Goods market multiplier in an open economy

The goods market multiplier in an open economy indicates how much equilibrium production or income increases with an increase in investment demand. In economics , a multiplier is a factor that indicates the extent to which an economic activity (independent variable) influences a unit to be analyzed (dependent variable). The multiplier process is an essential mechanism that stimulates overall economic demand. The multiplier analysis is a core idea of ​​the Keynesian theory .

conditions

The goods market equilibrium with income-dependent demand

Multipliers in an open economy

An open economy is considered, which means that the influence of foreign trade also plays a decisive role in the analysis. In countries with a strong export and import motivation, foreign trade relations can have a major impact on the domestic economy . To simplify the analysis, the price level and exchange rates are fixed as constant. Since exports are a component of economic demand, it follows that their increase has a positive effect on gross domestic product (GDP) or national income. Imports increase with growing GDP or national income of the inland. The extent of the import change is represented by the marginal import propensity. If the autonomous demand components are varied, the multiplier is lower than in closed economies.

Equilibrium in the goods market

There must be an equilibrium on the goods market, which is defined by the equality of aggregated demand and aggregated supply. When the aggregate demand function intersects the 45 ° line, the goods market is in equilibrium. A goods market equilibrium results in the level of production or income if this demand function is assumed. ${\displaystyle Y_{\text{r}}^{*}}$

Graphic derivation

Change in autonomous demand

Based on the goods market equilibrium, a continuous increase in investment ( ) is shown. The income-dependent demand components are grouped into. As a result of the increase in autonomous demand, the aggregate demand shifts upwards and develops into . The graph shows that the increase in equilibrium income is far greater than the increase in investment demand. ${\displaystyle \Delta I_{\text{aut}}}$ ${\displaystyle N_{\text{aut}}=I_{\text{aut}}+C_{\text{aut}}}$ ${\displaystyle X_{\text{N0}}}$ ${\displaystyle X_{\text{N1}}}$

The increase in demand ( ) leads to an increase in income and consequently stimulates consumer demand. The increase in the autonomous investment demand then creates an impulse for marginal consumption and thus leads to a multiplicative effect. ${\displaystyle \Delta I_{\text{aut}}}$

The equilibrium income after increasing investment demand by : ${\displaystyle \Delta I_{\text{aut}}}$ ${\displaystyle Y_{\text{r}}^{**}={\frac {1}{1-c}}\ (I_{\text{aut}}+C_{\text{aut}}+\Delta I_{\text{aut}})}$

${\displaystyle Y_{\text{r}}^{**}}$	= National income after increasing investment demand
${\displaystyle c}$	= marginal consumption rate
${\displaystyle I_{\text{aut}}}$	= autonomous investment
${\displaystyle C_{\text{aut}}}$	= autonomous consumption
${\displaystyle \Delta I_{\text{aut}}}$	= Change in autonomous investment

The change in equilibrium income is: resp. ${\displaystyle \Delta Y_{\text{r}}=Y_{\text{r}}^{**}-Y_{\text{r}}^{*}}$

${\displaystyle \Delta Y_{\text{r}}={\frac {1}{1-c}}\ (I_{\text{aut}}+C_{\text{aut}}+\Delta I_{\text{aut}})-{\frac {1}{1-c}}\ (I_{\text{aut}}+C_{\text{aut}})}$

${\displaystyle \Delta Y_{\text{r}}}$	= Change in national income
${\displaystyle c}$	= marginal consumption rate
${\displaystyle I_{\text{aut}}}$	= autonomous investment
${\displaystyle C_{\text{aut}}}$	= autonomous consumption
${\displaystyle \Delta I_{\text{aut}}}$	= Change in autonomous investment

It follows: ${\displaystyle \Delta Y_{\text{r}}={\frac {1}{1-c}}(\Delta I_{\text{aut}})}$

The quotient denotes the multiplier ( ) ${\displaystyle {\frac {1}{1-c}}}$ ${\displaystyle m}$

is also possible: ${\displaystyle \Delta Y_{\text{r}}=m*\Delta I_{\text{aut}}\!\,}$

The increases in demand derived from increased income become weaker over time and increase current income by an ever lower amount.

Consequences of the increase in investment

The increase in investment results in excess demand. The companies decide to increase the level of production. Accordingly, higher profits are generated, new workers may be hired and the entrepreneurs are able to increase household incomes. The households react with a time lag of one period. As a result, households will increase their consumption and since we are considering an open economy, part of the demand will be covered by imports from abroad. Furthermore, part of the money is saved and thus seeps into the income cycle (seepage loss). As a result, the demand arising from the increase in income is always less than the increase in income itself. ${\displaystyle \left(Y_{(t-1)}\right)}$

Critical appreciation of the multiplier analysis

The effects of the autonomous increase in investment are reduced to a sum formula. This is only a very rough representation of the economic process. This leads to the view that every increase in investment results in an increase in income and employment, namely by a value that is many times (multiplicative) higher than the input.

An analysis of the periods would prove that the overall effect only sets in after countless phases and this can not be reconciled with the ceteris paribus conditions .

The marginal consumption rate is also a weak point of this theory. It cannot be set to a fixed value, as households belong to different income levels. Households in the high income classes save a large part of their income and thus have a low consumption rate. As a result, lower income groups have a comparatively high consumption rate. The influence of the multiplicative effect therefore depends on which income class the investment increase is transmitted to. It is also relevant whether the autonomous burst of expenditure is directed towards capital or labor-intensive branches of the economy. ${\displaystyle (c)}$

Ultimately, this model assumes an equilibrium position that is disturbed by the multiplier process and leads to a new equilibrium point. Economic reactions in particular often occur when there is an imbalance in the market. Therefore, the calculation results of the above formulas must be examined critically.

literature

• Gerold Blümle , Wolfgang Patzig: Basic features of macroeconomics . 4th, revised and updated edition. Haufe Verlagsgruppe, Freiburg 1999, ISBN 3-448-03789-3
• Reiner Clement, Wiltrud Terlau: Basics of Applied Macroeconomics . 2nd, revised and expanded edition. Verlag Franz Vahlen, Munich 2002, ISBN 3-8006-2793-0
• Michael Heine, Hansjörg Herr: Economics . 3. Edition. Oldenbourg Wissenschaftsverlag, Munich 2003, ISBN 3-486-27293-4
• Sigurd Klatt: Introduction to Macroeconomics . 2nd, expanded edition. R. Oldenbourg Verlag, Munich, 1989, ISBN 3-486-21289-3
• Gerhard Schmitt-Rink, Dieter Bender: Macroeconomics of closed and open economies . 2nd, completely revised edition. Springer-Verlag, Berlin / Heidelberg 1990/1992, ISBN 3-540-55905-1

Individual evidence

1. ↑ Reiner Clement, Wiltrud Terlau: Fundamentals of Applied Macroeconomics 2nd revised and expanded edition. Verlag Franz Vahlen, Munich 2002, pp. 159–160
2. ^ Michael Heine, Hansjörg Herr: Volkswirtschaftslehre 3rd edition. Oldenbourg Wissenschaftsverlag, Munich 2003, pp. 404-406
3. ↑ Gerold Blümle, Wolfgang Patzig: Grundzüge der Macroeconomics 4th revised and updated edition. Haufe Verlagsgruppe, Freiburg 1999, p. 267
4. ↑ Reiner Clement, Wiltrud Terlau: Fundamentals of Applied Macroeconomics 2nd revised and expanded edition. Verlag Franz Vahlen, Munich 2002, p. 152
5. ↑ Sigurd Klatt: Introduction to Macroeconomics 2nd extended edition. R. Oldenbourg Verlag, Munich 1989, pp. 125-126