The multiplier effect in the simple Keynesian model: A change in investment spending

[lostmy1]

Hayek has it against the use of government spending to increase the level of output.

[Andersll11]

Man, do I love Hayek!

[liquidribs]

hey what video was before this video?? as you were saying "we now explored etc etc at 0:16"

[lostmy1]

@liquidribs It has to do with the determination of the equilibrium income level in the Keynesian model. But I have not uploaded it yet.

[HolyGaia]

@jackie8mccall I'm not sure I get what you're saying.

The version of the model shown in the video does not include a Central Bank and a financial system, even so... The multiplier is akin to the velocity of money. There is the same amount of money in the system in the end as in the beginning, but it circulates faster. You can see that in video: every time an arrow shows up, it indicates the velocity of money is increasing.

[HolyGaia]

Notice the geometric series.

[lostmy1]

@HolyGaia Indeed, In this example the geometric series is:

100 + (0.8 x 100) + 0.8 x (0.8 x 100) + 0.8 x (0.8 x 0.8 x 100) + ...

And the general formula for the sum of this geometric series is: 1/1-0.8 = 5 which is the multiplier.

[lostmy1]

Adding taxes will decrease the value of the multiplier as it decreases spending by households. Imports also decrease the value of the multiplier as it spending on goods not produced domestically. As long as there capacity to produce the multiplier will work regardless of inflation. Interest paid by one person is income for another person. As long as it does not leak out of the system the multiplier is unaffected.

[longhornssb]

Good video.

What if you make it more realistic however. Add taxes, corporate profits, and rising prices due to inflation and a growing demand. Does the multiplier effect work then? Eventually the person who made the initial investment will have to pay off his loan (with interest) and since there is only a total of $100 circulating in the economy, he will not be able to pay it off without someone else making another investment, right?

[lostmy1]

@longhornssb Adding taxes will decrease the value of the multiplier as it decreases spending by households. Imports also decrease the value of the multiplier as it spending on goods not produced domestically. As long as there is capacity to produce the multiplier will work regardless of inflation. Interest paid by one person is income for another person. As long as it does not leak out of the system the multiplier is unaffected.

[longhornssb]

@lostmy1 Why would the multiplier effect not be affected by inflation? In terms of dollars I understand, but the amount of additional productivity has to be diminished each cycle right?

Also regarding the initial investment, I guess I wasn't clear. Let's say that the gov't made the initial $100 investment. Then at some point (unless the gov't doesn't plan on repaying its debt) the $100 will have to be leaked out of the economy right?

[lostmy1]

@longhornssb If the government finance the $100 through taxation then the taxation is the leakage. If the government finance it by borrowing from savings by households there is no leakage. Repaying the household at the end of the year by decreasing its spending by 100 will cause a lower stimulus (not a leakage). Or it can borrow the money again.

In a recession with excess capacity you will not experience diminishing returns. Once full employment is reached there is no multiplier.

[lostmy1]

In this Keynesian world you have resources that are idle - they are not being used. By increasing spending producers will react by increasing production to meet the higher demand. As production increase income increase and the multiplier is in opration. So by increasing money you are increasing the use of resources.

[gabrifernandes2009]

these are all nominal values therefore by printing $100 you would be initiating a new "false" cycle in which the value added is actually artificial. Remember you don't increase resources by increasing the quantity of $ in circulation. Sooner rather than later prices will adjust in order to account for the newly created $ (inflation). All the false gains of this false boom evaporate as soon as its consequent imbalances cause this bubble to burst.

[lostmy1]

Spending is injected into the system and that spending is the money. The money is supplied by the central bank.

[jackie8mccall]

This system is flawed for one reason. It can only start if money is injected into the system. Where did this money that is being injected into the system come from?

[HolyGaia]

jackie8mccall Look, before you say something you positive is a fundamental flaw, that one has bothered to raise over the past 80 years, think again.

I've heard that point before and my original reply was «We aren't starting anything. This is the 21st century.» But to answer your question, in this case businesses lead the surge, so they can either use their savings or access credit.

[lostmy1]

@HolyGaia Businesses will only be willing to prodcue goods if someone is willing ot buy these goods. If the demand for goods is less than produdction while businesses increase production?

[HolyGaia]

@lostmy1 True. If there isn't increase in demand, there isn't an incentive to increase output.

[jackie8mccall]

@HolyGaia I am saying the people that are lending the money. Where are they getting it from? The government is promising to pay + interest (credit) and the people lending the money are promising to pay.

[perfectfailure23]

This video doesn't ask "what is savings?" Savings is just money you plan to spend later (what would be the purpose of dying a billionaire?) and therefore most reasonable people put excess savings(the sum leftover after your rainy day funds) into investment projects. Savings CREATE investment. This model treats savings as a negative but only because consumption drives production(in reality production drives consumption ex. apple makes iPhone, people want to get one, THEN the multiplier begins).

[lostmy1]

@perfectfailure23 Maybe it is because people want IPones and have the means and willingness to purchase it that it is produced. So spending drives producion. And it is the invevstment that creates the savings. If people save and do not spend produciton will suffer. There is no reason to think that just because peole save more that businesses will invest more. The decision to save and the decision to invest are two seperate things.

[peace33783]

this model is flawed because it doesnt consider the fractional reserve lending allowing leverage/debt creation, so when population start becoming savers compared to consumers money contraction occurs eliminating debt from the circulation and bubbles occur, to a complete slowdown. Research austrian economics. Regards AC

[IUEC38]

@peace33783 Wrong. Wrong on Austrian econ and wrong about the multiplier. Look up the marginal propensity to consume, it's the foundation of this model.

[MarkEDenman]

Great video, helped me understand this concept for my Macro Economics course much better than the book or Pro could.

[lostmy1]

This is the magic of the multiplier. If you built a factory for 80 then demand and output increases with 80.  An increase in production of 80 leads to an increase in income of 80 of which households then spend 64. Demand increase then increases with 64 and so does produciton and income and the cycle continues.

Moving 10 dollars from from your left pocket to the right will not increase it to 11 but spending it will increase production in the eoncomy with more than 10 dollars.

[tegalans]

Sorry, but that's bullshit. It's not a multiplier but diminished returns. For every cycle there is less demand. The 80 million cannot be spent twice. So it's not 80+64. Demand starts out at 80 million and then goes to 64 and so on. You can't spend 64 and 80 because 64 is the 80 minus savings. Perpetual motion isn't real, hell this is even worse. You can't move 10 dollars from your left pocket to the right and have it magically become 11.

[MarkEDenman]

@tegalans It's not saying it creates new money. It is of course the same cash being shifted back and forth between households and firms. what is created is GDP.  The money going back and forth is motivating the firms and households to Work/Do/Create/Service.

it isn't 10$ becoming 11$ it is the same money being used to pay various people back and forth ultimately creating more than $10 value/GDP.

at least that is my understanding.

[keepitsimpleplease1]

Thanks for posting this man, this makes total sense now. You saved my grade in econ.

[rabarbaley]

would c be the same when the income rises? if you get paid 3000$ and then get a temporary bonus of 1000$, would you spend 80% of that money, too? I think most of the people would save more than the average 20%. e.g. if c is just 50% the multiplier would be just 2 and not 5. here in Gemany the Federal Office of Statistics figured out, that the multiplier for the olympic games in munich '79 was only 1.44. In a depression where a lot of people are unemployed, it would be even lower.

[lostmy1]

Its not a level thing. It is an explanation of a basic concept. To understand complex things one must understand basic things.

[missfanning]

wt level of study is this theory in? im in form 7 now n i am learning this gosh

[lostmy1]

What his thing is telling you is that in a world where we have excess capacity - that is factories are not producing at full capacity - an increase in demand will cause an increase in production and an increase in production causes an increase in spending which causes a further increase in production. Hence a multiplier effect. There is no need for a mathematical formula.

[jackie8mccall]

@lostmy1 Increasing the money supply without an increase in goods in services results in higher prices for Goods and services.

[TussenPerpaalsa]

BS. How about the little arrow from savings going back to investment with interest over time? No, the money is under someone’s mattress. Oh and good luck with creating a mathematical formula for something incredibly unpredictable and human as economics (affected by macroeconomics for example). If your formula worked, you would own the world.

[falconpierce]

keep in mind MPC is not a fixed amount

[AnthonyCommonE]

I love how this works in a world where scarcity does not mean anything and that income will keep growing. Well if income keeps growing then the more money you make the less it is worth. As we see in the graph it must spending and production must keep going up in order to maintain equilibrium. As spending and production goes up so does inflation. This must keep going on perpetually. Until we hyper-inflate the currency or our means of income. Leading to collapse of the whole economic system.

[Rwehappy2day]

Education is the key to this rather than half-formed opinions. I guess these folks are saying they are more qualified in their ten minute youtube assertions than the folks that go to Harvard and receive the specialize knowledge required- I wonder how much time they have spent researching macro-economics, pricing, the business cycle and the like, and to have an opinon after only listening to 10 minutes to a video on youtube kind of shows you the level of intelligence we are NOT dealing with here.

[coolestnameavailable]

ben from lost

[asleeperj]

Investment spending is an oxymoron. It's like saying "Saving spending." Investments make you money, while liabilities take money. This is based on an assumption that all "Investment spending" creates money. What if the investment goes south? Then it becomes a liability, where is the multiplier in that?

[shotsky94]

Keynesian Economics is an oxymron

[FREESOULIA]

this is dumbest idea ever .... so if government spend 14 trillion we will have 70trillion worth of economic boom and we will still have 14 trillion in saving ??.... ok money is just a medium of exchange it does not mean it can increase resources we can use ... hahahaha just cus you counted circulation more times doesnt mean you got richier hahaha Keynesian economics are dumber than i thought hahaha

[asleeperj]

@FREESOULIA Yeah, Keynesians do not take into account how wealth is created. Not from government spending but from individuals in transactions. Transactions do not take place unless both parties feel better off.

[IUEC38]

@FREESOULIA I think you need to watch the video again, you are obviously lost.

[FREESOULIA]

@IUEC38 where did i get lost ??

[HolyGaia]

@FREESOULIA Watch out everybody, we've got an asshat over here.

[zaztec]

Keynes. YOU DA MAN

[ph0chiz0]

this makes perfect sense...

[joezhou]

need more videos like this!!

[razerfish]

this crap is still being taught? Oh, brother.

[sjmulder]

@razerfish what is considered the better alternative? (layman here)

[oleg0583]

I LOVE THIS VERSION

[randomrainbow17]

Thanks... YOU'RE A LEGEND!!!!!! 

[ved434]

brilliant!!!

[quartznafi]

I wish.... you are my lecturer

[Geertjr1]

Hallelujah!

[polarspirit]

I finally fucking understand. Fuck my lecturer. Thank you, my friend, for posting this up. I was confused about the magic of multiplier effect.

[MrAlgoss]

nice video

I love it so much

thanks for efforts

carry on of making a lovely videos like this

[AlexMerced]

- Also this model in the video treats income as if we get check that vary in size throughout the year... last I checked I get generally the same pay check every two weeks, this may have some truth with part time hourly labor... but then kicks the fallacy that savings doesn't get re-invested and the ignoring of taxation as leakage. (Government debt would also cause leakage cause it'd divert some of that investment capital away from firms... and then tax the firms... lots of leakage)

[spinner883]

@AlexMerced I'm not seeing how this model implies that and if it does, it shouldn't as Keynes was a proponent of absolute income hypothesis (people entering into contracts leads to stickiness in Aggregate demand, i.e). Keynes also doesnt ignore taxation as a leakage or that savings will be reinvested - hence the "in the long run we are all dead." The point is to prevent the basically infinite spiral downards, as deflation has the ability of delaying reactions, which hurts the economy, and thus..

[spinner883]

@AlexMerced the continous spiral downards. Yes, it is true that if demand for money is insensitive, the rise in interest rates CAN "crowd out" investment and change the composition of the economy (more reliant on gov spending). However, we should beware of the "Economics in One Lesson," ch 2, explanation of Keynesian spending as simply moving money around the economy (Broken Window). The problem with that is that G spending can "crowd in" just as much or accelerate investment...cont

[spinner883]

@AlexMerced We should not just look at something as pure quantity (tax 100 from one person and give 100 another) but also its qualitative impacts. For example, if I raise water by 5 C degrees and it is only 55 degrees C at the start, it will only get warmer. But if I raise water temp by 5 C degrees and it is at 95 degrees, it can change the whole molecular structure of the mass and transform it into vapor. Thus, a little boost in Gdp might be totally useless and perhaps negative but....

[AlexMerced]

- They assume savings doesn't get re-invested which is false... this is what banks do, re-invest people savings so the entire 100m in the model would continue you to circulate, actual leakage in the system is portion of that income doesn't go to households or firms cause of taxation in different parts of the productions and consumption process. If banks arn't lending to firms at the current time it's cause they can play it safe with the growing supply of T-bills, again a side effect of govt

[spinner883]

@AlexMerced ...it also may lead to a whole new economic environment and change the subjective conditions of investors. It was never implied that savings don't get re-invested (or atleast this video shouldnt say so) but that there can be time periods (i.e last 3 years) when people don't invest because they don't think they are going to get anything back. Banks have been sitting on the money that the FED tried to inject (probably to wait for prices to drop) Its not false...

[spinner883]

@AlexMerced The assumption isn't false - its only in classical and neo-classical market theories and models that Savings are automatically reinvested by banks. But like you have said, banks are "playing it safe" - more like smart. Waiting for deflation with all that money is just an easy way of making money. The whole problem, really a side effect of Capitalism, is that the cycle of leakages and investments must continue to run like an engine - this isnt what I would like to live under but...

[AlexMerced]

- When they show the effect of demand changes on Equilibrium... they don't even acknowledge the possibility of the production/output curve moving cause they assume producers won't produce unless there is demand, which would mean there would never be new products and much less new product classes... for example who demanded an Ipad 3 years ago?

[spinner883]

@AlexMerced ...that's what it is. As for the Say's law paraphrase, "who would of demanded" - A few things 1) I think the idea that something "new" is created is false. Theodor Adorno has talked alot about the "culture industry" and how it pretends to create "new" things when it really simply rehashes old "concepts" or formulas. The people who thought up the Ipad were consumers themselves - perhaps they demanded to see such a commodity. Even more so, Apple knows people already like computers...

[spinner883]

@AlexMerced and blackberry's and other devices that have been combined into one product.

Finally, I read some of your blog. Very interesting - I applaud you for having your own philosophy. I think you would perhaps be suprised by certain historical figures who are considered the opposite of the Mises crowd who would actually agree with you.

[sunshineyjessie]

this is brilliant!!!!! the example really helped me to understand how the formulas are derived. cheers! :D

[brewmaster95060]

It isn't.

[GrandArchitect3D]

if the multiplier effect is real then why dont they tax people at 100%  ?????

[spinner883]

@GrandArchitect3D

Diminishing returns. 2) once a market gets going, the point of stimulating aggregate demand, then the government can back away.

[GrandArchitect3D]

@spinner883 we have seen that it does not work. if government spending adds a percentage then we would have been taxing 100% since the days of Jesus.

[spinner883]

@GrandArchitect3D

where and when have we seen it not work? See when people just make broad strokes like this, they come across as ignorant. Has the "stimulus" in the US in the last two years worked? Perhaps not. But what about Australia 2 years ago? Oh ya, they went from .8% negative growth to .4% growth in about 4 months. And we have seen the multiplier work, it just works to different degrees depending on what its being used for (i,e food stamps are extremely effective).

[spinner883]

@spinner883 Thus, no 100% tax.

Plus, there are multiple variables in determing tax rates. Even if the multiplier effect is true, people's personal bias and beliefs come into play when determing tax code. the end

[spinner883]

@spinner883

i would also question people's belief in the Federal recovery act of 2009 being any sort of proper stimulus, considering about only 1/3 was actual direct government spending ( others being state bailouts and tax cuts) and even then, more should of been done. o well fuck it. now we are going to have massive austerity measures and turn into estonia

[AlexMerced]

@spinner883 injecting stimulus will increase GDP on the short term. Is the economy structured for sustainable growth and does money circulating for the sake of money circulating intriniscally mean a better quality of life is a different story. I think GDP is a poor measure of an economy for many reasons. I prefer looking at adoption rates of the newest innovations, if your poor can be early adopters faster than other nations, life may just be a little more pleaseant in that country.

[spinner883]

@AlexMerced I 100% agree with you on the point that I think GDP can be a worthless determinent of quality of life. Perhaps it might seem contradictory for me to say this because of what I wrote 2 months ago but I was responding to the other person's comments. But For example, to quote Louis CK, we could just start opening up more and more "Shitasspetfuckers" stores and hire people - ultimately money will be turnover but does having such a store benefit society? As for your suggesting...cont

[spinner883]

@AlexMerced cont of adoption of innovations amongst the poor. That is interesting factor that I have not considered and probably an increase in that rate would do much to lower the Gini. I was also wondering if something like a measurement of Underemployment (as opposed to unemployment) could more accurately measure a quality of life because it would give a rough estimate of worker's effort at their jobs (which could be used to modify possible productivity levels) and how much they value them

[spinner883]

@GrandArchitect3D

keep in mind we are also talking about short-term growth, not long term growth.

[GrandArchitect3D]

@spinner883 i understand the theory but it is just a theory. like global warming.

[johnhassle]

@GrandArchitect3D The word theory is actually much more powerful than your preconceived notion that a theory is negligible observation. In fact, a theory is a series of observable facts proposed together to create a larger hypothetical factual event. Thus a theory is actually an inductively proposed component of evidence.

[GrandArchitect3D]

@johnhassle too bad we can test these theories and we see this one failing right before our eyes.