The Private Sector

The private sector should be contrasted with the public sector, or government sector, which is the sector that forces involuntary resource allocation decisions on the rest of the economy through laws, rules, and regulations.

The distinction between the private and public sectors is critical in Keynesian economics. This is largely due to the Keynesian view that the private sector (especially the business sector) is the source of business-cycle instability, and that stabilization policies by the public sector are the recommended way of stabilizing the economy.

The private sector, as noted above, contains the household and business sectors.

• Household Sector: The household sector includes everyone in an economy who consumes goods and services. It is the entire population of an economy. The household sector is responsible for consumption expenditures on gross domestic product.


• Business Sector: The business sector contains the private, profit-seeking firms in the economy that combine scarce resources into the production of wants-and-needs satisfying goods and services. The business sector is responsible for investment expenditures on gross domestic product.

Autonomous and Induced

• Autonomous Expenditure: An autonomous expenditure is an aggregate expenditure (consumption, investment, government purchases, and net exports) that does not depend on national income or gross domestic product.


• Induced Expenditure: An induced expenditure is an aggregate expenditure (consumption, investment, government purchases, and net exports) that depends on national income or gross domestic product.

This simplification makes it possible to identify two key aspects of Keynesian equilibrium.

• First, how equilibrium is disrupted by changes in autonomous expenditures.


• Second, how equilibrium is restored by changes in induced expenditures.

Aggregate Expenditures: The C + I Line

C + I Line

The exhibit to the right can be used to illustrated the two-sector (C + I) aggregate expenditures line.

• We begin with the consumption line. This graph measures expenditures on the vertical axis and aggregate production on the horizontal axis. The consumption line (C) presented here is positively sloped. The intercept is autonomous consumption and the slope of the line is induced consumption, measured by the marginal propensity to consume.


• The aggregate expenditures line is derived by adding investment to the consumption line. Investment is assumed to be totally autonomous. As such, the aggregate expenditures line is obtained by adding a constant amount of investment to the consumption line. The resulting aggregate expenditures line can be displayed by clicking the [AE] button.

An Equilibrium Guide: The 45-Degree Line

45-Degree Line

The equilibrium guide line is a 45-degree line that bisects the 90-degree angle formed by the horizontal and vertical axes. The exhibit to the right presents a 45-degree line. Careful measurement of the angle between this line and either the vertical axis or the horizontal axis should confirm a value of 45 degrees.

The most important feature of the 45-degree line is that it contains every point in the diagram in which aggregate production is equal to aggregate expenditures. In other words, if you pick an aggregate production value, such as $5 trillion, move vertically to the 45-degree line, then take a right turn to the vertical axis, you reach an equal $5 trillion value for aggregate expenditures.

Because this 45-degree line contains EVERY potential equilibrium value for the two-sector Keynesian model, equilibrium MUST take place somewhere ON this line. Exactly where equilibrium occurs, however, depends on the aggregate expenditures line.

We often find it convenient to give this guide line the label of Y = AE, where Y is the common designation for aggregate production and AE is the abbreviation for aggregate expenditures. Such a label descriptively indicates that this is, in fact, the equilibrium guide line for the Keynesian model.

The Equilibrium Intersection

Equilibrium

Equilibrium is achieved at the intersection of the 45-degree line and the aggregate expenditures line. Click the [Equilibrium] button to identify this point and corresponding aggregate production.

• Equilibrium is achieved with $12 trillion of aggregate production. At this level, aggregate expenditures are also $12 trillion.


• Only at $12 trillion are aggregate expenditures equal to aggregate production. At every other production level, aggregate expenditures are either greater than or less than aggregate production.


• At this $12 trillion level, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have.


• The lack of surpluses and shortages means that we have equilibrium. Neither buyers nor sellers are dissatisfied with this condition, and thus have no reason to alter the production level.


• A key indicator of this equilibrium is business inventories -- stockpiles of raw materials and finished goods. The business sector has no unexpected, or unplanned, changes in inventories.

Two Other Variations

• Three-Sector Model: Perhaps the most commonly analyzed variation of the Keynesian 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.


• 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.