Use the Keynesian cross to explain why fiscal policy has a multiplied effect on national income?
The Keynesian cross is a graphical representation of the relationship between aggregate income and spending in the economy. It helps explain why fiscal policy, such as changes in government spending and taxation, has a multiplied effect on national income.
In the Keynesian cross diagram, the horizontal axis represents aggregate income (Y) and the vertical axis represents aggregate spending (AD). The 45-degree line represents equilibrium, where income equals spending (Y = AD). The diagram also includes the aggregate expenditure (AE) line, which represents the total spending in the economy at each level of income.
According to Keynesian economics, changes in government spending or taxation have a multiplied effect on national income because they affect both autonomous spending (i.e., spending that doesn't depend on income) and induced spending (i.e., spending that depends on income).
Suppose the government increases its spending. This will shift the AE line upward, as total spending in the economy increases at each level of income. As a result, the equilibrium level of income will increase, leading to a multiplied effect on national income.
The multiplied effect occurs because the increase in government spending not only directly increases aggregate spending, but it also leads to a chain reaction of increased income and spending. As national income increases, consumers have more income available to spend, which increases their consumption spending. This increase in consumption, in turn, leads to an increase in aggregate income, creating a cycle of increased spending and income.
Similarly, if the government decreases its spending or increases taxation, it will shift the AE line downward, leading to a decrease in the equilibrium level of income. Again, this decrease will have a multiplied effect on national income through the chain reaction of reduced income and spending.
Overall, the Keynesian cross illustrates how changes in government spending and taxation have a multiplied effect on national income, as they impact both autonomous and induced spending. By understanding these relationships, policymakers can use fiscal policy to stimulate or stabilize the economy during times of recession or inflation.