24 Questions
What determines the level of GDP in the long-run?
Potential output
What is the purpose of the (C+I) curve?
To represent the level of total spending
At what point is the total spending exactly equal to the total level of output (GDP)?
At the intersection of the (C+I) curve and the 45σ line
What is the multiplier in a closed economy?
The amount by which we would multiply an initial change in expenditure to find the change in income
What is the primary reason why the Investment Function (II) is independent of the level of disposable income?
It relies on external factors, such as expectations and taxes.
What is represented by the point of intersection of the SS and CC curves?
The equilibrium level of GDP.
What is the effect of a change in spending on GDP and employment?
It has a positive effect on GDP and employment through the multiplier effect
What happens when firms in the economy decide to invest $100 million?
It will lead to an increase in aggregate demand
What is the significance of the horizontal II curve in the Investment-Saving graph?
It indicates that investment is independent of income.
What is the primary difference between the Keynesian Multiplier Model and the Expenditure Approach?
The Keynesian Multiplier Model determines equilibrium output using the leakages-injections approach, while the Expenditure Approach determines equilibrium output using the aggregate demand approach.
What is the marginal propensity to consume in the given example?
0.8
What is the relationship between the consumption function (CC) and the saving function (SS)?
SS is the mirror image of CC.
What is the process by which an initial change in expenditure leads to a multiplied change in income?
The multiplier effect
What is the condition for equilibrium in the Investment-Saving model?
Planned S = Planned I.
What is the significance of the multiplier effect in the Keynesian Multiplier Model?
A dollar spent in the economy leads to more than a dollar change in real GDP.
What is the primary focus of the Expenditure Approach in determining output?
The aggregate demand for goods and services.
What is the value of the multiplier if the marginal propensity to consume is 0.5?
2
If the initial investment is $100 million, what is the total change in income resulting from the multiplier effect?
$500 million
What is the relationship between the marginal propensity to consume and the multiplier?
A higher MPC leads to a larger multiplier
What is the effect of a decrease in autonomous investment on GDP?
A decrease in GDP
What is the formula for calculating the change in output resulting from a change in investment?
Change in output = [1 / (1 - MPC)] X change in investment
What is the value of the multiplier if the marginal propensity to save is 0.2?
4
What is the effect of an increase in autonomous investment on the level of GDP?
An increase in GDP
What is the relationship between the multiplier and the marginal propensity to save?
A higher MPS leads to a smaller multiplier
Study Notes
The Keynesian Multiplier Model
- The model explores how the equilibrium level of national income is determined in the short-run in a closed economy with fixed wages and prices.
- The model is called the multiplier model because a dollar spent in the economy leads to more than a dollar change in real GDP.
Consumption Function (CC)
- Each point on CC represents the planned or desired consumption at each level of disposable income.
Saving Function (SS)
- Each point on SS represents the planned or desired saving at each level of disposable income.
- SS is the mirror image of CC, and what affects CC will affect SS but in the opposite direction.
Investment Function (II)
- Investment is determined by factors like interest rate, expectations, and taxes, making it autonomous (independent of the level of disposable income).
- II curve is horizontal, indicating that it is constant regardless of the level of output.
Investment-Saving Graph
- The graph shows the equilibrium point E where planned saving equals planned investment.
The Expenditure Approach of Determining Output
- The total desired spending by households and firms is represented by (I + C).
- The (C + I) curve represents the total desired spending, which intersects with the 45° line to determine the equilibrium level of output.
Real GDP and Aggregate Demand
- Real GDP is an indicator of the economy's progress and is determined by potential output in the long-run and aggregate demand in the short-run.
- Any change in spending will have an impact on GDP and employment through the multiplier effect.
The Multiplier
- The multiplier is the amount by which an initial change in expenditure is multiplied to find the change in income (output).
- The formula for the multiplier is: Multiplier = 1 / (1 - MPC) = 1 / MPS
Example of the Multiplier
- If firms invest $100 million, and the marginal propensity to consume (MPC) is 0.8, the initial investment will lead to an additional income of $500 million.
- The multiplier effect continues as individuals spend 80% of their income, and so on.
The Size of the Multiplier
- The size of the multiplier depends on the consumption pattern, with a larger MPC leading to a larger effect on income.
- The formula for the change in output is: Change in output = [1 / (1 – MPC)] X change in investment.
The Downward Effect of the Multiplier
- If autonomous investment decreases rather than increases, the multiplier effect will also work downwards, leading to a decrease in GDP.
Learn about the Keynesian Multiplier Model, which determines the equilibrium level of national income in a closed economy, where a dollar spent leads to more than a dollar change in real GDP.
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