Even before the war, in 1936, John Keynes published his work, which in many ways 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 made an attempt to explain economic fluctuations in the most general sense. In particular, the economic and financial upheavals during the Great Depression, which the United States was in from the late 20s to the early 30s of the last century.
The main idea, first expressed by the author, was the idea that economic recessions and downturns can occur due to inadequate market demand for goods and services. This idea was intended not only for professional economists, and even not so much for them, but for people who determine public policy. In the face of rising unemployment and a low level of economic activity, Keynes called for an increase in government spending to boost demand for goods and services. This ideawas contrary to the concept of the "invisible hand of the market", which implies that market relations in themselves are able to resolve the situation, and any state intervention in these relations can only worsen the situation.
The Keynesian multiplier as a concept states that an increase in consumption spending can increase the gross domestic product in a larger proportion. In simple terms: a 2-fold increase in the total consumption of the country's population can more than double the gross domestic product.
Components of Keynesian theory
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 tip the economy into recession and even recession. But the negative consequences of making such decisions in the private sector, that is, at the level of the population of citizens, can be effectively countered by government agencies through the creation of tax or monetary incentives. Actually, this is the cornerstone of the theory of the multiplier by John Keynes.
The second component is the assertion that prices, as well as wages, often react to changes in the balance of supply and demand with a certain delay. Therefore, a surplus or shortage of labor is accumulated gradually, and theirregulation is stepwise.
And finally, the third postulate can be formulated as follows. Changes in aggregate demand have the biggest impact on economic growth and employment growth. Consumer and government spending, investment and exports increase the gross domestic product. At the same time, their influence occurs through a multiplier, that is, with a coefficient that allows relatively small injections to provide significant growth. You can see this clearly in the chart below.
When aggregate demand grows from the initial level to the first level, GDP grows to the second level, and not linearly, but along a curve close to the conditional exponent.
Formula and multiplier calculation
Keynes introduced the concepts of marginal propensity to consume and to accumulate. 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 for consumption and for accumulation, including investment. Suppose an employee's salary increased by 1000 rubles. Of this additional money, he directed 800 rubles to increase consumption, and put 200 rubles in the bank. Then the marginal sum of the propensity to save will be 0.2, and the marginal sum of the propensity to consume will be 0.8. It is important to note that here we are talking about additional money, that is, about its increment, which introduces the word “marginal” into the definition. Further is quite simple. Valuesthe Keynes multiplier is equal to one divided by the marginal propensity to save, or (which is the same) one divided by the difference between one and the marginal propensity to save.
The mechanism of the impact of the Keynes multiplier (spending multiplier) on economic growth can be formulated as follows. With the growth in consumption, which is caused by additional investments from the state, part of the additional funds directed by the population of a particular country for consumption automatically creates incentives to increase production: from increasing production to assembling finished products. In each of the industries there is an increase in employment and an increase in output. Of course, all this is possible if there is a free labor force and idle production capacity. But it is precisely this 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 the Keynes investment multiplier.