Question

Explain why in a multiplier model a rise in household wealth relative to target will ceteris paribus shifts the AD curve upwards and raise output.

Answer 1

Multiplie theory of Keynes Sinabi na > static in nature negeects time lags > Cons" (n is stable in short ewn ie MPC is stable by comedy from A in autonomous components of AD ie 1,9 ) especially from sin unstable I demand. > A given change in an autonomous component of AD causes a large equi income due to multiplier effect. Ду varies from o too (inv.) Proof: I less imp.) A in > Multiplier = k = I I- MPC MPS AI AY = AC + AI Coatby Дc = ЬАу A Y = 5 AY + A I I AY AT 1-b I- MPC b = MP C d MPC +MPS = 1 = 1 1-MPS > Wher > When MDC = 1, Rao MPC = 0 c csin I = everything of Y is consumed 11] two limiting a iny) R-1 excess capacity exists MPC remains constant closed eco- in economy Assumptions in multiplice theory works not only prices of money instantaneous multiplies-ie there in no time lag b/w Din E Тад, у. ก teny but also in real tums goods are constant P in factor fin c p in demand > AI → p in prod" & output ( siondilar to ripple effect) payments Th7 for goods YADA : 6+1,440 AB=C+IEGO > effect of 51 14 same 0 y (income / output) -5+To ↑ in autonomous investme on equilibrum Y diagram for a ↑ in autor onuous gout. Spending • Ay > AI in the diagram au to multiplice effect changes in → AI < je AIK business exb. ( brestment Multiplici 1 1,+G09 AC + ду 1340 c5 Scanxed With CamScanner cincome output)

risen Income govt may . and up having the -nities same as Leakages in multiplice process (a) Paying off debts or past obligations of debt from the risen income b) Holding cash (idle) for precautionary e spectative motives from (C.) Impats : PinyPin import demand no beneft to home country AD (d) Taxation Pncrease → not use it for 4 a other AD stimul - ating activity (e) Inflation a p in p reduces k. Paradox 4 Thift :: explained by multiplier theory > as per this paradox , in an attempt to thift (save) for future uncertai end may not become fuitful they may initial savings but also cause then co standard of living to fall penny saved is a permy earned." Saving can lead to low env. & therefore low output & emp. ↑ Savings by all tin ce feuther fall in Y by multiplice process. This can be solved of savings chemelised into inv. through financial markets as a result I skift up again Yo to achieved. ( Backward ef feet of nucltipliee). Effect on impact of multiplica also depends upon the outcome olemus mou the elastic AS greater the impact of multiplier Dynamic thesy of Multiplicy Continuous injection model: considers time lag blw sI to AY and cons" th. change ins AD , As same amount ie 4 I = AY . ? in G because of Reuiod 4! p in I trin y because of > Truft :"A more » Keynes 5 au l 7 no Puuiod : Period 2: Priod 3 Inu P → ya by AY AC Continues b - MPC 1-6 Gout expenditure multiplier & AY AG • Tax multiplics : AY = -b (lump-sum) to ( Tay You vc) AT I-b ( Opposite effect of R Balamed Budget cannan both tasses ! CamScanner Dont shoudina - 1

Effect of poportional income way C+I+G - c'tita yx output Due to cons.d C-fly) peop taxo tax p as YT 1 . 9,"yo Fiscal Stubiti zation Policy: :: 45 Ao = (+8t9=C+I+4, > a > -AD=C+ 1tGo у Sue to business epp, to falls to 1, as a result AD shifts down Yp > Y Gout via fiscal policy ie gout spending to G, fue Go as a result AD shifts back to the leve earlier e output again eaches full cup level - • Examples of fiscal policy: Kennedy-Johnson tax cut in 1964 * American Recovery & Reinvestment Act, 2009 - SIT b Ist Go = I, ta, -I, +40 * 4 sector Keynesian Model: M= . > , uxox oxual . Y = AS = C+ I +G + X-M where x = exports imports Import demand = f (Y) M= utvy (marginal propensity Exports depends upon foreigh demand or income & hence exogenous. Additional variables that would impact xfM= relative prices, exchange rate would be lessen would be the A in y due to a in leonomy autonomous exp. like 9, I ete. ( imports basically leakeges). for domestic goods higher u means lower MPC for dom.goods & lower value for the multiplice- • Increase in exports would have some impact aina (same diagram) • p in M Cimport) & in equy (contractionary effect). Mou open a au b-v = MPC as of CS Scanned with CamScanner