Keynesian Multiplier

Definition

The Keynesian multiplier is a concept in macroeconomics that describes the relationship between an initial change in aggregate demand, such as an increase in government spending or investment, and the resulting change in total output or national income. It represents the idea that a small change in spending can have a larger, multiplied effect on the overall economy.

5 Must Know Facts For Your Next Test

1. The Keynesian multiplier formula is $k = \frac{1}{1-MPC}$, where $k$ is the multiplier and $MPC$ is the marginal propensity to consume.
2. The larger the marginal propensity to consume, the greater the multiplier effect, as more of the additional income will be spent, leading to further rounds of increased spending and income.
3. The Keynesian multiplier explains how a small change in autonomous spending (e.g., government spending or investment) can lead to a larger change in total output or national income.
4. The multiplier effect occurs because the initial increase in spending leads to higher incomes, which in turn leads to more spending, creating a ripple effect throughout the economy.
5. The size of the Keynesian multiplier depends on factors such as the marginal propensity to consume, the marginal propensity to save, and the degree of leakages from the circular flow of income (e.g., taxes, imports).

Review Questions

• Explain how the Keynesian multiplier concept relates to the relationship between changes in aggregate demand and changes in total output or national income.
  • The Keynesian multiplier concept describes the relationship between an initial change in aggregate demand, such as an increase in government spending or investment, and the resulting change in total output or national income. The multiplier effect occurs because the initial increase in spending leads to higher incomes, which in turn leads to more spending, creating a ripple effect throughout the economy. The size of the multiplier depends on factors like the marginal propensity to consume, the marginal propensity to save, and the degree of leakages from the circular flow of income.
• Analyze how the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) influence the size of the Keynesian multiplier.
  • The Keynesian multiplier formula is $k = \frac{1}{1-MPC}$, where $k$ is the multiplier and $MPC$ is the marginal propensity to consume. The larger the marginal propensity to consume, the greater the multiplier effect, as more of the additional income will be spent, leading to further rounds of increased spending and income. Conversely, the larger the marginal propensity to save (MPS), the smaller the multiplier, as more of the additional income will be saved rather than spent. The relationship between MPC and MPS is crucial in determining the size of the Keynesian multiplier and the overall impact of changes in autonomous spending on total output or national income.
• Evaluate the importance of the Keynesian multiplier concept in understanding the macroeconomic effects of government policies and interventions.
  • The Keynesian multiplier concept is crucial in understanding the macroeconomic effects of government policies and interventions, such as changes in government spending or tax rates. By recognizing the multiplier effect, policymakers can better anticipate the broader economic impact of their actions. For example, an increase in government spending can have a larger effect on total output or national income than the initial increase in spending, as the additional income generated leads to further rounds of spending and income creation. Similarly, a reduction in taxes can stimulate consumption and investment, with the multiplier effect amplifying the overall economic impact. Understanding the Keynesian multiplier is essential for designing effective fiscal and monetary policies to stabilize the economy and promote economic growth.

Related terms

Aggregate Demand:

The total demand for all goods and services in an economy at a given time and price level.

Marginal Propensity to Consume (MPC):

The fraction of an additional unit of income that is spent on consumption rather than saved.

Marginal Propensity to Save (MPS): The fraction of an additional unit of income that is saved rather than spent on consumption.