1.5 The multiplier and the Accelerator

Question 1

What is the National income multiplier?

Answer 1

The ratio of a change in equilibrium real income to the autonomous change that brought it about.

Question 2

What factors determine the size of the National income multiplier?

Answer 2

Marginal propensity to withdraw
Marginal propensity to save
Marginal propensity to tax
Marginal propensity to import

Question 3

How is the size of the National income multiplier determined?

Answer 3

National income multiplier is the amount by which the national income increases as a result of an injection into the circular flow of income.
multiplier ( K ) = I/ marginal propensity to withdraw

Question 4

What increases / decreases national income?

Answer 4

An injection into the economy through either investment, govt expenditure or exports increases the national income. The amount by which it decreases depends upon the value of the national income multiplier.

Question 5

What’s the accelerator?

Answer 5

Theory by which the level of investment depends on the rate of change in national income.

Question 6

What is the accelerator affect?

Answer 6

An increase in national income results in a proportionately larger rise in investment.

Question 7

Why is investment needed to replace or purchase new capital stock?

Answer 7

Level of investment will rise if if economic growth is positive and demand is rising as firms wish to increase their productive potential and supply capacity to meet this rising demand.

Question 8

What is gross and net investment?

Answer 8

Gross investment= total investment into capital stock

Net investment = gross investment minus depreciation of capital stock

Question 9

What happens when economic growth falls during an economic slowdown?

Answer 9

Firms destock and reduce the level of investment or possibly stop it all together, because they don’t want to be left with unused machinery or buildings.

Question 10

What is the impact of the national income multiplier and accelerator on aggregate demand and the economic cycle?

Answer 10

Investment as an injection into the circular flow of income should lead to greater national income due to the national income multiplier. This rise in aggregate demand results in a higher level of investment and so on…
National income continues to rise until productive potential of the economy is reached or economic growth slows down
Economic growth reached its ceiling once it’s reached the economy’s productive potential
It has reached its floor when it gets to its minimum level in a recession
These ceilings and floors represent a turning point in the economic cycle and firms must invest a minimum amount to replace working physical capital.

Question 11

What is the average propensity to consume?

Answer 11

The proportion of the household income devoted to consumer spending
APC = consumer expenditure/ household income

Question 12

What’s the average propensity to save?

Answer 12

Proportion of household income devoted to saving.

APS = 1 - APC

Question 13

What’s the average propensity to withdraw?

Answer 13

Average amount withdrawn from the circular flow of income.

APW = APS + APT + APM

Question 14

How are marginal propensities calculated?

Answer 14

mpc = 1- mpw 
mps = 1 - mpc 
mpw = mps + mpt + mpm

Question 15

What are output gaps?

Answer 15

Difference between the actual output of an economy and its potential output.

Question 16

What’s negative output gap?

Answer 16

It occurs when actual GDP is below potential GDP so economy is not producing to its productive potential due to unemployed factors of production in the economy - i.e. there is spare capacity

Policy makers can affect this through incentive in order to stimulate the economy through expansionary demand - side policy measures.

PAGE 128 - CAN YOU DRAW THE NEGATIVE OUTPUT GAP

Question 17

Explain positive output gap.

Answer 17

Positive output gap occurs when actual GDP is above potential GDP.
This will only happen in the short run where the economy is producing above its productive potential and some resources are operating beyond their normal capacity.
In the long run; cost of production will rise causing the short run aggregate supply to slow down.

PAGE 129 - DRAW THE POSITIVE OUTPUT GAP

Question 18

What are the causes of an output gap?

Answer 18

Negative output gaps are caused by actual GDP being below potential GDP when factors of production are under utilised and some resources are unemployed.
Economic shocks can cause a negative output gap - e.g COVID led to reduction in demand as consumers in lockdown

Positive output gap caused by actual GDP exceeding potential GDP as factors of production are employed above normal capacity

Question 19

What are the consequences of an output gap?

Answer 19

Positive output gaps = inflationary pressure as aggregate demand outstrips aggregate supply.

Negative output gaps = are more significant - can signal a lack of aggregate demand which then causes firms to not invest or recruit staff. The consequences will depend on whether the cause is long term or temporary.