So I have the Clep exam review here, and it explains that the multiplier is 1/MPS. This makes sense to me. If the propensity to save were 100%, any government expenditure (in their theory) would only be worth the face value. If the propensity to save were 0, then the new money would circulate to infinity.
The problem is, in a test question:
If government purchases increase $10bil and the MPS is .75, what is the final effect on the economy?
They have the answer “GDP increases by $40bil” as correct. In the question review it says the "injection of govt. spending is subject to the full multiplier - the mulitplier is 1/(1-mps) or 1/.25 = 4. so that’s 40 billion added to gdp.
Please verify that this is, even in their own theory, clearly wrong. If $10 bil is injected, and the MPS were 75%, then you have about a 13 bil overall gdp increase - which is not available as an answer. This may be covered in some errata somewhere, but..
I’ll be glad when I get these 3 credits behind me.
Nope, but thanks for illustrating how the keynesians (and others trying to use keynesian theory) can get burried in their own formulas and never bother to think about whether they make sense (not that I’m calling you a keynesian)
The formula you have above would imply that the higher the savings rate, the more money circulates and flows through the economy: if nothing was saved the multiplier would only be 1, and if everythign was saved, then the flow would increase to infinity.
Hah, I never thought about it that way. You’re correct, if MPS were 1, then the multiplier would be 1/(1-1)=1/0=undefined (infinity). I suppose Keynesians would claim that 100% saving is impossible, therefore making this result impossible anyway.
yeah, of course 100% savings is impossible, but 100% consumption leading to nirvana utopia of infinite capital, no problem there!
It’s the same math as the Fractional reserve multiplier. I think of the reserve requirement as the MPS of banks, and I thank the mises institute for helping to reveal this to me.
I think you have it a bit backwards kaju - in typical Keynesian fashion [;)].
The multiplier (m) is equal to 1 / MPS or more formally 1 / (1-MPC), Remember MPC + MPS = 1 (Keynesianism teaches us that people either save or consume all income.
So if people saved all their income, that is MPC = 0 and MPS = 1, then m = 1/ (1-0) = 1. So here any government spending will have no miraculous healing powers as it is multiplied only by one.
If people spend all their income (the Keynesian dream), that is, MPC = 1 and MPS = 0, then m = 1/(1-1) =. As Saiphes said - nirvana where all scarcity ends. And as Rothbard put it: It sure beats workin’!
Now Keynes safeguards against this fact by stating “prices will rise without limit”. But as Herbener duly notes, if prices are important in the multiplier process, Keynes should have included them and explained their impact. So Keynesians must either give up the multiplier’s mathematical accuracy (rendering the theory bunk) or reconcile it with the general economic theory (impossible).
You are right on one thing though Kaju - when I learned about the multiplier I was taught that marginal propensity to consume was bound between zero and one, ie, 0 < MPC < 1. Although it clearly is possible to save everything, to consume everything, or even spend more than you earn (go into debt).
If you guys are interested I suggest you read Herbener’s chapter on the Multiplier and Accelerator in Dissent on Keynes for a thourough dismantling of the idea.
(not that I’m calling you a keynesian)
. As Saiphes said - nirvana where all scarcity ends. And as Rothbard put it: It sure beats workin’!