2) Multiplier Effect

Keynes argued that Δ in J, W & total expenditures (or Cd) lead to multiplied Δ in Y. It’s known as multiplier effect.

Multiplier effect of Δ in J (I)	Multiplier effect for Δ in W (S)	Multiplier effect of Δ in E (C+I)
If there is an increase in J, e.g. I. The more J the more Yeq. Size of ­Y is > than initial increase in J, ΔY>ΔJ ((Ye’-Ye)>(J’-J)). ΔY=k*ΔJ, where k is injections multiplier coefficient-the number of times by which an ­ in Y exceeds an ­ in J. An ­ in J causes a multiplied ­ in Y.	A ¯in W causes a multiplied rise in Y. ΔY>(-ΔW)®inverse Δs; ΔY=k*ΔW, where k is withdrawals multiplier coefficient-number by which an ­ in Y exceeds a ¯ in W. A decrease in W leads to multiplied ­ in Y.	ΔY>ΔE, ΔY=k*ΔE, where k is expenditure multiplier coefficient - the number of times by which an ­ in Y exceeds an ­ in E. Increase in E leads to multiplied ­ in Y.

There is a logical explanation of multiplier effect. There are 2 basic points for logicl explanation of M effect:

• Spending for one person is always income for the other

• Spending for one person causes spending of others

E.g. 1. Assume u decide to build a new country house. Acc-g to Y accounting it will be considered as ­ in I. To construct it u employ workers.

2. Workers receive this money & spend a part of their income to buy sth. E.g. clothes

3. Sellers of clothes receive this income for consumption.

They all spend only a part of their income, the 2^nd part will be saved. As a result ­Y. Y=I (initial spending on I)+additional C of workers + ΔC of clothes sellers, etc. Final ­Y is more than initial spending. ΔY=k*ΔI.

Multiplier effect is a cornerstone of Keynesian theory. Practical application.

2 Main practical conclusions from mult. Theory:

1. The more C & total exp-rethe Ythe greater ec.growththe better living standard. That’s why Keyn. slogan is “consume more! and your life will be better in the future”.

2. The ­S (or W in general) the ¯ Y® the lower economic growth® the worse future living standard: “Save less!”

Classical economists argued that savings or thrift is a national virtue. Keynes destroyed it, formulated the so-called paradox of thrift- the ­ S the ¯ S. ­S®multiplied ¯Y®S¯ future.

The intensity of multiplier effect depends on the size of the multiplier coefficient.

2) Ways to derive multiplier coefficient

Graphical way

Simple algebra way

1. Assume some decrease in W; 1^st case: resulting ­Y is less than in the 2^nd case. The flatter the W f-n the bigger multiplied rise, the bigger M coeff. The slope of W f-n is determined by mpw. The flatter W f-n the lower mpw. K=f(mpw): k=1/mpw 2. Expenditure line The steeper E f-n the bigger rise in Ythe bigger M coefficient. The slope of E f-n depend on E=Cd + J. The steeper E f-n the greater mpCd –direct relationship. mpCd + mpw = 1 because every $1 of your income may be spent only for C, S, T or M. k=1/(1-mpCd)=1/mpw

ΔY=k*ΔJ ® k = ΔY/ΔJ; equilibrium level W=J ® k= ΔY/ΔW and mpw= ΔW/ΔY ® k = 1/mpw or k = 1/(1-mpCd).

Remark: according to original K. analysis the following formula can be found: k=1/mps=1/(1-mpc).