It will be seen from Figure 10. Therefore, the multiplier is reduced to the extent of price inflation. It can be interpreted from Figure-3 that although the aggregate demand and aggregate supply curve are moving in the same direction, but they are not alike. In developing countries like India the extra incomes and demand are mostly spent on food-grains whose output cannot be increased so easily. The higher the rate of interest, the lower the demand for money, and vice versa. But that helped end the 1981 recession. However, it may be noted that even in the fifties and early sixties the view that Keynesian multiplier did not work in the under developed countries did not go entirely unchallenged.
The multiple increase in income and demand will also encourage the increase in private investment. Thus, bond price is seen as an inverse function of the rate interest. No doubt, if the Government expenditure increases by an amount equal to the taxation, it would not have any adverse effect on the increases in income and investment and in this way there would be no leakage in the multiplier process. A decline in total effective demand would lead to unemployment. Saving is a function of income, i. Aggregate Supply Price : Aggregate supply price refers to the total amount of money that all organizations in an economy should receive from the sale of output produced by employing a specific number of workers.
But this may or may not happen. Thus, Keynes recommended Government investment in public works to solve the problem of depression and unemployment. Keynes further asserted that free markets have no self-balancing mechanisms that lead to full employment. During the Great Depression of the 1930s, existing economic theory was unable either to explain the causes of the severe worldwide economic collapse or to provide an adequate public policy solution to jump-start production and employment. Further, it now became clear that the Government intervention, through the adoption of appropriate fiscal and monetary policies, can avert the collapse of the economy such as that happened during 1929-33. Rather than seeing unbalanced government budgets as wrong, Keynes advocated so-called countercyclical fiscal policies that act against the direction of the business cycle.
Keynes ignored the time-lag in the process of income generation and therefore his multiplier is also called instantaneous multiplier. The motives to hold it may be of any number. Illustrations inspired by Olivier Ballou. Keynes advocated during the of the business cycle. It follows from above that the Keynesian assumptions for the working of multiplier in real terms, namely: a The supply of output of goods is elastic due to the existence of large excess capacity, b The supply of raw materials and other intermediate goods can be adequately increased, c There exist involuntarily unemployed workers searching for work and, d Sufficiently elastic agricultural output. In the panel at the bottom of Fig.
The Keynesian cross model of under-employment equilibrium is explained in Figure 2 where income and employment are taken on the horizontal axis and consumption and investment on the vertical axis. Keynes book was published post-Great Depression period. Now, with this rise in price level to P 1, aggregate expenditure curve in the upper panel a will not remain unaffected but will shift downward. On the hand, aggregate demand price is the total amount of money that an organization expects to receive from the sale of output produced by a specific number of workers. According to Keynesian economics, state intervention is necessary to moderate the booms and busts in economic activity, otherwise known as the business cycle. Thus, higher the price required to induce the different quantities of employment, greater the level of employment would be.
But the situation in the present-day developing countries has substantially changed in the last 60 years. Aggregate demand price schedule refers to the schedule of expected earnings by selling the product at different level of employment Mo higher the level of employment, greater the level of output would be. It should have a balanced budget and incur little debt. Effective demand is determined by two factors, the aggregate supply function and the aggregate demand function. In the real world, all income received by the people as a result of some increase in investment is not consumed. Low consumption rate leads to a decline in effective demand. It will be seen from Fig.
It is important to observe that the saving which had risen to Y 1A Rs. Increased income leads to a rise in the demand for consumption goods which leads to further increase in employment and income. Imports are important leakage from the multiplier process and we have ignored them in our above analysis for the purpose of simplicity. Since marginal propensity to consume is actually less than one, some saving does take place. The transactions motive gives rise to the transactions demand for money which refers to the demand for cash of the public for making current transactions of all kinds.
In an economy, the employment level depends on the number of workers that are employed, so that maximum profit can be drawn. The multiplier is the reciprocal of one minus marginal propensity to consume. People hold their wealth in liquid form for three motives: 1 transaction motive 2 precautionary motive 3 speculative motive Demand for cash for transaction and precautionary motives depend upon the level of income while that for speculative motive depends upon the rate of interest. Further, even when there is no preexisting excess capacity in the industries increase in investment leads to the increase in demand for consumption goods which in turn causes further rise on investment to meet that consumption demand. The demand for individual organizations or industries refers to a schedule of quantity purchased at different levels of price of a single product. Diagrammatic Representation of Multiplier: The level of national income is determined by the equilibrium between aggregate demand and aggregate supply.