# These previously unemployed workers are now getting

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These previously unemployed workers are now getting paid. In the first round of spending, \$100 million is added to the economy. Now suppose that the public's marginal propensity to consume is 90

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KEYNF.S RESPONDS TO CAPITALISM'S GREATEST CHALLENGE 161 Figure 5.2 The General Theory Was Written-When Interest Rates Were at Their All~Time Lows Interest rate 16.00 ~~------ .. -··~- .. --- ·-- ... --.-- ... - ... -·. ·-·---- .. -- ----- ·1 14.00 +----------------.-----4 12.00 +----------------tr----~ 1000 +----------------+-,__ ____ __, ::: I A A I jJ\ . I ''°I' 4 - .''"''"""""' ............. , rv _u., ~ Y II_\_ , ' I 2,00 v o.oo ! ........... ~ .. ,,;;;;:: ............ """"""""' J ., "' ., 4> "' ' .. .~ """ ,_, "' ,, "' ' "' ' ,,,o ,<?. '"" """ {!I -?' ~ ... ~ "q> ._Of .._ct' '"" ~ "("jj' ... ~ .._Of' ,cf' ~ percent, that is, these workers spend 90 cents of every new dollar earned. (Another way of saying it their marginal propensity to save i.s JO percent.) In the second round of spending, \$90 mil1ion is added to the economy. Then there is a third round. After the workers spend their new money, that \$90 million becomes the revenues of other businesses- shopping malls, gas stations, supermarkets, car dealerships, and movie theaterf'i. These business may in turn hire new workers to handle the new demand, paying them more wages, too, and these workers also ·spend 90 percent of that income. They receive an additional \$81 mil- lion (90 percent of \$90 million) of spending power. Ultimately, the public investment has a multiplier effect that generates round after round of gradually declining spending. By the time the new spend- ing has run its course, the aggregate spending has increased tenfold. Keynes's formula for the multiplier (k) is, k=--- 1-MPC where MPC =marginal propensity to consume.
162 THE BlG THREE IN ECONOMICS Since MPC:: .90 in the example above, k = I 0. As Keynes stated, "the multiplier k is JO; and the total employment caused by ... increased public -works will be ten times the primary employn1ent pfovided by the public works themselves; assun1ing no reduction of investment in other directions" (l 973a [I 936J, 116-17). Keynes Makes a Mischievous Assumption Note that in the Keynesian model, only consumption spending gener- ates additional income and employ1nent in the economy. Keynes as- sumes that saving is sterile, that it aborts into cash hoarding or excess bank reserves. Thus, the Keynesian model as originally proposed is considered a "depression" model. As we shall see in the next chapter, this was a crucial mistake that led to much mischief and misunder- standing in economics in the postwar era. Keynes Offers a Drastic Measure to Stabilize Capitalism The Cambridge leader was not satisfied with temporary measures such as public works and deficit spending to reestablish full employment. Once maximum output was reached, he reasoned, there is no reason to believe il will stay there; Investment is unprcdiclable and ephen1eral, Keynes said. Long-term expectations, a stable business climate, and savings equal to inveslment could never be guaranteed as long a<> irra- tional !'animal spirits" operated in a laissez-faire financial marketplace.

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• Fall '10
• GRIFITH
• Economics, Keynesian economics, Keynes

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