Question

3. Many economists use the ideas embedded in the circular flow to describe their understanding of the capitalist market economy. Using the circular flow’s concepts explain what has to happen in order for there to be a full employment level of equilibrium income achieved. What does the full employment level of income imply about the economy’s operation? You can draw the circular flow if that will help you answer the question, but you don’t have to draw it.

4. Keynes created the economic concept of the multiplier. While it may seem like magic, it’s not. Explain why the idea of a multiplier is important in macroeconomics and how it works.

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Answer 1

NOTES:

CIRCULAR FLOW OF INCOME: The circular flow of income is a representation of how the income is ciruclated in the economy.

LEVEL OF EQUILLIBRIUM INCOME: A nation is said to be at its equillibrium level of income when its total supply and total demand are equal. To be more clear GDP= TOTAL EXPENDITURE. For a nation to attain its full employment equillibrium level of income, the equillibirum between aggregate demand and aggregate supply should take place at full employment resources that is all willing and capable people get job at the existing wage rate and there should not be unused resources. Only then the nation will achieve full employment equillibrium level. FORMULA for the equillibrium level of income is AD=AS (Aggregate demand = Aggregate supply) and when modified we can write the formula as Y= C + I + G where Y stands for income, C stands for consumption, I stands for investment expenditure and G for stands for government expenditure.  

The circular flow diagram represents how goods, services, and money move through our economy. In circular flow model there are two main charatersitics HOUSEHOLDS and FIRMS. Where households represents consumers and firms represent producers. In circular flow model there are two flows, there is a clockwise flow of real resources and real goods and services. and the counterclockwise direction is the flow of money. When the output corresponds to full employment the economy remains in equillibrium at full employment.

KEYNESIAN MULTIPLIER EFFECT: Keynesian multiplier theory states the more the government spends the more the economy will flourish. The more the government spends on the economy the more the economy will boom. EXAMPLE: Let us say it is $200 million government project to construct a dam, might pay $100 million on pure labor then the workers take that $100 million and, minus the average saving rate and spend it at various businesses now what happens these businesses will have more money to hire more people to produce more products which leads to another round of spending. In short on dollar of government investment will promote more than a dollar in the economic growth.

The importance of keynesian multiplier effect in macroeconomics is, the concept of "Multiplier" occupies the most important place in keynes theory of income, output and employment. Any changes in any expenditure component will have a larger effect on the GDP than the value of initial change.    FORMULA : MULTIPLIER= 1/(1- MPC) MPC stands for marginal propensity to consume. Keynes multiplier theory is more important in macroeconomics which studies the the behaviour of the economy as a whole, it speaks about the importance of government investment in the economy which will help the economy to flourish.