ECONOMICS

Economics

Economics

Question 1

(a) What is the 'multiplier effect' and how do Keynesians believe this will affect the economy in the long run?

The multiplier effect is the development of various businesses (economic activity) due to the additional demand resulting from the launch or expansion of a business. Multiplier effect shows the growth of money supply of country which results from banks being able to let borrowing. The deposit percentage depends on the size of the multiplier effect as the banks need to hold the deposit as the reserves. Moreover, it is money which is used to make additional money and is calculated by dividing total amount of deposit in the bank by the requirement of reserve.

Moreover, in its simplest form Keynes stated that it is important and crucial to take proactive steps by the governments during economic down turns instead of relying upon the decrease in interest rate and power of the markets. The proactive steps by the government should be taken in the sense that the government should take loan and start spending (Bayer, 1998, 561). Moreover, in the long run, Keynesian believe that the multiplier effect will affect the economy as government cannot make an economy as a perfect economy by frequently adjusting its monetary and fiscal policies in order to keep the high level of employment. In this view, there is simply too long a time lag between recognizing the requirement of policies like tax reduction, or tax holiday etc. Furthermore, even if the policy makers quickly recognize the issue that is being faced by the government, it takes time for laws to be outlined and passed, and more time still for the tax reduction or tax holiday in reality to trickle in the course of the wider economy.

(b) Why do Classical economists disagree with the theory of the multiplier effect?

In view of the multiplier effect, it is noted that the Classical economists disagree with the theory of the multiplier effect. Pertaining to this, the effect of the interest rate was analyzed by Keynesians on investment; however, the supply of funds that is saving in the classical model was determined the amount of fixed investment in business. It is noted by Keynesians that the investment amount was find out separately for profit expectations in the long term and, the rate of interest to the lesser amount. The recent opens the conceivability of directing the economy through changes in the supply of money, by means of monetary policy. In situations like Great Depression, Keynes contended that the approach of multiplier effect may be moderately incapable contrasted with fiscal policy. However, in normal times, extension in monetary policy can strengthen the economy, generally by supporting the construction of new housing (Fontana, 2008, 131-133).

Question 2

Increasing money supply will only increase inflation. Discuss.

Historical data show that the rapid increase in money supply drives higher inflation. This was seen very clearly in a period of hyperinflation in Germany in the 1920's and Latin America in the 1980's However, even the more moderate ...