Economics 101: Something from nothing

Keynesian money multiplier effects



I've learned that my post back in January 2014 (below) was greatly inaccurate though the result is still essentially the same. -- docsalvage, June 2014
See the Wikipedia article...

Money Supply - Fractional Reserve Banking - example


Economics 101 tries to teach us that "the money supply," GDP, GNP, and every other discussion of "the economy" doesn't count "money" the way you and I do. If I give you a dollar for some service, to you and me, our two-person "economy" still only has a "money supply" of one dollar.

However, economics doesn't actually count "dollars." It counts "dollar transactions." In economics, if I give you a dollar, our "economy" now has a money supply of 2 dollars! If you then pay me for a service, our money supply has increased to $3! Three times what we started with! The more transactions there are in an economy, the higher the Gross Domestic/National Product. It's called the Money Multiplier. That's why the terms use the word "product." It refers to the mathematical "product" of a multiplication.

The result is that $1 given to a poor person will become part of many more transactions than $1 given to a rich person because the poor person spends that dollar immediately for many low-priced goods and services. When the rich person finally spends that dollar, it will be for higher priced products and thus fewer of them. Even though they cost more, it's not nearly enough to make up for the money created by the multiplier at work as many poor-person-dollars make their way through many hands. The lower the prices, the more times the dollar will likely change hands and thus the greater the multiplier.

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