Overview: The Multiplier Model

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In 1936 John Maynard Keynes published his General Theory of Employment, Interest and Money. Keynes, whose earlier work had made him one of the world's most respected economists, offered a new framework for approaching the questions of recession and unemployment. Arriving at a time in which most economists seemed confused about the state of economic affairs, the book revolutionized thinking about macroeconomics questions, sweeping before it the old business-cycle framework and the quantity theory of money.

There is controversy about what Keynes really meant, but this controversy is of no importance to us. Although some economists argue that the development of "Keynesian" economics in the 1940s and 1950s involved distortions of the true message of Keynes, it is these developments that had become the conventional wisdom of economics by 1965. These readings explore the mechanics and implications of the simplest "Keynesian" models that economists have used to explain problems of unemployment and recession.

The "Keynesian Revolution" emphasized markets for goods and services as the source of macroeconomic disturbance and de-emphasized monetary and financial sources. The simple income-expenditure model developed in this group of readings implicitly assumes that all interesting action takes place in the goods and services market, and that all other markets adjust passively. In contrast, the quantity theory of money assumed that the interesting action took place in the market for money balances, and the market for goods and services adjusted. Although by the 1960s most economists had come to accept the Keynesian view that the source of economic disturbance should be sought in the market for good and services, this view is probably no longer a majority position. The tide of Keynesian economics, which once swept all before it, has greatly receded.

After you complete this unit, you should be able to:

  • Define consumption function, marginal propensity to consume, marginal propensity to save, paradox of thrift, and fiscal policy.
  • Explain the logic of the multiplier model in terms of circular flow, leakages of spending, and injections of spending.
  • When given a simple multiplier model in the form of a table, find the equilibrium and compute the multiplier.
  • When given the multiplier in a multiplier model and a desired change in total spending, be able to predict the required change in exogenous spending.
Copyright Robert Schenk