Keynesian Economics: The Multiplier Effect

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Questions and Answers

Who first developed the concept of the employment multiplier?

John Maynard Keynes

A.K. Dash

RF Khan (correct)

Milton Friedman

What does the investment multiplier express?

The ratio of consumption to savings

The change in interest rates due to investment

The relationship between investment and final income (correct)

The effect of employment on investment

What is the formula for calculating the multiplier K?

K = (1 - MPS) / I

K = I / Y

K = 1 / (1 - MPC) (correct)

K = Y / I

If investment in the economy increases by 1 crore and national income rises by 3 crore, what is the multiplier value?

3 Signup and view all the answers

Which statement about the marginal propensity to consume (MPC) is true regarding the multiplier?

Higher MPC values correspond to a higher multiplier Signup and view all the answers

In Keynesian theory, what must fill the gap between income and consumption?

Investment Signup and view all the answers

What happens whenever an investment is made in the economy, according to the multiplier concept?

Total income increases by a multiple of the original investment Signup and view all the answers

What are the components that would need to be purchased for a construction investment, according to the multiplier process?

Land, labor, and materials Signup and view all the answers

What is the final increase in income assuming an initial investment of 100 crore and an MPC of 0.5?

200 crore Signup and view all the answers

Which of the following assumptions of the multiplier indicates that prices do not change?

No changes in prices and wages Signup and view all the answers

In the multiplier process, the relationship between consumption and income is described by which statement?

Consumption is a function of current income Signup and view all the answers

What does the investment multiplier indicate when there is an increase in investment?

A greater increase in income than the increase in investment Signup and view all the answers

When is the investment multiplier typically applied?

In an economy with less than full employment Signup and view all the answers

What characteristic of the economy is required for the multiplier effect to operate?

An industrialized economy Signup and view all the answers

In the aggregation of expenditures approach, what does the 45-degree line represent?

Income level and aggregate supply curve Signup and view all the answers

What happens in the multiplier process if there is an instantaneous decrease in investment?

Income decreases less than the investment decrease Signup and view all the answers

What happens to the equilibrium level of income when autonomous investment increases?

Income rises from OY0 to OY1. Signup and view all the answers

What does a marginal propensity to consume (MPC) of 0 imply about the multiplier (K)?

K is equal to 1. Signup and view all the answers

Which of the following statements about the multiplier and MPC is true?

The multiplier ranges between 1 and infinity. Signup and view all the answers

If the multiplier (K) is equal to 1, what can be inferred about consumption and savings?

All increments of income are saved. Signup and view all the answers

What characterizes the multiplier effect when the MPC is equal to 1?

The entire increment of income is spent on consumption. Signup and view all the answers

Study Notes

Multiplier

The concept of the multiplier was first developed by R.F. Khan in 1931.
Khan's multiplier tracked the impact of investment on employment.
Keynesian multiplier is an improved version of Kahn's multiplier, demonstrating how a small investment affects final income.
The multiplier is crucial in Keynesian economics for understanding income, employment, and output relationships.
MPC (marginal propensity to consume) is less than 1. This means that increases in income don't lead to proportionate increases in consumption, leaving a gap that investment fills.

Multiplier Formula and Calculations

Multiplier = 1 / (1 - MPC)
K = Multiplier, Y = National Income, I = Investment
Arithmetically, Y = K*I where K is the multiplier, I is initial investment, and Y is the final increase in income

Multiplier Process

Initial investment triggers a chain reaction, generating income for various parties.
Each round of spending further increases income in the economy.
Consumption and saving are key factors in this process.

Assumptions of the Multiplier

Autonomous and induced investments are separate.
Full employment is not a condition
Prices and wages remain constant.
No foreign influences affect the closed economy.
The economy is industrialized, and the MPC is constant.
There are no time delays in the multiplier effect. Increases (decreases) in investment lead to proportionate changes in income instantaneously.

Investment and Saving Approach

The savings curve (S) and investment curve (I) intersect at equilibrium (EO).
An increase in investment (ΔI) shifts the investment curve to (I + ΔI), creating a new equilibrium (E1) with higher income (Y1).

Aggregate Expenditure Approach

The aggregate expenditure curve shifts upward from C + I + G to C + I + G + ΔI in response to increased investment, creating a new equilibrium with higher income.
The increase in income (ΔY) is greater than the initial increase in investment (ΔI).

Relationship Between MPC and Multiplier

A higher MPC leads to a larger multiplier, and vice versa.
The larger the MPC, the more the multiplier.
If MPC = 0, K = 1 and if MPC = 1, K approaches infinity.

Deriving the Multiplier from MPS

The multiplier (K) is calculated from the MPS (marginal propensity to save) as K = 1 / MPS
the value of the multiplier varies directly with the MPC (marginal propensity to consume) and inversely with the MPS (marginal propensity to save).

Exercises and Examples

Exercises are provided to illustrate how to calculate multipliers given MPC or MPS values.

Different Types of Multipliers

The multiplier can be further categorized/expanded to include government spending, tax multipliers, and foreign trade multipliers, each affecting income differently.
Balanced budget multiplier, a combined approach reflecting both government expenditure and taxation, typically equals 1.

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Description

Explore the concept of the multiplier in Keynesian economics, including its formulation and significance in investment and income generation. Delve into the differences between Khan's and Keynes' interpretations, as well as the underlying formula and its implications for employment and output. Test your understanding of these key economic principles with this quiz.