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Curiosity 4.2: What Is the Multiplier?


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Kennedy P. E.
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    Keynesians and their modern counterparts, New Keynesians, believe that judicious government intervention in the economy is appropriate. Classical economists (see appendix 4.1), monetarists (see chapter 9), and their modern counterparts, New Classicals, believe that government intervention is to be avoided. This issue is revived in chapter 9 when discussing the ''rules-versus-discretion" debate: Should policy authorities be permitted to enact policy as they see fit?
    Media Illustrations
    Example 1
    All this frugality is producing a consumer-generated recession. What is needed is some policy action to stimulate consumer spending to move the economy out of its current lassitude. Consumer attitude surveys indicate that the time is ripe for such a move, and the high savings rate of recent years has led many economy watchers to predict an upturn.
    What is a consumer-generated recession?
    There has been a fall in consumer spending, decreasing aggregate demand and, through a contractionary multiplier process, causing a recession.
    What kind of policy action could stimulate consumer spending?
    A decrease in taxes could increase consumer spending.
    How would stimulating consumer spending move the economy out of its current lassitude?
    Stimulating consumer spending would increase aggregate demand; through a multiplier process, greater demand would move the economy to a higher level of income.
    What is the relevance of consumer attitude surveys?
    If consumer attitudes toward spending are negative, policy actions to increase consumer spending, along with the multiplier process that relies on higher incomes increasing consumption demand, may not work.
    Why has the high savings rate of recent years led to a prediction of an upturn?
    The high savings rates have increased people's wealth. Feeling wealthy, consumers may increase their spending.
    Example 2
    Under present circumstances there is such a thing as a "free lunch." In effect, all of the ingredients of that lunch are already there the people who want to work, the factories and equipment standing idle, and the raw materials not being used. It is just a question of injecting a little spending power to prevent the free lunch from going to waste.
    What kind of government policy is this a plea for?
     
    Table 4.1 Output and Expenditure ($ billions)
    Output Consumption Investment Government Spending Net Exports
    100 80 26 20 10
    150 120 26 20 8
    200 160 26 20 6
    250 200 26 20 4
    300 240 26 20 2
    350 280 26 20
    400 320 26 20 -2
    Interpret these numbers as follows: The income level given in the output column gives rise to the sector demands shown in the other columns.

    N7. From the data in table 4.1, when the level of income is 350, what will be happening to inventories?
    N8. What is the equilibrium level of income for the economy described in table 4.1?
    *N9. Using the data in table 4.1, by how much should the level of income have increased after two rounds of the multiplier process if the economy begins at its equilibrium position and increases government spending by $50 billion?
    *N10. Suppose that last year consumption was $570 billion, tax receipts were $240 billion, and income was $900 billion. The corresponding numbers for this year are $600 billion, $250 billion, and $950 billion.
    a. What is the MPC (marginal propensity to consume out of disposable income)?
    b. What is the marginal tax rate?
    Appendix 4.1—
    Macroeconomics Before Keynes: the Classical School
    The classical school dominated macroeconomic thinking before Keynes published his famous book The General Theory of Employment, Interest, and Money in 1936. The purpose of this appendix is to lend some perspective to this chapter's exposition of the Keynesian approach by providing a brief description of the classical view, which has three distinguishing characteristics, and by contrasting them with Keynes's view.
    Wage and Price Flexibility
    Classical economists believed that prices and wages were quite flexible, so that disequilibria were uncommon. They explained unemployment, a disequilibrium in the the labor market, as a tem-
     

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    Kennedy P. E.
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