Keynesian model  of Income Determination:

Consider the simple Keynesian model of income determination:

The parameter  β₁ represents the  marginal  propensity  to  consume  (MPC).  From macroeconomic theory we know  that  β₁ is expected  to remuin between 0 and 1. Equation is the consumption function which shows that consumption depends on autonomous consumption expenditure β₀ and income induced consumption β₁Y . Equation is the national income identity, signifying that total income is equal to total consumption  expenditure  plus total investment expenditure.

From the consumption function it is clear  that C  and Y  interdependent  and that  Y₁  is not expected  to  be  independent of the  disturwce term, u₁  . When  u, changes (because of a variety of factors subsumed  iwe error  term) the consumption function also shifts, which,  in  turn,  affects y₁ Therefore, once again the classical least-squares method is not applicable. If applied, the estimators thus obtained will be  inconsistent.