May 10, 2013
The Multiplier in Action
The impact of contractionary fiscal policies,
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Chapter 12 Keynesian Economics: An Expanded View
aggregate demand (C + I + G + EN )
Other factors affecting consumption and therefore saving include
wealth (savings), expectations about personal needs and future
economic activity, and concerns about consumer, business, and
B. Investment is business spending on capital goods, inventory, and
research & development.
1. The level of investment is a function of expected profit, interest rates,
and the level of technology required to maintain a desired competitive
2. Investment spending tends to be somewhat volatile.
C. Government Spending is assumed to be constant.
D. Net Exports, exports minus imports, are also assumed to be constant
for this simplified model.
Note: Points on a 45-degree line
The savings decline is not a [problem because developing countries save
a substantial amount because unstable political systems mean they need
more protection form uncertainty. There precautionary motive is high.
One problem with this
simplified assumption is it assumes investment
is fixed. The following graph shows that it is not fined.
II. Aggregate Demand and Equilibrium
A. Equilibrium (E) is where planned and actual AD and AS are equal.
1. Equilibrium is where all goods produced for sale are sold.
2. At points below equilibrium, AD < AS, inventories are building and
business activity is contracting. This level of economic activity was
depicted by the horizontal (Keynesian) range of AS explained in the
3. At points above equilibrium AD > AS, inventories are decreasing and
business activity is expanding
as depicted by the intermediate range and eventually the classical
range of AS.
4. Economic activity (Real GDP) will be wherever AD intersects AS.
Equilibrium seldom exists as
economic activity is usually in one stage or another of the business
B. If economic activity is not in balance, a dynamic situation exists and
will continue until equilibrium is reached.
C. Keynes believed that E could settle at a level of economic activity with
large amounts of unemployment.
1. If potential Real GDP is greater than what actual AD yields, a reces-
sionary gap exists and may persist indefinitely. The solution to this
unacceptable equilibrium is to increase AD.
2. If potential Real GDP is less than what actual AD yields, an inflationary
gap exists and the inflation may persist indefinitely. The solution to this
unacceptable level of economic activity is to decrease AD.
3. Inflationary and Recessionary Gaps- ACDC Economics in 60 Seconds
D. Multiplier Affect (K) is important to determining the change in AD needed
to reach equilibrium E.
1. Changes in AD will result in larger changes in NNP as increases are not
spent and respent.
2. Decreases in AD have a similar but opposite affect.
3. K = 1/MPS = 1?(1-MPC) Note: As MPS increases, K decreases.
4. A MPS is 20%, Multiplier is 5 as 1/20% = 1/(1/5) = 1X 5 = 5
5. Fiscal policy and the multiplier... is an 9 minute video from youtube
III. Fine Tuning Economic Activity
Macroeconomic Phenomena in the AD/AS Model
A. When determining the required change in AD needed to achieve E, the Multiplier (K) concept must
B. This concept states that a change in AD will result in a larger change in Real GDP as these changes
multiply (are spent and re-spent or not spent and re-not spent) throughout the economy.
C. Saving will act as a leakage eventually stopping the change.
D. Suppose more is spent on investment and people receive this as income.
1. People receiving the income spend some (MPC) and save some (MPS)
2. A second group receives the spending of the first group as income and they also spend
some (MPC) and save some (MPS).
3. The process continues until savings eventually stops the progression.
E. Calculating multiplier (K), the multiple by which GDP will increase given some increase in AD.
1. K = 1 / MPS = 1 /(1 - MPC)
2. As MPS increases, K decreases
3. If MPS = 20% then 1/MPS = 1/.2 = 5
4. An increase of $100 billion in investment will result in 5($100) = $500 billion in new national
5. K = change in Real GDP / change in AD = 500/100 = 5
6. Some unpleasant Keynesian arithmetic Dank Rodrik
7. Multiplier Interactive practice problems from reff economics
F. Multiplier and Accelerator Effects from tutor2you
G. Accelerator/multiplier theories from The History of Economic Thought
H. Fed infrastructure spending has big multiplier 12/1/12 from econintersect
V. For more concerning Keynesian economics
A. Maynard's Revenge: Keynesianism and the Crisis February16, 2010
B. Keynesian economics - Wikipedia
C. view information from the Institute for Economic Analysis
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Robert Shiller and James Tobin Explore Keynesian Economics
A Modern Guide to Macroeconomics:
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