Question

What do you mean by a multiplier? Explain and derive its formulation in a 4-

sector Keynesian model. Highlight and illustrate all the multiplier properties,

interpretations and graphical representations in your analysis.

Answer 1

A multiplier is an economic factor that when increased or changed, causes increases or changes in many other related economic variables.

The Keynesian multiplier bis derived through the concept of change in aggregate demand. It says that the output in the economy is a multiple of the increase or decrease in spending. For instance, If the fiscal multiplier is greater than 1, then a $1 increase in spending will increase the total output by a value greater than $1.

The increase from $AD_1$ to $AD_2$ leads to an increase in output from $Y_1$ to $Y_2$. But with a multiplier, there is a rise to $AD$ and a further increase in output at $Y_3$ .

The value of the multiplier depends on two properties:

• Marginal Prospensity to Save- this is the change in total savings as a result of a change in total income. When an individual's income increases, the MPS measures the proportion of income the person saves rather than spend on goods and services. $MPS=\frac{∆S}{∆Y}$
• Marginal Prospensity to Consume- this is the change in total income as a result of a change in total income. Keynesian theory states that an increase in production leads to an increase in the level of income and thus, an increase in spending. The value of MPC allows us to calculate the size of the multiplier using the formula:$\frac{1}{(1-MPC)}.$