2.4.4 Flashcards
What is the multiplier effect?
injections of new demand for goods/services into the circular flow of income stimulate further rounds of spending
What is the equation for total change change in real GDP?
Total change in real GDP = injection x multiplier
What is the equation for Multiplier (K)?
Multiplier (K) =Change in real GDP (Y) / Change in injections (J)
The bigger the multiplier, means what?
The bigger the change in real GDP
When is the multiplier larger?
When withdrawals from the circular flow are smaller.
Marginal propensity to consume (MPC)?
The proportion of additional income that is spent in the domestic economy
Marginal propensity to import (MPM)?
The proportion of additional income that is spent on imports
Marginal propensity to save (MPS)?
The proportion of additional income that is saved
Marginal propensity to tax (MPT)?
The proportion of additional income that is paid to the government as tax
Marginal propensity to withdraw (MPW)?
The proportion of additional income leaving the circular flow.
What is the formula for the value of a multiplier in a closed economy with no government?
Multiplier = 1/(marginal propensity to save)
or
Multiplier = 1/(1-marginal propensity to consume)
What is the formula for the value of the multiplier in a closed economy with government?
Multiplier = 1/(sum of the marginal propensity to save + marginal rate of tax)
What is the formula for the value of the multiplier in an open economy with government?
Multiplier = 1/(sum of the propensities to save + tax + import)
What is a positive multiplier?
When an initial increase in an injection leads to a greater final increase in real GDP
What is a negative multiplier?
When an initial decrease in an injection leads to a greater final decrease in real GDP
What factors are there which means there is a high multiplier value?
-Economy has plenty spare capacity to meet higher aggregate demand
-Marginal propensity to import and tax is low
-High propensity to consume any extra income
What factors are there which means there is a low multiplier value?
-Economy is close to it’s capacity limits
-Propensity to import goods/services is high = extra demand leaks from circular flow.
-Higher inflation causes rising interest rates which then dampens the other components of AD
