In economics, the 45-degree line illustrates a variety of economic phenomena, specifically that of the Keynesian model and the consumption line. Rather than describing a real-world relationship, it is used as an instrument to derive a final value with the use of other curves such as the aggregate production curve and the consumption curve.
The 45-Degree Line
The 45-degree line intersects both the y-axis and x-axis at the origin, as well as forming an angle of 45 degrees with both axes. A line of this sort will always have a slope equal to one. For this reason, if both the variable on the y-axis and x-axis are measured in the same units, it will depict each point when both variables are equal to each other. The 45-degree line is commonly used to explain to concepts in economics, that is, consumption and the Keynesian model.
The Keynesian Model
The Keynesian model describes the relationship between aggregate expenditures and aggregate production. Production is graphed on the x-axis while expenditures is graphed on the y-axis. It thus offers an explanation of how much a firm must spend in order to obtain a certain level of production. Due to the 45-degree line relationship, a one billion expenditure in inputs produces one billion in production value. This relationship is actually represented in a much larger representation of the Keynesian model, which includes three additional graphs depicting the foreign sector, aggregate expenditures and the equilibrium level of production. The intersection of aggregate expenditures, determined by the foreign sector, with the 45 degree-line produces an equilibrium level of production.
Another use for the 45-degree line in economics is to give a point of reference when demonstrating the relationship between consumption and income. As people's incomes rise, they consume more. However, the relationship is not directly proportional. Income is measured on the x-axis and consumption is measured on the y-axis. The slope of the consumption curve is positive but is less than one. This slope is equal to the marginal propensity to consume (how much an increase in income will make you consume more). Illustrated with the 45-degree line, it is easier to see differences in propensities in a comparative analysis. The intersection of both lines shows where consumption equals income.
The 45-degree line in economics is used only for illustrative or theoretical purposes. It is never used to show an actual relationship between two factors. In the case of the Keynesian model, it is used as an instrument to obtain aggregate production, given a derived aggregate production curve. In the case of consumption, it is only used to show where consumption equals income, given a derived consumption curve.