The Keynesian Cross Diagram is an essential tool in understanding the relationship between aggregate demand and output in an economy. To construct the diagram, follow these steps:
- Axes: Start by drawing a graph with two axes. The horizontal axis represents national income (or output), labeled as ‘Y’, and the vertical axis represents aggregate expenditure (or aggregate demand), labeled as ‘AE’.
- Aggregate Expenditure Line: Draw a line labeled ‘AE’ that slopes upwards. This line represents the total planned spending in the economy at different levels of income. The line generally starts above the origin since even at zero income, there can be autonomous spending, such as investments or government expenditures.
- 45-Degree Line: Next, draw a 45-degree line from the origin (0,0) to indicate points where aggregate expenditure equals income (Y = AE). This line helps identify equilibrium points in the economy.
- Equilibrium Point: The intersection of the AE line and the 45-degree line indicates the equilibrium level of income. Label this intersection point as ‘E’. At this point, total spending in the economy equals total output, meaning there is no tendency for the economy to change production levels.
- Shifts in AE: If you wish, you can show the effects of an increase in aggregate demand by drawing a new AE line above the original, indicating that at every income level, total planned spending has increased, leading to a new equilibrium point.
By clearly labeling your curves and the equilibrium point, you create a useful visual aid for understanding Keynesian economic theory, particularly how output can diverge from its full-employment level and how government intervention can help move the economy back to equilibrium.