Question

In a basic Keynesian model (such as Model II in Models and Multipliers) the size of the government expenditures multiplier is very straightforward—depending on the magnitude of the MPC. However, in a case more closely resembling the “real world” (such as Model IV in Models and Multipliers), the size of the government expenditures multiplier is less certain. Examine the two models and indicate what conditions (or parameter values) would cause the Model VII multiplier to be larger or smaller than the Model II multiplier.

Answer 1

Answer:-
The effect of changes in government expenditure and taxes can be understood by the effect of each multiplier. The government expenditure multiplier explains the percentagechange in income the economy experiences when the government expenditure is changed by 1%. Similarly, the tax multiplier shows the percentage change in income when the taxes are changed by 1%. The government spending and tax multipliers are as follows:

Since, the tax multiplier is lower than the Government expenditure multiplier, thus if the government increases spending and taxes in the same amount, the effect on income will not be cancelled out. The net effect on the income is as follows:

Add the two multipliers to get the effect:1/MPS+[-MPC/MPS]=1 Thus, in that case the multiplier will be one.