Okay, in our previous model of this lesson we have done the hard work

of laying down a strong foundation for the application of fiscal policy.

We have done so principally by developing the basic Keynesian model and

introducing the concept of the Keynesian expenditures multiplier.

Now it's time to put that Keynesian multiplier to work demonstrating

the actual application of fiscal policy.

So let's start with this example.

[MUSIC]

Suppose the potential GDP of India is 900 billion rupees,

and actual GDP is at 800 rupees, and

further assume a marginal propensity to consume of 0.8.

Take a minute now to see if you can draw this situation using the Keynesian model.

Then calculate the increase in government expenditures needed to close

the recessionary gap of 100 billion rupees, and illustrate this in the model.

So give it a try, and when you're ready, let's see if your figure and

your answer is correct.

[MUSIC]

This figure shows what this recessionary gap looks like.

Of course, to determine the degree of fiscal stimulus in this example we

first have to calculate the Keynesian multiplier.

Since the MPC it's 0.8, the MPS is 0.2, and

1/0.2 gives us a pretty big multiplier of 5.

That means the Indian government only has to increase government expenditures

by 20 billion rupees to close the 100 billion rupee recessionary gap.