Answer to Question #153728 in Macroeconomics for Maduwanthika

Question

In the simple Keynesian model, an increase of one dollar in autonomous expenditure wil

cause equilibrium income to increase by a multiple of this one dollar increase. Explain the process by which this happens using different approached of explanations..

Answer 1

Solution:

The reason for this occurrence is because a change in aggregate expenditure revolves around the economy. The process can be explained as follows: households purchase from firms, these firms pay workers and suppliers, these workers and suppliers purchase goods from other firms, those firms pay their employees and suppliers, and so on. In such a way, the initial change in aggregate expenditure is absolutely spent more than once. This is known as the expenditure multiplier effect: an initial increase in spending revolves continuously through the economy and has a massive impact than the initial dollar amount spent.

Another process is, for example, the government coincidentally buy $50 billion worth of goods and services. The manufacturers of those goods and services experience an income increase by the same amount. They then utilize that income to pay their bills, pay wages and salaries to their workers, rent to their landlords, and pay for the raw materials used in producing the goods. Any income left is profit, which becomes income to their shareholders. Every one of these economic agents takes their new earned income and spend some of it. Those purchases then become new income to the sellers, who then turn around and spend a part of it. That spending becomes someone else’s income. The process continues, and when the dust settles, the amount of the new income produced is multiple times the original increase in spending.