. A further result of this is that a changed in a balanced government budget will have a net effect on equilibrium income, with a multiplier of one.When we extend the Simple Keynesian Model to allow for government and taxes, we see that these instruments of government policy can influence the equilibrium level of production. the use of taxes and government spending to influence production and employment is called "fiscal policy."
Government purchases are a component of autonomous expenditure, and so they will affect equilibirum income through a multiplier effect, very much like investment or net exports. Once we allow for government purchases, of course, we must also allow for taxation. Taxes, however, act indirectly in the model, reducing consumption, and so they have a different multiplier, . A further result of this is that a changed in a balanced government budget will have a net effect on equilibrium income, with a multiplier of one.
In all of this, it may help to distinguish between the Keynesian Diagnosis and the Keynesian Prescription. The Keynesian Diagnosis says that macroeconomic problems can occur as a result of insufficient or excessive aggregate demand. This is a question of fact, either true or false, and no less true in inflations than in depressions. The best-known Keynesian prescription is for increased government deficit spending. But that prescription is limited to particular times and circumstances, and even then, is not simply true or false. No prescription is ever just true or false. When a doctor diagnoses a patient's illness, the diagnosis may suggest a treatment -- but there could be good reasons not to prescribe the treatment. For example, the drug might have bad side effects. In such a case, the patient might face a trade-off between the cure and the side effects or considerations that are purely subjective, such as the trade-off between a short, active life and a longer life of disability. The Keynesian prescription is like that. Economists and others debate about how serious its side effects are. Here is the point: even if the Keynesian diagnosis is true, there could be good reasons not to accept the presecription. And, conversely, it is a fallacy to reject the diagnosis because we don't like the prescription. The diagnosis is either true or false -- whether we like it or not, either way! But it is the diagnosis, not the prescription, that is the essence of Keynesian economics. If we don't like the prescription, we can figure out another one -- consistent with the diagnosis that fits the facts.
The model we are considering here remains too simple for practical application, though. Its purpose is really to illustrate how a model of equilibrium unemployment might work, and to illustrate some of the effects that could enter into the determination of employment in the real world. The student should remember that such things as the constant marginal propensity to consume of 0.7 and the multiplier of 3.33 are not facts, but illustrative examples. There are other effects in the real world, some of which will tend to offset the ones we have considered here. We will look at some of them in the next chapter as we bring interest rates and the money supply into the Keynesian model.
Next Chapter: The Complete Keynesian Model of Aggregate Demand
