The Multiplier Model Compared with the AS-AD Model

As you read about the multiplier model, you may have asked yourself how this approach fits with the AS-AD model of Chapter 20. There is no contradiction they are in no w,differentiate theories. Rather, the multiplier model explains the workings of aggregate demand b)’showing how consumption, investment, and other variables inter-ad to determine aggregate demand-it is a special case of the ‘aggregate demand-and-surplus model.

The key assumption in the multiplier analysis is that prices and wages are fixed in the short run; because they are fixed, all the adjustments in the economy come through output and employment. In other words, we assume the AS curve is horizontal. This assumption of fixed wages and prices is an oversimplification because these variables definitely do •react to short-run business conditions. In later chapters we will consider the, price and wage reactions that occur as markets respond to supply and demand shocks.

This discussion again points to a crucial feature of the multiplier model. While it may be a highly useful approach to describe depressions or even recessions, it cannot apply to periods of full employment. Once factories are operating ill full capacity and all workers are employed, the economy simply .cannot produce more output. ” We have now completed our presentation of the simple multiplier model. We next move on to extend the analysis of aggregate demand by showing how government fiscal policy enters. the picture.

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