A Keynesian general equilibrium model with competitive firms and rational expectations

A Keynesian general equilibrium model is developed from neoclassical principles. The model is based on competitive firm behavior, and optimizing agents that form expectations rationally. Firms determine their product price to maximize expected profits. Non-neutrality results follow from micro foundations that view firms as committing to a price and output level before actual demand is observed. It follows that optimal output levels are in part determined by demand conditions. In the general equilibrium framework, increases in government spending lead to welfare-improving increases in aggregate output.