The Multiplier Model

The United States and other market-oriented economies are subject to frequent and unpredictable fluctuations in output, prices, and unemployment, In the. past, these fluctuations, known as business cycles, generally occurred, because of changes in spending on investment, consumer durable, or defense. As economists, we want to understand the mechanism by ‘which changes in spending get translated into changes in output and employment. This chapter develops the’ simplest approach to understanding business cycles, the Keynesian multiplier model. We will see in the’ first pan of this chapter how an increase in investment raises the incomes of consumers and thereby leads to a cascading but ever decreasing chain of further spending, increases -,Investment changes are therefore multiplier into larger output increases. The multiplier mechanism actually applies, much more broadly than to investment alone, as we will see in the second half of this chapter. In fact, changes in government purchases, exports;’ or other exogenous spending streams wiki also be amplified into larger output changes. We show below how , government purchases have a multiplied effect upon output in much the same ways , does investment; this point led man}’ macro economists to recommend using fiscal policy”as a tool for stabilization economics.

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