Welcome back. Now it's time to get a little bit happier. Why? Because we are about to finish what we have discussed about GDP. Remember, GDP stands for Gross Domestic Product is my income and the components of my GDP are consumption, investment, government expenditure, exports minus imports. But if you want to go a little bit deeper and understand how the Keynes multiplier works. What does it stand for Keynes multiplier? Let's go step-by-step. Keynes was a British economist. John Maynard Keynes died in 1946. He always pledged what? That the government should intervene in the economy if the aggregate demand was not working. I just want to explain what this Keynes multiplier stands for and works, that we can do. You will see that's pretty much easy and I'm going to ask you, I would suggest actually to use a much easier approach rather than algebra now. Let's go in principle to understand this Keynes multiplier. How the economy can multiply itself. For example, let's focus on our macroeconomic identity. Y equal to C plus I plus G plus X minus M. Let's see how the Keynes multiplier works without algebra. Is that easy? Yes. Put in your mind, the equation, the macroeconomic identity. Let's assume, for the sake of simplicity, the government expenditure increased by $100 million. Just that. Obviously, at the first round, GDP will increase by $100 million because G increase make sense? Yes. But remember at the beginning, as GDP is equal to income, once the income increase, consumption will also increase later on. As we said, the increase in this income has been triggered by higher government expenditure that will lead household consumption to increase, which in terms hetero feed the increase in GDP. Let's make it even easy yet. If the government decides to spend $100 million by building a non-hydro plan, how does $100 million could trigger a much greater effect in the economy? Remember, the government is spending $100 million in government expenditure. We all know that he will have to hire workers to do the job. Those workers will get paid and with this income, they will buy stuffs, consumption, to be produced, hence, multiplying the effects of GDP. Does it make sense? G increase by 100 million. GDP increase by 100 million but as GDP's income consumption also increase. If consumption increase, we will have another round of boost in my GDP. That's the Keynes multiplier. Obviously, it depends on the marginal propensity to consume. That's the only thing you need to know but Professor, I would like to use some algebra. If you want to use algebra, that's pretty much easy. You see, you have all these equations in front of you. The only thing we have to do is just to isolate the Y and then you figure out that the Keynes multiplier is going to be equal to one over one minus C plus M. Do you understand that the higher the marginal propensity to consume the higher the Keynes multiplier. You can see looking by algebra in this formula, one over one minus C plus M. Let's forget about M, one minus C. If the government expenditure increase, income increase. If the marginal propensity to consume increase, this higher income will boost consumption much stronger. That's why GDP increase. That's why we said that the Keynes multiplier increase if the marginal propensity to consume is higher or increase itself. Well, this is very good, yes, but don't forget, Keynes multiplier, works for the good, and for the bad. What I mean for the bad? If the country experienced or the government wants to do our contractionary fiscal policy, let's say, deduct or restrain $100 million in terms of government expenditure, my GDP, everything else constant will decline further. Why? G goes down. GDP goes down, income goes down, income goes down, consumption goes down, consumption goes down, hetero feed, GDP to go down as well. This is just what I want to show in terms of the Keynes multiplier and now for the next lesson, we will discuss some say about inflation.
