A Keynesian Microeconomic Model:
Actual Gross Domestic Product: Y = C + I + G + N

    C = Consumer Spending
    I = Private Investment
    G = Government Spending
    N = Net Exports

GDP can be projected as AE = Cp + I + G + N
where Cp is the Consumption Function: C = a + b(Y-T)
New terms in C = a + b(Y-T)

    T = Gross Taxes
    a = Offset of consumption function*
    b = Marginal Propensity to Consume dC/dY

(Y/AE-1) * 100% ~= % Imbalance

    If projected income or output AE = Y then
         the economy is in balance

    Else if Y > AE then
         output is too high and *may* recede

    Else if Y < AE then
         output is too low and *may* rebound

Note* The 'a' term is arbitrary consumption that changes autonomously from GDP and greatly affects results of the model. In the table below for lack of better data, term 'a' initial offset is 7.5 in 1929 and grows %7.45 APR thereafter.

GDP & Tax Source: U.S. Bureau of Economic Analysis


Seasonally adjusted GDP, Tax, and Consumption Term Table 1929-2008q3 with constant growth of autonomous consumption:


Percent Imbalance over time given constant growth of autonomous consumption:

Dow Jones Industrial Stock Index

I'm sure the multiplier model is not entirely perfect, but the results are encouraging. Looking at the recessions overlay, there is a high correlation with the business cycle and negative imbalances which might suggest overshooting the correction. It is very interesting to note that the wild swings pre-1952 disappear in the post WWII period. The results in the late 1990's are also interesting since a down-turn was suggested by the data starting from 1998 (year of LTCM bail-out and the "Asian-Contagion"), but stock market sentiment euphoria kept the consumer happy until mid-2000. Correlation between the model changes and stock price changes are not strong over the entire period, but year to year during booms and busts the correlation is very strong with R2 often > 0.70 before turns in the business cycle. Overall, it seems the conclusion is that producers knowledge and use of the theory has smoothed the bumps in the economy and allows us to achieve "more happiness".

The Java Applet above allows the user to plug in GDP and other data from the the table. Be careful not to put the GDP value in for C. Each box has a corresponding field in the table for data input (the next version of the Applet will have the data built-in so the user only needs to select the year).

Copyright © 2008 by John Steven Denson
All Rights Reserved