Overview
Purpose:
To discuss how the ideas of J.M. Keynes, specifically the Keynesian multiplier, contributed to a better understanding of why the Great Depression was so severe.
Objectives:
1. One of J.M. Keynes’ basic contributions to macroeconomics was to show how the multiplier process explains many of the swings in the economy.
2. For example, in a single economy with no government and no trade sector, aggregate demand is equal to consumption plus investment. Income is either spent by consumers or saved. In the economy there is one leakage (saving) and one injection (investment).
3. If investment increases, then aggregate demand increases, which in turn means that equilibrium GNP and national income increase.
a) Part of an increase of income is saved and part is spent by consumers. The new consumption spending means higher aggregate demand, more GNP, more income and again more consumption and saving.
b) Ultimately GNP and national income will have risen by a multiple of the original rise in investment.
c) The size of this multiplier depends on how much consumers spend out of each incremental dollar of disposable income (the marginal propensity to consume). The higher the marginal propensity to consumer, the higher will be the multiplier.
4. Keynes had two main complaints about classical economics
a) He felt that money not only had an impact on prices but on employment and output.
b) He emphatically felt that supply did not create its own demand.
| Key Economic Concepts circular flow, leakages
injections, saving, investment, marginal propensity to consume, Keynesian cross, aggregate demand, consumption. |
| Contemporary Issues In his State of the Union Message on January 28, 2003, President Bush outlined a series of proposed changes to the tax code that would encourage both savings and investment. What would an increase in savings (a decrease in consumption) and an increase in investment do for growth in the short-run and in the long-run? Is such a policy good under all circumstances (e.g. during a recession)? How would your answers differ if the president had proposed changes in the tax code that would only encourage additional savings? |
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