Academic journal article Atlantic Economic Journal

On the Size of the Multiplier

Academic journal article Atlantic Economic Journal

On the Size of the Multiplier

Article excerpt

On the Size of the Multiplier

According to the common wisdom of macroeconomics, the multiplier is greater than unity. However, for small open economies this may be untrue. Take the reasoning of an important textbook as a starting-point [Lipsey, Steiner, and Purvis, Economics, 1987, pp. 518-21].

Aggregate expenditure (AE) is divided into autonomous (A) and induced (N) expenditure: AE = N + A. (1)

Since N varies with income, one can write: N = zY. (2)

Substituting (2) into (1) yields: AE = zY + A. (3)

The equilibrium condition is thus: AE = Y. (4)

Substitution of (3) into (4) yields: Y = zY + A, (5) which can be rewritten (in changes): Y = A/1 - z (5a)

If the multiplier is designated by K, one can write: K = Y/ A = 1/1 - z (6)

On the basis of this result Lipsey, Steiner, and Purvis conclude that the smallest possible value of the multiplier is unity. In this case, the increase in income is confined to the initial increase in autonomous expenditure, because none of the original increase in income is spent (z = 0).

Although the formal analysis is correct, the conclusion is wrong. …

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