Illustrate and discuss the simple keynesian model. What are its policy Essay

Illustrate and discuss the simple keynesian model. What are its policy implications - Essay Example nt of time, government intervention was the prime needs to stabilize the economy and role of the government gets severely distorted under an open economy. The following is a very simple representation of his theory known as the Simple Keynesian Model. For the above-mentioned model we assume that the aggregate price level is fixed. The central idea of Keynesian model is the output to be at the equilibrium level, it has to be equated with the aggregate demand. If ‘Y’ stands for total output, that is, the GDP and ‘E’ equals the aggregate demand, then equilibrium condition requires: The aggregate demand or the desired expenditures on output is a summation of household consumption or ‘C’, desired business investment demand or ‘I’, and government expenditure or ‘G’ (government expenditure is nothing but the government sector’s demand for goods and services). Incorporating all these components into the equilibrium condition, the equilibrium condition can be written as: Now, national income or ‘Y’ in general can be decomposed into three parts – one part of the national income gets consumed (C), one part gets paid in taxes (T) and the rest is saved (S). So we may write: So, the equilibrium condition for output in Simple Keynesian Model is desired business investment equal to realized investment. At any disequilibria situation, (Ir – I) will either be greater than or less than zero. Ir and I may differ in the following ways. In the above case, (Ir-I) represents the unintended inventory accumulation. This is the amount by which the total output level surpasses the aggregate demand and will result in the unsold output that exceeds the level of desired inventory of the firms. In this situation there is an inventory shortfall of (I-Ir) which is again undesired or unintended. Here demand exceeds production and the firms end up selling more than planned. Thus inventory falls short of the desired level. The equilibrium is reached where Ir=I. It