4. The figure below is sometimes used to argue that the total government expendi

Question

4. The figure below is sometimes used to argue that the total government expenditure multiplier should be higher than unity. In the figure the government spending increases from G to G2 and the total demand curve shifts up by exactly the same amount. Demand of goods C+I+G, C+1+G, Income a) What does the government expenditure multiplier mean and why is it greater than unity in the figure? b) What mechanisms of general equilibrium models are omitted in the above argument and how do the omissions affect the conclu- sions about the magnitude of the government expenditure multi- plier?

Explanation / Answer

a) The government multiplier means how much the demand for goods change in response to a variation in the Governmet expediture, an exogenous variable, which affects the income. The multiplier is bigger than one because the expediture of an agent is the income of the other agent, and this last agent expends almost his entire income.

b) Some mechanisms ommited here are for example, the supply side of the economy. In this case, if we don't take into account the supply of and economy, the government expediture can create inflation and unemployment, because, the production in the economy is determine for other variables aside public expediture. Therefore, the magnitude of this expediture multiplier could be smaller if we include a complete economy, that is , if we include the supply side.

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