Question

Consider the economies of Macmillana and Bloedelo, which are identical except that the multiplier in Macmillana is smaller than that in Bloedelo. This means that Macmillana's GDP is Bloedelo's GDP to fluctuations in the components of total spending. Features of the economy that reduce its sensitivity to shocks are called automatic stabilizers. Suppose again that the economies of Macmillana and Bloedelo are identical except that Macmillana has instituted a system of unemployment insurance, whereas Bloedelo hasn't. Macmillana's economy is sensitive to fluctuations in GDP than Bloedelo's economy. This is because the system of unemployment insurance has Macmillana's multiplier.

Answer 1

Macmillana's GDP is less sensitive economic fluctuations than Bloedelo's GDP. Two reasons account for this:

1) The keynesian multiplier is smaller.

The keynesian multiplier tells us about the sensitivity of GDP to increases in domestic expenditure (consumption, investment or government purchases). If the keynesian multiplier is small, then, GDP will be less sensitive to fluctuations in aggregate expenditure.

2) Macmillana's economy has implemented automatic stabilizers, while Bloedelo's economy has not.

Automatic Stabilizers are government policies meant to reduce fluctuations in GDP. The two most common automatic stabilizers are: income taxes and unemployment benefits.

Automatic Stabilizers reduce the kenyensian multiplier, dampening Macmillana's GDP sensitivity to fluctuations even more.