The expenditure multiplier is a concept in Keynesian economics that describes the amplified effect of a change in autonomous spending on the overall level of economic output. It represents the ratio of the change in national income to the initial change in autonomous spending.
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The expenditure multiplier is calculated as 1 / (1 - MPC), where MPC is the marginal propensity to consume.
A higher marginal propensity to consume leads to a larger expenditure multiplier, as more of the additional income is spent on consumption, generating further rounds of spending.
The expenditure multiplier explains how a change in autonomous spending, such as an increase in government spending or investment, can have a magnified effect on the overall level of national income.
The expenditure multiplier is a key concept in Keynesian economics, as it demonstrates how fiscal policy can be used to stimulate economic activity and achieve full employment.
The size of the expenditure multiplier depends on the openness of the economy, with a smaller multiplier in more open economies due to higher propensities to import.
Review Questions
Explain how the expenditure multiplier works and its relationship to the marginal propensity to consume.
The expenditure multiplier describes the amplified effect of a change in autonomous spending on the overall level of economic output. It is calculated as 1 / (1 - MPC), where MPC is the marginal propensity to consume. A higher MPC leads to a larger expenditure multiplier because more of the additional income is spent on consumption, generating further rounds of spending. This multiplier effect demonstrates how a change in autonomous spending, such as an increase in government spending or investment, can have a magnified impact on national income.
Discuss the role of the expenditure multiplier in Keynesian economics and its implications for fiscal policy.
The expenditure multiplier is a key concept in Keynesian economics, as it shows how fiscal policy can be used to stimulate economic activity and achieve full employment. By understanding the multiplier effect, policymakers can use changes in autonomous spending, such as government spending or investment, to generate a larger impact on national income. This provides a rationale for active fiscal policy interventions to address economic downturns or boost economic growth. The size of the multiplier also depends on the openness of the economy, with smaller multipliers in more open economies due to higher propensities to import.
Analyze how the expenditure multiplier would be affected by changes in the marginal propensity to consume and the openness of the economy.
$$\text{Expenditure Multiplier} = \frac{1}{1 - \text{MPC}}$$ The expenditure multiplier is inversely related to the marginal propensity to consume (MPC). A higher MPC leads to a larger multiplier, as more of the additional income is spent on consumption, generating further rounds of spending. Conversely, a lower MPC results in a smaller multiplier. Additionally, the openness of the economy affects the size of the multiplier. In more open economies with higher propensities to import, the multiplier will be smaller, as a portion of the additional spending 'leaks' out of the domestic economy through imports. This means fiscal policy interventions may have a more limited impact on national income in more open economies.
Autonomous spending refers to the components of aggregate demand that are independent of the level of income, such as consumer spending, investment spending, government spending, and net exports.