Question

Explain how a rise in autonomous spending can increase total spending by some multiple.

Short answer

A rise in autonomous spending increases demand, leading to increased production, income, and further consumer spending. This ripple effect, or multiplier effect, can increase total spending by more than the initial autonomous spending. This principle is illustrated by the Keynesian multiplier theory.

Step-by-step solution

Understanding Autonomous Spending

Autonomous spending refers to expenditures that occur irrespective of the current levels of income. Examples of autonomous spending are government expenditure, investments by businesses, and a portion of consumer spending.

Rise in Autonomous Spending

Suppose there is an increase in autonomous spending, say Government expenditure or Investments. This would mean more money being poured into the economy, thus increasing the overall demand.

The Multiplier Effect

According to the multiplier theory, this rise in demand from increased autonomous spending will further stimulate production. Businesses increase their output to meet this demand, leading to higher income. This income, in turn, increases consumer spending, thereby leading to higher total spending in the economy.

Calculating the Multiplier

The multiplier (\(k\)) is used to quantify the impact of autonomous spending on total spending. It is calculated as \(k = \frac{1}{1 - MPC}\), where MPC is the Marginal Propensity to Consume, a measure of the increase in consumer spending due to an increase in income. The concept of the multiplier indicates that every dollar of autonomous spending can lead to more than one dollar of total spending.