Samuelson's book Summary Chapter 24

Chapter 24 Summary

A. The Basic Multiplier Model 1. The multiplier model provides a simple way to understand the impact of aggregate demand on the level of output. In the simplest approach, household consumption is a function of disposable income while investment is fixed. People's desire to consume and the willingness of businesses to invest are brought into balance by adjustments in output. The equilibrium level of national output must be at the intersection of the saving and investment schedules, SS and II. We can also see this using the expenditure-output approach in which equilibrium output comes at the intersection of the consumption-plus-investment schedule, C + I, with the 45E line. 2. If output is temporarily above its equilibrium level, businesses find output higher than sales, with inventories piling up involuntarily and profits plummeting. Firms therefore cut production and employment back toward the equilibrium level. The only sustainable level of output comes when buyers voluntarily purchase exactly as much as businesses desire to produce. 3. Thus, for the simplified Keynesian multiplier model, investment calls the tune and consumption dances to the music. Investment determines output, while saving responds passively to income changes. Output rises or falls until planned saving has adjusted to the level of planned investment. 4. Investment has a multiplied effect on output. When investment changes, output will at first rise by an equal amount. But as the income receivers in the capital-goods industries get more income, they set in motion a whole chain of additional secondary consumption spending and employment. If people always spend r of each extra dollar of income on consumption, the total of the multiplier chain will be 1 + r + r^2 + ... = 1/(1 - r) = 1/(1 - MPC) = 1/MPS The simplest multiplier is numerically equal to the reciprocal of the MPS or, equivalently, to 1/(1 - MPC). The multiplier works in either direction, amplifying either increases or decreases in investment. This result occurs because it always takes more than a dollar of increased income to increase saving by a dollar. 5. Key points to remember are (a) the basic multiplier model emphasizes the importance of shifts in aggregate demand in affecting output and income and (b) it is primarily applicable for situations with unemployed resources. B. Fiscal Policy in the Multiplier Model 6. The analysis of fiscal policy elaborates the Keynesian multiplier model. It shows that an increase in government purchases-taken by itself, with taxes and investment unchanged-has an expansionary effect on national output much like that of investment. The schedule of C + I + G shifts upward to a higher equilibrium intersection with the 45E line. 7. A decrease in taxes - taken by itself, with investment and government purchases unchanged - raises the equilibrium level of national output. The CC schedule of consumption plotted against GDP is shifted upward and leftward by a tax cut. But since extra dollars of disposable income go partly into saving, the dollar increase in consumption will not be quite so great as the dollars of new disposable income. Therefore, the tax multiplier is smaller than the government expenditure multiplier. 8. Using statistical techniques and macroeconomic theory, economists have developed realistic models to estimate expenditure multipliers. For mainstream approaches, these tend to show multipliers of between 1 and 1½ for periods of up to 4 years.