Economics Chapter 2: Keynesian Multiplier Model

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Questions and Answers

What determines the level of GDP in the long-run?

Aggregate demand

Multiplier effect

Potential output (correct)

Expenditure approach

What is the purpose of the (C+I) curve?

To identify the equilibrium level of output

To determine the level of aggregate demand

To represent the level of total spending (correct)

To calculate the multiplier effect

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 (correct)

At the point where the aggregate demand is maximum

At the point where the multiplier effect is maximum

At any point on the (C+I) curve

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 Signup and view all the answers

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. Signup and view all the answers

What is represented by the point of intersection of the SS and CC curves?

The equilibrium level of GDP. Signup and view all the answers

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 Signup and view all the answers

What happens when firms in the economy decide to invest $100 million?

It will lead to an increase in aggregate demand Signup and view all the answers

What is the significance of the horizontal II curve in the Investment-Saving graph?

It indicates that investment is independent of income. Signup and view all the answers

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. Signup and view all the answers

What is the marginal propensity to consume in the given example?

0.8 Signup and view all the answers

What is the relationship between the consumption function (CC) and the saving function (SS)?

SS is the mirror image of CC. Signup and view all the answers

What is the process by which an initial change in expenditure leads to a multiplied change in income?

The multiplier effect Signup and view all the answers

What is the condition for equilibrium in the Investment-Saving model?

Planned S = Planned I. Signup and view all the answers

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. Signup and view all the answers

What is the primary focus of the Expenditure Approach in determining output?

The aggregate demand for goods and services. Signup and view all the answers

What is the value of the multiplier if the marginal propensity to consume is 0.5?

2 Signup and view all the answers

If the initial investment is $100 million, what is the total change in income resulting from the multiplier effect?

$500 million Signup and view all the answers

What is the relationship between the marginal propensity to consume and the multiplier?

A higher MPC leads to a larger multiplier Signup and view all the answers

What is the effect of a decrease in autonomous investment on GDP?

A decrease in GDP Signup and view all the answers

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 Signup and view all the answers

What is the value of the multiplier if the marginal propensity to save is 0.2?

4 Signup and view all the answers

What is the effect of an increase in autonomous investment on the level of GDP?

An increase in GDP Signup and view all the answers

What is the relationship between the multiplier and the marginal propensity to save?

A higher MPS leads to a smaller multiplier Signup and view all the answers

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.

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Description

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.