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    9.6 Keynesian Multiplier

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    The Keynesian multiplier measures how much total spending and economic output increases in response to an initial increase in spending, known as an injection. It depends on leakages from the economy through saving, taxes, and imports. A higher marginal propensity to consume leads to fewer leakages and a larger multiplier effect, amplifying the initial change in income. The multiplier is important in Keynesian economics as it shows how fiscal policy can be used through government spending to boost aggregate demand and national income.

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    9.6 Keynesian Multiplier

    Uploaded by

    kimmo
    60 views23 pages
    The Keynesian multiplier measures how much total spending and economic output increases in response to an initial increase in spending, known as an injection. It depends on leakages from the economy through saving, taxes, and imports. A higher marginal propensity to consume leads to fewer leakages and a larger multiplier effect, amplifying the initial change in income. The multiplier is important in Keynesian economics as it shows how fiscal policy can be used through government spending to boost aggregate demand and national income.

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    The Keynesian multiplier measures how much total spending and economic output increases in response to an initial increase in spending, known as an injection. It depends on leakages from the economy through saving, taxes, and imports. A higher marginal propensity to consume leads to fewer leakages and a larger multiplier effect, amplifying the initial change in income. The multiplier is important in Keynesian economics as it shows how fiscal policy can be used through government spending to boost aggregate demand and national income.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    60 views23 pages

    9.6 Keynesian Multiplier

    Uploaded by

    kimmo
    The Keynesian multiplier measures how much total spending and economic output increases in response to an initial increase in spending, known as an injection. It depends on leakages from the economy through saving, taxes, and imports. A higher marginal propensity to consume leads to fewer leakages and a larger multiplier effect, amplifying the initial change in income. The multiplier is important in Keynesian economics as it shows how fiscal policy can be used through government spending to boost aggregate demand and national income.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 23

    Macroeconomics

    9.6 Keynesian Multiplier


    25. Explain, with reference to the concepts of leakages (withdrawals) and
    injections, the nature and importance of the Keynesian multiplier.

    Multiplier:
    The multiplier is concerned with how national income changes as a result of a
    change in an injection, for example investment.
    The multiplier was a concept developed by Keynes that said that any increase
    in injections into the economy (investment, government expenditure or
    exports) would lead to a proportionally bigger increase in National Income.
    This is because the extra spending would have knock-on effects creating in turn
    even greater spending.
    The size of the multiplier would depend on the level of leakages.
    Multiplier effect
    The theory that a particular increase in private or government spending (C, I,
    G, or Xn) in an economy will lead to a larger overall increase in GDP than the
    initial change in spending, due to the fact that the increase in incomes that
    result will lead to further increases in private spending throughout the
    economy. The size of the multiplier effect depends on the spending multiplier.
    25. Explain, with reference to the concepts of leakages (withdrawals)
    and injections, the nature and importance of the Keynesian
    multiplier.
    The Multiplier effect comes about because injections of new demand for
    goods and services into the circular flow of income stimulate further
    rounds of spending – in other words “one person’s spending is another’s
    income”.
    This can lead to a bigger eventual final effect on output and
    employment.
    What is a simple definition of the multiplier?
    It is the number of times a rise in national income exceeds the rise in
    injections of demand that caused it.
    The Multiplier and links to Keynesian Economics
    The concept of the multiplier process became important in the 1930s
    when John Maynard Keynes suggested it as a tool to help governments to
    maintain high levels of employment.
    This “demand-management approach”, designed to help overcome a
    shortage of capital investment, measured the amount of government
    spending needed to reach a level of national income that would prevent
    25. Explain, with reference to the concepts of leakages (withdrawals)
    and injections, the nature and importance of the Keynesian
    multiplier.
    The value of the multiplier depends on:
     Propensity to import
     Propensity to save
     Propensity to tax
     Amount of spare capacity
     Avoiding crowding out
    The multiplier will have a large effect on the economy when:
     The propensity to spend extra income on domestic goods and services is high
     The marginal rate of tax on extra income is low
     The propensity to spend extra income rather than save is high
     Consumer confidence is high (this affects willingness to spend gains in income)
     Businesses in the economy have the capacity to expand production to meet increases in demand
    Evaluation: Time lags and the multiplier effect
    It is important to remember that the multiplier effect will take time to come into full effect.
    Another problem is that the actual value of the multiplier effect is likely to change at different points of
    the economic cycle.
    25. Explain, with reference to the concepts of leakages
    (withdrawals) and injections, the nature and importance of the
    Keynesian multiplier.

    Key points:
     The higher is the propensity to consume domestically produced goods and services, the
    greater is the multiplier effect. The government can influence the size of the multiplier
    through changes in direct taxes. For example, a cut in the rate of income tax will
    increase the amount of extra income that can be spent on further goods and services
     Another factor affecting the size of the multiplier effect is the propensity to purchase
    imports. If, out of extra income, people spend their money on imports, this demand is
    not passed on in the form of fresh spending on domestically produced output. It leaks
    away from the circular flow of income and spending, reducing the size of the multiplier.
     The multiplier process also requires that there is sufficient spare capacity for extra
    output to be produced. If short-run aggregate supply is inelastic, the full multiplier
    effect is unlikely to occur, because increases in AD will lead to higher prices rather than
    a full increase in real national output. In contrast, when SRAS is perfectly elastic a rise
    in aggregate demand causes a large increase in national output.
     Crowding out – this is where (for example) increased government spending or lower
    taxes can lead to a rise in government borrowing and/or inflation which causes interest
    rates to rise and has the effect of slowing down economic activity. Thus the multiplier
    effect will be reduced.
    Topic 3.2-
    Multipliers

    6
    The Multiplier Effect
    Why do cities want the Superbowl in their
    stadium?
    An initial change in spending will set off a spending chain
    that is magnified in the economy.
    Example:
    • Bobby spends $100 on Jason’s product.
    • Jason now has more income so he buys $100 of Nancy’s
    product.
    • Nancy now has more income so she buys $100 of Tiffany’s
    product.
    • The result is an $300 increase in consumer spending.
    The Multiplier Effect shows how spending is
    magnified in the economy. 7
    Effects of Government Spending
    If the government spends $5 Million, will AD
    increase by the same amount?
    • No, AD will increase even more as government
    spending becomes income for other consumers.
    • Consumers will take that money and spend, thus
    increasing AD.
    How much will AD increase?
    • It depends on how much of the new income
    consumers save.
    • If they save a lot, spending and AD will increase
    less.
    • If the save a little, spending and AD will be
    increase a lot. 8
    25. Explain, with reference to the concepts of leakages
    (withdrawals) and injections, the nature and importance of the
    Keynesian multiplier.
    25. Explain, with reference to the concepts of leakages (withdrawals) and injections, the nature and importance of the
    Keynesian multiplier.
    The multiplier = change in real GDP/initial change in expenditure

    Marginal propensity to consume (MPC):


    Is the proportion of each extra dollar of disposable income spent by households
    on consumption of domestically produced goods and services. .
    For example, if a person earns 1 more and consumes 60% of it, then the MPC is
    0.6.
    Marginal propensity to Save (MPS):
    Is the proportion of each extra dollar of disposable income saved by
    households.
    Marginal propensity to tax (MPT):
    Is the proportion of each additional income taxed.
    Marginal propensity to import (MPM):
    Is the proportion of additional income spent on imported goods and serves.
    Marginal Propensity to Consume
    Marginal Propensity to Consume (MPC)
    •How much people consume rather than save
    when there is a change in disposable income.
    •It is always expressed as a fraction (decimal).

    MPC= Change in Consumption


    Change in Disposable Income
    Examples:
    1. If you received $100 and spent $50.
    2. If you received $100 and spent $80.
    3. If you received $100 and spent $100.
    12
    Marginal Propensity to Save
    Marginal Propensity to Save (MPS)
    •How much people save rather than consume
    when there is a change in disposable income.
    •It is also always expressed as a fraction (decimal).

    MPS= Change in Savings


    Change in Disposable Income
    Examples:
    1. If you received $100 and save $50.
    2. If you received $100 your MPC is .7 what is
    your MPS?
    13
    MPS = 1 - MPC
    Why is this true?
    Because people can either save or consume.
    Calculating the Spending Multiplier
    If the MPC is .5 how much is the multiplier?
    Spending
    OR
    Multiplier

    •If the multiplier is 4, how much will an initial


    increase of $5 in Government spending increase
    the GDP?
    •How much will a decrease of $3 in spending
    decrease GDP?
    Total change
    in GDP
    = Multiplier x Initial Change
    in Spending
    15
    How is Spending “Multiplied”?
    Assume the MPC is .5 for everyone.
    •Assume the Super Bowl comes to town and there is an increase of
    $100 in sales at Ashley’s restaurant.
    •Ashley now has $100 more income.
    •She saves $50 and spends $50 at Karl’s Salon.
    •Karl now has $50 more income.
    •He saves $25 and spends $25 at Dan’s fruit stand.
    •Dan now has $25 more income.
    This continues until every penny is spent or saved.
    What is the multiplier? 2
    What is the total change in GDP? 2 x $100 = $200
    Total change
    in GDP
    = Multiplier x Initial Change
    in Spending
    16
    The Multiplier Effect
    Let’s practice calculating the spending
    multiplier.
    Spending
    OR
    Multiplier

    1. If MPC is .9, what is multiplier?


    2. If MPC is .8, what is multiplier?
    3. If MPC is .5 and consumption increased
    $2M, how much will GDP increase?
    4. If MPC is 0 and investment increases $2M.
    How much will GDP increase?
    Conclusion: As the Marginal Propensity to
    Consume falls, the Multiplier Effect lessens. 17
    26. Calculate the multiplier using either of the following formulae 1/ (1-MPC) or 1/ (MPS + MPT + MPM)

    The Simple Formula: (Got to know)


    The simple expenditures multiplier is the ratio of the change in aggregate
    production to an independent change in an aggregate expenditure when
    consumption is the only induced expenditure.
    This multiplier is as simple as it gets while capturing the fundamentals of the
    multiplier. The simplistic multiplier, that is the reciprocal of the marginal
    propensity to save is a special case used for illustrative purposes only.
    Simply multiplier = 1/ (1-MPC) =1/MPS
    If, for example, the MPC is 0.80 (and the MPS is 0.20), then an autonomous
    $400m change in investment expenditures results in a change in aggregate
    production of $2 trillion.
    M = 1/(1-.80) = 1/.20 = 5, so $400 x 5 = $2 trillion
    26. Calculate the multiplier using either of the following formulae 1/ (1-MPC) or 1/ (MPS + MPT + MPM)

    The complex multiplier is the multiplier principle in Keynesian economics.


    The multiplier applies to any change in independent expenditure, in other words, an
    externally induced change in consumption, investment, government expenditure or net
    exports.
    Each of these operates to increase or reduce the equilibrium level of income in the
    economy. The size of the multiplier should take account of all leakages from the circular
    flow of income and expenditure occurring in all sectors.
    Complex Multiplier = 1 / (sum of the propensity to save + tax + import)
    or Complex multiplier = 1/ (MPS + MPT + MPM)
    Therefore if there is an initial injection of demand of say $400m and:
    The marginal propensity to save = 0.2
    The marginal rate of tax on income = 0.2
    The marginal propensity to import goods and services is 0.3
    Then the value of national income multiplier = (1/0.7) = 1.43
    An initial change of demand of $400m might lead to a final rise in GDP of 1.43 x
    27. Use the multiplier to calculate the effect on GDP of a
    change in an injection in investment, government spending or
    exports.
    Calculating the value of the multiplier
    Between 2009 and 2010, Germany’s national income increased by $100 billion.
    As a result:
     Taxes increased by $20 billion
     Household spending (on all goods, including imports) increased by $70 billion
     Savings increased by $10 billion
     Imports increased by $10 billion
    Thus:
    MPT = .20
    MPC = .60 ~($70b -$10b = $60B)
    MPS = .40
    MPM = .10
    Simple multiplier = 1/(1-MPC) = 1/(1-.60) = 1/.40 = 2.5
    $100 billion x 2.5 = $250 billion
    28. Draw a Keynesian AD/AS diagram to show the
    impact of the multiplier.
    28. Draw a Keynesian AD/AS diagram to show the
    impact of the multiplier.
    28. Draw a Keynesian AD/AS diagram to show the
    impact of the multiplier.

    The Multiplier with Price Level Changes:


    Multiplier is smaller if price level varies. When the
    Aggregate Demand curve shifts and the Aggregate
    Supply curve is upward sloping, the multiplier effect
    is smaller.
    The economy moves from point A to point C, instead
    of going to point B when the Aggregate Supply curve is
    horizontal.
    The smaller effect results because Aggregate Demand
    is partially dampened as the price level rises.
    With an upward sloping Aggregate Supply curve, the
    impact of an increase in Aggregate Demand goes
    towards higher output and prices.
    In the extreme case of a perfectly vertical Aggregate
    Supply curve, the output multiplier is zero.

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