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Keynesian Multiplier (e.g. (The gov. increases spending on school supplies…
Keynesian Multiplier
Idea
Depending on how much additional income is consumed, saved, taxed and spent on imports, the government's initial expenditure (which causes an increase in AD) will also cause a further increase in AD when recipients spend their new earnings - knock-on effects
Spending of one individual is the income of another = any change in spending leads to a chain reaction of income changes so that the final change in income is greater than the initial change in spending
e.g.
The gov. increases spending on school supplies by €100 = the seller of the school supplies receiving the €100 will spend the money according to their marginal propensities - consumer (MPC), save (MPS), of taxes (MPT) and import (MPM)
The MPC for the person is 0.65 ==> 65% of €100 is spent on the C of g's and s's. The remaining 0.35 = 35% is spent on MPM + MPT + MPS
The following buyers of the 65% of €100 (€65) then spend this income on the same MP's = 65% of the €65 they received = €42.25 and the remaining on savings + tax + import --> 35% of 65 = 22.75
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A multiplied effect on AD, and hence on real GDP, due to a change in spending
Key points:
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Works the same the other way ==> A decrease in gov spending = multiplied decrease in AD and Real GDP
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AD/AS diagram
If investment spending :arrow_up: by €10 billion and the MPC = 0.75 - multiplier = 4, AD will increase by €40 billion (10x4) at every PL
The €40 billion :arrow_up: = an initial increase in Ad of €10 billion ( equal to the increase in investment) + €30 billion after due to the multiplier / knock-on effects
If the increase is in the second or third stage of the K LRAS, AD will increase less than it would if it were in the first stage (would be the same as the AD) due to the purely inflationary gap