Author: Lori Alden
Audience: High school
and college economics students
Time required: About
Standards: 18, 19, 20
activity helps students understand the simple Keynesian
model of spending and output, the multiplier effect, and how government can affect GDP
through fiscal policy.
Keynesian Theory in a Nutshell
here to download 10 pages of materials. Print the pages on 8½ X 11
white cardstock. (Note: The materials are in pdf format. To view
them you'll need an Adobe Acrobat
Reader, which you can download
Punch four holes each in the "Spending" and
"Output" cards as shown below. [Note: Your text may use
different terminology. Instead of "Spending," you
may want to use "Aggregate Demand," "AD,"
"Expenditures," "E," or "C + I + G + NX."
"Output" can be replaced with "Aggregate
Supply," "AS," "Production," "GDP" or "Y."]
Thread a length of twine or
cord through each of the cards and hang them vertically against a
wall, blackboard or whiteboard so that the strings are taut and
about 8" apart. When the cards are at the same level,
the Spending card should overlap the Output card so that the
colored areas are completely covered.
On one side of the strings,
tape the "Spending < Output" and "Spending >
Output" legends as shown below. On
the other side of the strings, tape the Inflation Zone, Healthy
Economy Zone, and Unemployment Zone cards.
Cut the Event cards along the dotted lines and set
#1: Equilibrium in the Keynesian Model
the Spending and Output cards at the same
level in the Healthy Economy zone, so that the Spending card blocks
the colored region of the Output card. Ask your students to
assume the government increases spending and push the
spending card up a few inches so as to reveal part of the green
that the increase in spending means that firms are now selling at
a faster rate than they're producing and that their inventories
are going down. This tells firms to hire more workers and
produce more output until output is once again in line with
spending. Show this response by pushing the Output card
up so that it's again in line with the Spending card.
that whenever the green area on the Output card is exposed,
there's a "tendency to change," which means the economy
isn't in equilibrium. What's changing is that firms are
losing inventories, leading them to
produce more output.
more workers to increase output causes further boosts in spending, in a chain reaction
that economists call the "multiplier effect." The workers
that the firms hired increase their consumption spending,
since their disposable incomes are higher. This
increase in spending causes firms to hire still more workers so that
output once again matches spending. The newly hired workers, in
turn, increase their consumption spending, which leads to further
increases in output, which led to more hiring, and
demonstrate the multiplier effect, slide the Spending card and Output cards
up several times in succession, so that the Output card appears to
be trying to keep up with the Spending card. Make each
upward slide successively smaller so that the multiplier effect
eventually peters out. When you're done, the two cards
should be even with each other.
diagram below shows how spending would continue to rise over
several rounds if the multiplier equaled 4. (Output, not
shown, would passively rise each round to match spending.)
how it would look if the multiplier equaled 2:
show what happens when the government cuts spending. Slide
the Spending card down a few inches, revealing the yellow region
on the Output card.
that if spending is less than output, firms experience an increase
in inventories, which leads them to lay off workers and decrease
output. Note that when the yellow region is exposed, there's
once again a "tendency to change" in that firms are
gaining inventories and trying to reduce output. Show this response by sliding the Output card down
until it's once again level with the Spending card. This
will launch a downward multiplier effect, since the laid off
workers will cut back on spending. Show this by sliding the
two cards downward a few times in succession.
Demonstration #2: What caused
the Great Depression?
likely cause is that firms became pessimistic
and reduced their investment spending.
As spending went down,
so did output. To demonstrate
this, start with both cards are the
same level in the Healthy Economy zone. Pull down the
Spending card a few inches to show what happened when firms cut
back on investment spending at the beginning of the depression. Pull the Output card down to
was a multiplier effect, too. As firms
laid workers off, these workers cut back
on consumption spending. This
reduction in spending caused output to fall and led to more workers losing
their jobs, which led to further reductions in spending and
output. Show this by pulling the cards down several times in succession until they're
both at the same level in the Unemployment Zone.
#3: Is there a cure for recessions or depressions?
If any of us
were able to go back in time to the 1930s, we would have been able
to tell FDR how to end the Great Depression--just increase
spending. Firms would have responded by stepping up production and hiring more workers.
The newly hired workers, in turn, would have spent more,
leading to more output and even more spending.
government could have done this either by increasing government spending
or by decreasing taxes, the two main tools of fiscal policy.
Of course, it would have been hard to convince people back
then that this was the right thing to do. Raising
government spending while reducing taxes would have increased
the federal budget deficit. During
the Great Depression, most people (incorrectly) believed that the
federal budget needed to be balanced if we were to ever pull out
the effect of
an increase in government spending by lifting up
the Spending card a few inches so that part of the green region is
exposed. Pull up the Output card to match it.
Show the multiplier effect by pulling the cards up in succession for a few rounds.
Demonstration #4: Can we make
as large as we want?
By now, an exciting idea may have occurred to
If we can control spending, why can't we make our
nation's output as large as we like?
That way, everyone could live like kings and queens, with
mansions, fancy cars, fine clothes, and gourmet food.
this idea wouldn't work.
At some point, all of our resources would become fully
employed in the production of output.
If spending rose beyond that point, output wouldn't be able to rise any further to match it.
Firms wouldn't be able to hire the labor, land, and capital
needed to increase production.
isn't to say we haven't tried. In
the late 1960s, for example, we increased spending to a
level so high that output could not keep up.
The result? Inflation. When firms can't increase
their output to match spending, they respond instead by
this by placing both cards at the same level in the "Healthy
Economy Zone." Ask your students to assume that the
government increased spending and push the Spending card up, then
push the Output card up to match it. Show the multiplier
effect by pushing both cards up in succession for several rounds
until both cards are in the Inflation Zone.
the event cards to students (or teams of students) and ask each in turn to come up to the
front of the classroom and demonstrate how a given event will
affect GDP in the first round (ignore the subsequent multiplier
effects). The first card, for example, says "The
government increases defense
spending in order to fight terrorism."
To demonstrate this, a student would push up the Spending card and then
push up the Output card to restore equilibrium.
Lori Alden, 2005-7. All rights reserved. You may
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