Question

Suppose MPC is 0.3, use the spending multiplier to fill in the values for an autonomous government spending of $700.

Year	Autonomous Spending	National Income	Change in Income
Year 1	$ 700b		N/A
Year 2
Year 3
Year 4

What are some of the problems with the spending multiplier?

(10 Points)

[You must review the literature about the multiplier]

Answer 1

The size of the spending multiplier depends on the marginal propensity to consume (MPC) which is given to be 0.3
The multiplier is calculated as 1/(1-mpc) = 1/(1-0.3) = 1.43

Spending creates more income, and with increased income, there is a multiplier effect.
In this example, if spending increases by $1, then national income is multiplied by 1.43 and it become $1.43.
Using this logic, we fill the table: -

Year	Autonomous Spending	National Income	Change in Income
1	$700 b	700*1.43 = $ 1000b	N/A
2	0.3 * 1000 = $300	300*1.43 + 1000 = $ 1429b	$429 b
3	0.3 * 1429 = $428.7	428.7*1.43 + 1429 = $2042.04 b	$613.04 b
4	0.3 * 2042.041 = $612.6	612.6*1.43 + 2042.04 = $2918.075b	$876.035

Criticism of the spending multiplier

The multiplier theory comes from Keynes's theory which assumes a number of things which may not hold true.

1. There is no change in the MPC during the adjustment process, which remains more or less constant.

2. there is no time lag between the receipt of income and its expenditure.

3. there is no government intervention like taxation or expenditure.

Criticisms of the Keynes' theory are on the grounds that it makes the simple assumption that increase in investment or spending increases income, and also that the mpc is less than one. But actual studies have shown that increase in income is not so simple related with increase in spending.

Authors like D.H. Robertson, R.M, Goodwin and A.P. Lerner. have criticized the multiplier theory on the grounds that it considers the effects of increases in consumption as a result of increases in income, but it takes no account of the effects of increases in consumption on investment (induced investment). Prof AG Hart has dismissed the multiplier concept as a useless 'fifth wheel'.

The main point of criticism of Keynes' multiplier theory by these authors is - it assumes that changes in consumption, investment and income is a timeless phenomena. The changes happen instantaneously.