1.5 The Multiplier And The Accelerator Flashcards
What is meant by the multiplier ratio
This is the ratio of the rise of national income to the initial rise in AD
Number of times a rise in national income is larger than the rise in initial injection of AD
What is meant by the multiplier effect
This occurs when there is new demand in an economy
Refers to how an initial increase in AD leads to a bigger increase in national income
It leads to an injection of more income into the circular flow of income
This leads to economic growth and more jobs, higher income and more spending
What is meant by marginal propensity to consume (MPC)
The proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it.
This higher the MPC, the bigger the size of the multiplier
How can a government impact the MPC
They could change the rate of direct tax
More RDI due to lower taxes means propensity to consume might increase
What is meant by average propensity to consume and how is it calculated
It is the percentage of income spent rather than saved
Calculated by total consumption divided by total income
What is meant by marginal propensity to save (MPS)
It refers to the proportion of a raise in pay that a consumer saves rather than uses for consuming goods and services
MPS + MPC = 1
A high MPS will create a small multiplier
What is meant by average propensity to save and how is it calculated
This is the income that is not spent
Calculated by dividing change in savings by change in income
What is meant by marginal propensity to tax (MPT)
This is the proportion of each pound taxed by the government
Higher rates of tax mean less RDI for each consumer meaning a smaller multiplier
What is meant by marginal propensity to import (MPM)
Consumers spend income on imports rather than domestic goods and services
Therefore income is withdrawn from the circular flow of income
Reducing the size of the multiplier
What is meant by spare capacity in the economy
If there is spare capacity or a negative output gap then the multiplier effect on national income will be greater
How do you calculate the size of national income multiplier
1/(1-MPC)
1/MPW
How do you calculate marginal propensity to withdraw (MPW)
MPW = MPS + MPT + MPM
Explain how shifts in AD impact the multiplier
If SRAS is elastic it means the multiplier will be larger
A small increase in AD will lead to a larger increase in national income
If SRAS is inelastic the multiplier effect is likely to be smaller than its potential
This because if AD increases prices will increase meaning higher inflation. This will increase interest rates and encourage saving
What is meant by an output gap
This occurs when there is a difference between the actual level of output and the potential level of output
What is meant by a negative output gap
This occurs when the actual level of output is less than the potential level of output
This puts pressure on inflation usually meaning unemployment of resources
This means there is spare capacity in the economy