Keynesian Multiplier Flashcards
Why will the final increase in GDP be greater than the initial increase in GDP stimulated by a change in one of its components?
The initial change in expenditure produces a chain reaction of further expenditures, with the effect of increasing AD and real GDP to a value greater than the initial expenditure.
For example:
increase in investment spending of $8 million. This increase in investment is used to pay for materials, equipment, labour etc. This translates to income for these factors of production, which further induces their consumer spending.
What is marginal propensity to consume (MPC)?
Likelihood to consume.
Measured as the fraction of additional income spent on consumption.
What is marginal propensity to save (MPS)?
Likelihood to save.
Measured as the fraction of additional income saved.
What is marginal propensity to tax (MPT)?
Amount of additional income taxed
What is marginal propensity to import (MPM)?
Amount of additional income spent on imported goods and services
What is the Keynesian multiplier?
initial change in expenditure x Keynesian multiplier = change in real GDP
What is the equation for the Keynesian multiplier?
Multiplier = 1 / (1 - MPC)
or
Multiplier = 1 / (MPS + MPT + MPM)
What is autonomous spending?
The initial change in spending by a component of GDP, not determined by change in income.
Autonomous spending is stimulated by a determinants of aggregate demand
What is induced spending?
Consequent spending induced by change in income due to autonomous spending
When is the full effect of the multiplier experienced?
The full effect of the multiplier can be experienced only when the price level is constant. If the price level is increasing, the impact of multiplier is lessened.
What is the importance of the multiplier?
Since any increase or decrease in spending has a multiplied effect on real GDP, it is important for policy makers to know the size of the multiplier
