Unit 17 — The Great Depression and the Keynesian Revolution

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Purpose:

To discuss how the ideas of J. M. Keynes, specifically the Keynesian multiplier, contributed to a better understanding of why the Great Depression was so severe.

Objectives:

  1. One of J. M. Keynes’s basic contributions to macroeconomics was to show how the multiplier process explains many of the swings in the economy.
  2. For example, in a single economy with no government and no trade sector, aggregate demand is equal to consumption plus investment. Income is either spent by consumers or saved. In the economy there is one leakage (saving) and one injection (investment).
  3. If investment increases, then aggregate demand increases, which in turn means that equilibrium GNP and national income increase.

    1. Part of an increase of income is saved and part is spent by consumers. The new consumption spending means higher aggregate demand, more GNP, more income, and again more consumption and saving.
    2. Ultimately GNP and national income will have risen by a multiple of the original rise in investment.
    3. The size of this multiplier depends on how much consumers spend out of each incremental dollar of disposable income (the marginal propensity to consume). The higher the marginal propensity to consume, the higher will be the multiplier.
  4. Keynes had two main complaints about classical economics.

    1. He felt that money had an impact not only on prices but also on employment and output.
    2. He emphatically felt that supply did not create its own demand.

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Meet the Series Experts

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John Kenneth Galbraith

John Kenneth Galbraith

Economist known as the leading proponent of 20th-century political liberalism, and a prolific author who produced four dozen books and more than a thousand articles, including the popular trilogy American Capitalism, The Affluent Society, and The New Industrial State.

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Walter Salant

Walter Salant

Economist noted for his work on John Maynard Keynes.

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Eric Sevareid

Eric Sevareid

Prominent broadcast journalist best known for his work at CBS where he served as Chief of the Washington Bureau, 1946–1954.

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Lorie Tarshis

Lorie Tarshis

Canadian economist credited with writing the first introductory textbook on Keynesian thinking, The Elements of Economics, in 1947.

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  1. The consumption function is concerned with the relationship between consumption spending and:

    total income.

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  2. That portion of an EXTRA dollar of disposable income that is spent on consumption is called:

    marginal propensity to consume.

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  3. According to the theory of John Maynard Keynes and his followers, NNP is dependent MAINLY on

    consumer spending levels.

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  4. Suppose that the current marginal propensity to consume equals .75. What will be the impact on equilibrium NNP of an investment of $1 billion?

    $4 billion

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  5. The consumption function illustrated in the diagram shows:

    chart chart

    that saving is done only by households with incomes over $20,000. Answer derived from diagram.

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  6. The average propensity to consumer of the family identified as A is:

    chart chart

    greater than one.

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