investing in physical assets like plants or equipments and intangible assets like skills, knowledge, research, a firm first considers the benefits of investment or the future profits from this investment. The higher the degree of business confidence, the higher will be the planned investment spending.

ii) Interest rate : This is also known as cost of an investment. A firm takes this into consideration while making investment decisions. If interest rate is high, cost of borrowing funds for investment increases. This will decrease planned investment spending. If interest rate lowers, investment spending increases.