The Economics Book: From Xenophon to Cryptocurrency, 250 Milestones in the History of Economics by Steven G. Medema

The Economics Book: From Xenophon to Cryptocurrency, 250 Milestones in the History of Economics by Steven G. Medema

Author:Steven G. Medema [Medema, Steven G.]
Language: eng
Format: epub


1931

The Multiplier

Richard Kahn (1905–1989)

The Great Depression raised the question of whether government investment in public works, such as the construction of roads, dams, and schools, could increase employment and income. No one had devised a mechanism to estimate the magnitude of these gains until Cambridge University economist Richard Kahn came up with the concept of the “multiplier,” which measures how a dollar of additional spending affects national output and income.

In a 1931 article called “The Relation of Home Investment to Unemployment,” Kahn posed a practical problem: If a road-building project employs an additional worker, and that worker uses his income to purchase goods and services from other sectors, how many more workers will be employed economy-wide? Kahn’s answer involved determining the share of his income that the worker spends on these purchases. He formulated a multiplier that depends on the marginal propensity to consume, or the percentage of an income increase that consumers spend rather than save, finding that the greater the marginal propensity to consume, the greater is the boost to overall employment that results from hiring that additional worker.

While Kahn focused on the employment effects of public investment, his work helped his Cambridge colleague John Maynard Keynes make the case that deficit spending can lift an economy out of a recession. When government spending increases, production also increases, raising incomes for those involved in this production. This fuels additional consumer spending, boosting aggregate demand, output, and income even further and eventually putting the economy on an upward trajectory again.

Economists continue to dispute the magnitude of the multiplier. Some even suggest that it is close to zero, meaning that every dollar of additional government spending causes nearly a dollar of private output to disappear. Even so, policymakers often invoke Kahn’s multiplier to argue that increases in government spending or tax cuts can boost economic activity. Indeed, this motivated the U.S. government’s response to the Great Recession; its massive fiscal stimulus package included everything from the “cash for clunkers” program (to encourage new car purchases) to financing for massive public-works projects, the benefits of which spread across the economy.

SEE ALSO The Great Depression (1929), The Circular Flow Diagram (1933), Keynes’s General Theory (1936), The Multiplier–Accelerator Model (1939), The Keynesian Revolution (1947), The Great Recession (2007)

Workers compact concrete used to build the Boulder Dam (later renamed the Hoover Dam), located on the border of Arizona and Nevada, 1934. Kahn’s multiplier suggested that each dollar spent on a public works project like this would boost national output by more than one dollar.



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