LAWCOMM 403 long notes.docx-CONTENTS Tip...
LAWCOMM_403_long_notes.docx-CONTENTS Tips ......................................................................................................................................................................................... 4 Introducon ............................................................................................................................................................................
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LAWCOMM 403 long notes.docx-CONTENT...
LAWCOMM_403_long_notes.docx-CONTENTS Tips ......................................................................................................................................................................................... 4 Introducon ............................................................................................................................................................................
##### Page 23
4.
But if A
spends
\$66.67, someone else (B) must
that amount; and B, like A, will usually spend at least some of his
extra income. For example, B (like A) might spend 2/3 of his extra income: \$66.67 x 2/3 = \$44.47.
5.
Thus, the economy has now expanded by \$100 + 66.67 + 44.47 = \$211.14.
6.
And so on and so on.
If every person who receives extra income in this way spends 2/3 of it and saves 1/3, the result will be that if the government
spends an extra \$100, total spending will increase by \$300 – so the mulplier will be 3. If Keynes is right about this (and
economists generally seem to think that he is), then increases in public spending would seem to have the potenal to provide
very signiﬁcant smulaon to the economy. Economists disagree about the size of the mulplier, and they also say that it varies
from me to me and from place to place. But they mostly seem to think that’s its usually more than 1 and oﬅen 3 or 4.
Unfortunately, however, it also works in reverse if during a recession there are reducons in spending by:
The government
o
If the mulplier is 3, and the government cuts its spending by \$100, this will reduce the economy by \$300
Consumers
o
Consumers tend to reduce their spending during a recession, but not by much
Firms
o
Firms tend to reduce their spending signiﬁcantly
o
During a recession, businesses have lile conﬁdence in how the economy will behave in the short term – their
plans for expansion will be halted, and thus spending is halted
WHAT THE GOVERNMENT SHOULD SPEND THE MONEY ON
Obviously, if the government is going to increase its spending to alleviate the eﬀects of a recession, it should spend the
money on something useful
o
The problem, however, is that public spending (e.g. on building public housing) might merely displace private
spending, rather than adding to it – in which case, nothing will have been achieved. In fact, the result might be
negave, because public spending might be less eﬃcient than private spending.
Example: if the government spends money on housing, they could either employ workers themselves,
or they could contract with private companies to build it. Either way, the private sector may already
be building houses, so if they start building for the government instead, this will merely shiﬅ spending
on building private houses to building public houses
o
Largely for this reason, Keynes proposed that the government should spend money on
public works
that
would not otherwise have been undertaken
An example, in Auckland, is Tamaki Drive. This was a road built by a large number of previously
unemployed men. It would not have been produced by the market and the invisible hand. The
government spent extra money on previously unemployed people, who then spent the money.
Other Keynesian make-work projects that had this mulplier eﬀect:
o
the Egypan pyramids
This would have absorbed an enormous amount of unemployed and kept the economy going
o
Medieval European cathedrals
o
War
The government hires a large number of young men and send them to war – lots of employment
The government also purchases a lot of goods (e.g. ammunion, ships, uniforms, ordinance)
o
Burying banknotes in disused mineshaﬅs and then ﬁlling them in
The government can then aucon oﬀ the right to dig up the mineshaﬅs and get the money
This is a ridiculous thing to do, but this will contribute to the economic soluon – people will buy the
right to dig up the money, employ unemployed people to do the digging, which will allow them to
spend the money (increase aggregate demand) and thus get the economy closer to full employment
Obviously, it is beer to spend the money on doing something useful, like public works

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