What is an economic model, on one foot?

By omersimanovsky December 24, 2024 3 min read

Almost every diagram in economics constitutes an economic model through which we try to explain and analyze various economic developments. For example, how different markets reach an equilibrium point. The model also allows us to observe how changes in the market affect the equilibrium point. For example, how the imposition of a tax affects the equilibrium price in the market. The reference to an economic model is rather out of place, but we found it appropriate to emphasize that the diagrams in this chapter are part of an economic model developed by the economist Maynard Keynes and named after him. The model is presented here in its simplified and initial form. Later, we will incorporate two more elements into it: taxes and international trade. Using the Keynesian model, we try to understand when output in the economy is in equilibrium with aggregate expenditure (demand) and how different scenarios cause changes in the equilibrium point.

Factors that affect the upward shift of the equilibrium point

Growth in E ₀
Any increase in initial aggregate expenditure (E ₀ ) will cause an upward shift of the aggregate expenditure curve (E ). As a result, a new, higher equilibrium point will be obtained. Figure 601 shows 2 equilibrium points. At time A, initial aggregate expenditure is E _{0_A} , the aggregate expenditure curve is E , and equilibrium is obtained at point a. At time B, initial aggregate expenditure increases to E _{0_B} . The aggregate expenditure curve is E ₁ and the equilibrium point increases to b.

Factors affecting the increase in E ₀

The increase from E _{0_A} to E _{0_B} can result from any of the components of aggregate expenditure: C, I, and G. or a combination of them.

The background to the increase in C ₀ and I ₀

An increase in C ₀ and I ₀ is usually recorded in the following situations:
1. Expectation of an increase in household and/or firm income.
2. An increase in the economic security of households and/or firms.
3. A decrease in the interest rate.
The background to the growth in G ₀

A decision to increase G ₀ can be made both in times of recession and times of prosperity, depending on the structure and composition of the government. In times of recession, many countries want to provide employment and therefore increase their budget for this purpose. In times of prosperity, tax revenues increase, allowing the budget for spending on various projects to be increased.
An increase in c (marginal propensity to consume)
An increase in c causes the slope of the aggregate expenditure curve to rise and a new, higher equilibrium point is obtained. In Figure 602, at time A the aggregate expenditure curve E is based on c. At time B the aggregate expenditure curve E ₁ is based on c ₁ which is greater than c. The equilibrium point b obtained at time B is higher than that at time A (point a).

The factors affecting the growth of c
1. Increase in household economic security.
2. Expectation of increased revenue.

Factors affecting the decrease of the equilibrium point

All those factors whose increase led to an increase in the equilibrium point can lead to a decrease in the equilibrium point if they are regressed.

A retreat in E ₀ following a retreat in one of its components.
Retreat in c.

A recession is usually recorded when there is a deterioration in consumer confidence and/or an expectation of a decline in income.

What is an economic model, on one foot?

Factors that affect the upward shift of the equilibrium point

Factors affecting the decrease of the equilibrium point

More like this

Meeting aggregate expenditure (meeting demand)

The aggregate supply curve

Public demand for money, with reference to 3 approaches