(1) Why is it that on the basis of the Keynesian model of outputdetermination, a

Question

(1) Why is it that on the basis of the Keynesian model of outputdetermination, a multiplier of 3 implies that when investmentincreases by $1, consumption increases by $2, shouldn't theconsumption increase by $3, since the multiplier is 3?

(2) Given the following data for an economy, compute the value ofGDP. Consumption expenditures 1000 Imports 600 Government purchases700 Construction of new homes 500 Sales of existing homes 600Exports 500 Government payments to retirees 200 Household purchasesof durable goods 300 Beginning-of-year inventories 500 End-of-yearinventories 600 Business fixed investment 300

Thank you very much

Explanation / Answer

1. Consumption increases by $2 because the principal amount used isassumed to be in the multiplication. If we said consumptionincreased by $3, we would have double counting! So with a multiplier of 3, GDP must increase by $3. $1 is from theinitial input of money into capital investments, and then thismoney further flows through the economy to increase consumption by$2. $1 + $2 = $3. This is why the tax multiplier effect is thegovernment spending multiplier - 1--because there was not aninitial insertion of money into the economy. 2. GDP = C + G + I + NX (Consumption, government spending,investments, and net exports) Sales of existing homes do not count, nor to government payments toretirees count. These do not provide a new good or service.Beginning of the year inventories are subtracting and end of yearinventories are added. 1000 - 600 + 700 + 500 +500 + 300 + 600 - 500 + 300 = $2800

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