Question 1

What is planned aggregate expenditure and how does it relate to the Keynesian cross?

Accepted Answer

Planned aggregate expenditure (PAE) is the total spending households, businesses, and government expect to make on goods and services in a closed economy. The Keynesian cross model shows equilibrium where the PAE curve intersects the 45-degree line, which represents all points where output equals planned spending. This intersection determines the economy's equilibrium output level.

Question 2

How do rising interest rates affect investment and equilibrium output?

Accepted Answer

Rising interest rates increase borrowing costs, making investment projects less profitable for firms. Businesses delay or cancel expansion plans, reducing total investment spending. This lowers planned aggregate expenditure, shifting the PAE curve downward and decreasing equilibrium output. For example, a coffee shop may postpone expansion when loan rates are high.

Question 3

What happens to the economy when interest rates fall?

Accepted Answer

Falling interest rates make borrowing cheaper, encouraging firms to invest in expansion and new equipment. Increased investment raises planned aggregate expenditure, shifting the PAE curve upward. This leads to higher equilibrium output and greater economic activity. A delivery company, for instance, may purchase additional vehicles when financing costs decline.

Question 4

Why does the 45-degree line represent economic equilibrium in the Keynesian cross?

Accepted Answer

The 45-degree line shows all points where real output exactly equals planned spending. When the economy operates on this line, there is no unplanned inventory accumulation or depletion. The PAE curve intersects this line at the equilibrium point, where planned spending matches actual output, establishing macroeconomic balance.

Question 5

How does the Keynesian cross model connect interest rates to production levels?

Accepted Answer

The Keynesian cross demonstrates that interest rates influence production by changing investment spending. Higher rates reduce investment, lowering PAE and equilibrium output. Lower rates increase investment, raising PAE and equilibrium output. This mechanism shows how monetary policy affects the goods market through interest rate changes that shift planned spending.

Question 6

What components make up planned aggregate expenditure in a closed economy?

Accepted Answer

Planned aggregate expenditure includes three main components: consumption spending by households, investment spending by businesses on capital goods and equipment, and government spending on goods and services. Together, these three categories represent total planned spending in a closed economy without international trade.

Question 7

How does a downward shift in the PAE curve affect the economy?

Accepted Answer

When the PAE curve shifts downward, the intersection with the 45-degree line moves to a lower equilibrium output level. This occurs when interest rates rise or other factors reduce spending. Lower equilibrium output means less production, income, and economic activity. The economy contracts as planned spending decreases relative to productive capacity.

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