Even before the war, in 1936, John Keynes published his work, which largely changed the course of economic thought. His book was called The General Theory of Employment, Interest, and Money. It is still one of the classic works in the field of economics. In this book, he attempted to explain economic fluctuations in the most general sense. In particular, the economic and financial turmoil during the Great Depression, in which the United States was from the late 20s to the early 30s of the last century.
Keynesian Economic Theory
The main idea, first expressed by the author, was the idea that economic recessions and recessions could arise due to inadequate market demand for goods and services. This idea was intended not only for professional economists, and not so much for them as for people who determine public policy. Amid growing unemployment and low levels of economic activity, Keynes called for increased government spending to boost demand for goods and services. This idea was contrary to the concept of the “invisible hand of the market”, which implies that market relations alone are able to resolve the situation, and any government intervention in these relations can only worsen the situation.
Animator concept
Keynes's multiplier as a concept argues that increasing spending on consumption is able to increase gross domestic product in a larger proportion. In simple words: an increase in the total consumption of the country's population by 2 times is able to increase the gross product by more than 2 times.
Keynesian Theory Components
Aggregate demand and aggregate supply represent the development of the classical theory of supply and demand at the macroeconomic level. Both of these concepts are influenced by decisions made both at the level of individuals and at the level of public institutions. A fall in the level of aggregate demand can overturn the economy into recession and even into recession. But the negative consequences of making such decisions in the private sector, that is, at the level of the aggregate of citizens, can be effectively countered by government bodies by creating tax or monetary incentives. Actually, this is the cornerstone of the theory of the animator J. Keynes.
The second component is the assertion that prices, as well as salaries, often respond to changes in the ratio of supply and demand with a certain delay. Therefore, an excess or shortage of labor accumulate gradually, and their regulation occurs spasmodically.
And finally, the third postulate can be formulated as follows. Changes in aggregate demand have the greatest impact on economic growth and employment growth. Consumer and government spending, investment and exports increase gross domestic product. Moreover, their influence occurs through the multiplier, that is, with a coefficient that allows relatively small infusions to ensure significant growth. This can clearly be seen in the chart below.
With an increase in aggregate demand from the initial level to the first level, GDP grows to the second level, and not linearly, but along a curve close to a conditional exponent.
Multiplier formula and calculation
Keynes coined the concept of marginal propensity for consumption and accumulation. These indicators as a whole can be attributed rather to the field of human psychology. The bottom line is the ratio of the direction of the received additional income to consumption and accumulation, including investment. Suppose an employee has a salary of 1000 rubles. Of this extra money, he directed to increase consumption 800 rubles, and put 200 rubles to the bank. Then the marginal amount of propensity to save will be 0.2, and the marginal amount of propensity to consume will be 0.8. It is important to note that here we are talking about additional money, that is, about their increment, which introduces the word "marginal" in the definition. Further quite simple. The values of the Keynes multiplier are equal to one divided by the marginal propensity to save, or (which is the same thing) - a unit divided by the difference between the unit and the marginal propensity to accumulate.
The mechanism of the Keynes multiplier (cost multiplier) effect on economic growth can be formulated as follows. With the increase in consumption, which is caused by additional investments from the state, part of the additional funds allocated by the population of a country to consumption automatically creates incentives for increasing production: from increasing production to assembling finished products. In each of the sectors there is an increase in employment and output growth. Of course, all this is possible with free labor and idle production capacities. But it is precisely such a situation that is characteristic of any economic crisis. The more people spend, that is, the higher the propensity to consume, the stronger the impact of Keynes's investment multiplier.