Mar 13, 2009 (LBO) – The economic recession that began to plague the entire globe was the salient feature of the world economy during the period from 2007. Almost all the developed countries responded to the wide-spread recession by offering numerous stimulus packages funded by governments or the central banks. The recovery of the economy through government’s funding takes place as follows:
When people receive new income, they spend it on consumption.
The additional consumption will raise the demand for goods and services.
To satisfy the increased demand, producers will raise production by engaging resources, both physical and human.
It will put the economy back to the long term growth path.
The basic assumption here is that people, when they receive a new income, would immediately spend it on consumption. For instance if a person gets an additional 100 rupees, he would use the entirety of his new income or a significant portion of it, for increased consumption. Keynes believed that people have a tendency to spend a lesser amount out of an increase in income.
He called it marginal propensity to consume with a value of less than one because only a part of the new income is consumed, while the balance is saved. This consumed part is an expenditure for the person, but an inco