Objective: The goal of this activity is for economics students to review and apply their understanding of the circular flow of income and the Keynesian multiplier. By examining a real-world case study and using relevant data, students will calculate changes in GDP due to an injection in investment, government spending, or exports. The activity requires students to utilize concepts such as MPC, MPS, MPT, and MPM to demonstrate their mastery of the subject matter and enhance their analytical skills.
Review: The Keynesian multiplier is a concept that explains how an initial change in aggregate demand (e.g., through investment, government spending, or exports) can lead to a larger overall change in the equilibrium level of national income. The multiplier effect occurs because an initial increase in spending creates a ripple effect throughout the economy, as one person’s spending becomes another person’s income, which in turn is spent, generating further income, and so on.
The Keynesian multiplier can be calculated using two different formulas:
- Multiplier (k) = 1 / (1 – Marginal Propensity to Consume)
- Multiplier (k) = 1 / (Marginal Propensity to Save + Marginal Propensity to Tax + Marginal Propensity to Import)
Activity:
Read through each case study below and answer all of the questions.
Case Study 1: Government Spending – Infrastructure Project
The United States government has decided to invest in a major infrastructure project, building a high-speed rail system to connect major cities and boost economic growth.
Calculation Questions:
- Calculate the value of the Keynesian multiplier.
- Calculate the immediate change to the 2022 GDP value following the initial injection into the circular flow of income.
- How much additional income will be generated in the economy as a result of this project?
Evaluation Question: Evaluate the potential benefits and drawbacks of this infrastructure project for the United States. Consider potential side-effects and unintended consequences of increased government spending on the economy.
Case Study 2: Investment – Green Energy Expansion
Germany’s largest energy company has decided to invest heavily in renewable energy sources, such as solar and wind power, to meet the growing demand for sustainable energy.
Calculation Questions:
- Calculate the value of the Keynesian multiplier.
- Calculate the immediate change to the 2022 GDP value following the initial injection into the circular flow of income.
- How much additional income will be generated in the economy as a result of this investment?
Evaluation Question: Evaluate the impact of the green energy investment on Germany’s economy. Consider potential side-effects and unintended consequences of increased private investment in the renewable energy sector.
Case Study 3: Exports – Increased Agricultural Exports
Brazil has experienced a bumper crop season, leading to a significant increase in agricultural exports to its trading partners.
Calculation Questions:
- Calculate the value of the Keynesian multiplier.
- Calculate the immediate change to the 2022 GDP value following the initial injection into the circular flow of income.
- How much additional income will be generated in the economy as a result of the increased exports?
Evaluation Question: Evaluate the potential benefits and drawbacks of the increased agricultural exports for Brazil’s economy. Consider potential side-effects and unintended consequences of relying heavily on agricultural exports.
Extra Notes on MPC, MPS, MPT and MPM
The Marginal Propensity to Consume (MPC), Marginal Propensity to Save (MPS), Marginal Propensity to Tax (MPT), and Marginal Propensity to Import (MPM) are all measures of how households in an economy allocate their additional income. These measures are calculated as the change in each respective category (consumption, saving, taxation, and imports) divided by the change in income. Here’s how to calculate each one:
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Marginal Propensity to Consume (MPC): This is the proportion of an additional unit of income that is spent on consumption. To calculate MPC, divide the change in consumption by the change in income.
MPC = ΔC / ΔY
where ΔC represents the change in consumption and ΔY represents the change in income.
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Marginal Propensity to Save (MPS): This is the proportion of an additional unit of income that is saved. To calculate MPS, divide the change in saving by the change in income.
MPS = ΔS / ΔY
where ΔS represents the change in saving and ΔY represents the change in income.
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Marginal Propensity to Tax (MPT): This is the proportion of an additional unit of income that is paid in taxes. To calculate MPT, divide the change in tax revenue by the change in income.
MPT = ΔT / ΔY
where ΔT represents the change in tax revenue and ΔY represents the change in income.
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Marginal Propensity to Import (MPM): This is the proportion of an additional unit of income that is spent on imports. To calculate MPM, divide the change in imports by the change in income.
MPM = ΔM / ΔY
where ΔM represents the change in imports and ΔY represents the change in income.
In a closed economy without government intervention, the sum of MPC and MPS equals 1, as households allocate their entire income between consumption and saving. In an open economy with government intervention, the sum of MPC, MPS, MPT, and MPM equals 1, as households allocate their income between consumption, saving, taxation, and imports.