John Maynard Keynes is known as the father of macroeconomics.

Aggregate expenditure is the total amount the economy plans to spend in a given period. It is equal to consumption plus investment. Consumption: Consumption is the only spending component that varies with the level of GDP. Investment: Investment is spending on capital goods by firms and government, which will allow increased production of consumer goods and services in future time periods. When aggregate expenditure is lower than GDP:

There are more goods & services on shelf than people want to buy. Unsold goods increase the stock of inventory. In fact, unsold goods called unplanned inventory.

Aggregate affect GDP

When firms face a positive level of unplanned inventory, they recognized that they overproduced. Firms decide to produce less goods & services.

When aggregate expenditure is higher than GDP:

There is more buying than the goods & services offered for sale. The stock of goods kept as inventory declines since firms offer it for sale. In this case unplanned inventory is negative. i.e., actual inventory is lower than the planned level.

Aggregate affect GDP When firm face an unplanned reduction in the level of inventory, they recognized that they under-produced. They increase their level of production. GDP (y) Consumption Saving Investment (I) (A.E) (C) (S) 370 375 -5 20 395 390 390 0 20 410 410 405 5 20 425 430 420 10 20 440 450 435 15 20 455 The equilibrium level of 470 450 20 20 470 GDP is where the total 490 465 25 20 485 quantity of goods 510 480 30 20 500 produced (GDP) equals the total quantity of goods purchased (consumption+ Investment) that is the equilibrium level of national income or GDP. At the level of equilibrium, where there is no

tendency to change, GDP is equals to aggregate expenditure. On the level of (370-450) are disequilibrium, economy spending more expenditure and production have low. There is more buying than the goods & services offered for sale. So economy needs to increase the level of production. To achieve the equilibrium point, At 470 there is no shortage of product (GDP = A.E) it means all the products which are produced have consumed. Above the 470, firm is producing more, unsold goods increase the stock of inventory and firm needs to produce less goods & services. Multiplier is define as the ratio of a change in national income to the initial change in investment expenditure that bring The size of multiplier depends on the slope of the A.E curve. In general the steeper the A.E curve, the greater the multiplier, the flatter the A.E curve, the smaller the multiplier. Example: $1 increase in spending increase in GDP by more than $1. Interest higher, less is spent on purchased on credit. Save more & borrow less. Consumption curve shifts downward. More is invested if the opportunity cost of borrowing is lower. Fiscal policy is the use of taxes and government spending to control the economic activity of a country. Government spending is an additional component of A.E. The benefit of the multiplier effect can be derived as a one time increase in government spending to deal with a recession. In the leakage-injection analysis, government spending is an injection and contributes to move the economy to a higher level of equilibrium. Tax increase reduces income, and thus, A.E. tax increase A.E will move downward. A tax increase may be warranted in the case of excessive demand causing inflation. In the leakage-injection analysis the tax increase is a leakage and is added to saving. A.E decreases i.e. create a negative multiplier effect, because the economy was experiencing an increasing inflation. KEYNESIAN FISCAL POLICY: Keynes recommends to use an expansionary fiscal policy in the

case of a recession: reduce taxes and increase spending. In the case of inflation, the opposite is recommended. Expansionary fiscal policy may be less effective than needed if a crowding-out effect takes place as government prefers to finance spending through borrowings rather than taxes or new money. Fighting inflation may also be ineffective with reduced spending and increased taxation if the budget surplus is used to repay debt. If the increase in government spending is just
equal to the increase in taxes, the budget is balanced. A balanced budget with simultaneous increases in spending and taxes is not neutral but expansionary. The reason for an increase in output is that the taxes reduce both consumption and saving, and the reduction from the taxes is smaller than the increase from the additional spending. The value of the balanced budget multiplier is one. An expansionary fiscal policy would be used to speed up the rate of GDP growth or during a recession when GDP growth is negative. A tax cut and/or an increase in government spending would be implemented to stimulate economic growth and lower unemployment rates. These policies will lead to higher federal budget deficits. A restrictive fiscal policy involves raising taxes or cutting government spending in an attempt to dampen GDP (aggregate demand) growth and lower inflationary pressures.

FISCAL POLICY: Use of the federal government's powers of spending and taxation to stabilize the business cycle. If the economy is mired in a recession, then the appropriate fiscal policy is to increase spending or reduce taxes--termed expansionary policy. During periods of high inflation, the opposite actions are needed--contractionary policy. The consequences of fiscal policy are typically observed in terms of the federal deficit. BUSINESS CYCLES: The recurring expansions and contractions of the national economy (usually measured by real gross domestic product). A complete cycle typically lasts from three to five years, but could last ten years or more. It is divided into four phases -- expansion, peak, contraction, and trough. Unemployment inevitably rises during contractions and inflation tends to worsen during expansions. To avoid the inflation and unemployment problems of business cycles, the federal government frequently undertakes various fiscal and monetary policies Injections: The three injections -- investment, government purchases, and exports -- can be displayed by clicking the [Injections] button. These injection expenditures, like consumption, are used to purchase aggregate production through the product markets. Most importantly, injections add to the total volume of the basic circular flow. That is, they "inject" revenue into the product markets that is used for factor payments and becomes household income. Leakages: The three leakages -- saving, taxes, and imports -- can be displayed by clicking the [Leakages"] button. These leakages, like consumption, are how the household sector divides up or uses its income. Most importantly, leakages subtract from the total volume of the basic circular flow. That is, they "leak" income away from the product markets, making less available for factor payments and household income

Three Variations
The injections-leakages model comes in three common variations, each based on a different combination of the four macroeconomic sectors, and thus a different number of injections and leakages. Two-Sector Model: The simplest injections-leakages model includes the household and business sectors. Also termed the saving-investment model, this variation is often used to illustrate the basic operation of the model, including adjustment to equilibrium and the multiplier process. The two-sector model captures the role of induced activity through household saving and the role of autonomous expenditures through business investment. Saving is the only leakage and investment is the only injection. Three-Sector Model: The second variation of the injections-leakages model adds the government (or public) sector to the household and business sectors contained in the two-sector model. This variation is used to analyze government stabilization policies, especially how fiscal policy changes in government purchases and taxes can be used to close recessionary gaps and inflationary gaps. Saving and taxes are the two leakages. Investment and government purchases are the two injections. Four-Sector Model: As the name suggests, all four macroeconomic sectors--household, business, government, and foreign--are included in the four-sector Keynesian model. This model is not only used to capture the interaction between the domestic economic and the foreign sector, but also provides the foundation for detailed, empirically estimated models of the macroeconomy. Saving, taxes, and imports are the three leakages. Investment, government purchases, and exports are the three injections.

RECESSION A recession is a widespread decrease in economic activity. Such decrease usually causes many employees to be unemployed. A very serious recession is referred to as a depression. Causes for recession have been tied to excess inventories, decrease in consumption (attributable to fears about the future, for instance), lack of innovations and new capital formation, and random shocks. If the economy is in a recession, a combination of tax cuts and increases in government spending can stimulate economic activity

Recovery i. Time in which real GDP rises and unemployment declines. Production up Employment up. Increase in production and prices,Low interests rates. Recession Drops in prices and in output high Peak i. Real GDP reaches its maximum, stops rising, and begins to decline. Production highest Employment highest, Inflationary pressures Trough i. Real GDP reaches its minimum, stops declining, and begins to rise. Production lowest, Employment lowest

Expansion or recovery Increase in production and prices, Low interests rates, demands up, consumption up, investment up, profit up, Employment up , wages up. Peak Production highest, Employment highest, Inflationary pressure, level of income rises & goods and services rises, level of employment rises, rate of interest increases, profit high, demand increases, prices of goods and cost of production high, investment high Peak Low levels of unemployment shortages of labour occur pushing up wage rates High levels of consumer borrowing and spending Firms working at full capacity Profit levels high

Inflation Increasing Interest rates increasing Boom in housing market

Recessionis a general slowdown in economic activity over a long period of time, or a business cycle contraction. Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization household incomes, business profits and inflational fall during recessions. Bankruptcies and the unemployment rate rises