Question

12. Why, in the Keynesian system, does fiscal stimulus held in attaining full employment? Explain with the aid of the Keynesian Cross.

13. Explain the working of the Keynesian multiplier.

Answer 1

In a Keynesian system, the aggregate demand is said to be unstable, and that very unstability is what attributes to the business cycle. The aggregate demand, when increases via fiscal stimulus during a recession, the output increases and the economy can be brought out of a recession. Below is a graph of aggregate demand and output.

The aggregate demand comprises consumption, investment and government expenditure, and includes the net export in a nation, ie . Taking all other constant, an increase in , government expenditure, increases the aggregate demand. The equilibrium arrives where the aggregate demand is equal to total income, which is the output of a nation. As can be seen in the graph, the 45 degree line represents the equilibrium in an economy as AD=Y, and the ewuilibrium output Y1 or Y2 occurs where the AD1 and AD2 crosses that 45 degree line. The disequilibrium is also defined in the keyensian system. The 45 degree line can also be seen as desired spending line, which basically reflects the output of the economy. Before Y1 or Y2, the desired spending is less than the aggregate demand, and hence, output should be increased to meet the AD. After Y1 or Y2, the desired spending is greater than the AD, and should be reduced to be in the equilibrium. It is at AD=Y, is where the desired spending equals the AD, and the economy of the nation is in equilibrium.

13. The keynesian multiplier is based on the features of consumption and saving function. The consumption function is stated as , where C bar is autonomous consumption, mpc is marginal propensity to consume and t is proportional tax. The lump sum tax can be added, but has no effect on the keynesian multiplier. The investment function is stated as , where I bar is autonomous investment and mpi is marginal propensity to invest. Hence The AD is , and the equilibrium occurs at where , ie or or or or , where is the total multiplier, combining consumption and investment multiplier.

Suppose government expenditure increases from to , denoting an increment of . The income reises as from to . The change can be attributed as , ie or or or . Hence, the keynesian multiplier works as for an increase in government spending of amount , the change in is multiplier times the change in government spending. The value of k is greater than ine, which why, it works as an amplifier.