2.4.4 - multiplier Flashcards
Define multiplier effect
The multiplier effect occurs when an initial injection into the circular flow causes a bigger final increase in real national income
Define marginal propensity to consume MPC
The proportion of any change in income that is spent rather than saved
Define marginal propensity to save
The increase in savings following an increase in
income
Define marginal propensity to tax MPT
The increase in taxation following an increase in income
OR The change in taxation following a change in income.
Define Marginal popensity to import MPM
The increase in imports following an increase in
income
- The higher is the marginal propensity to import, the greater is the outflow of extra income in the circular flow model.
- A high MPM reduces the size of the multiplier effect.
Define marginal propensity to withdraw
The increase in leakages following an increase
in income
MPW=MPS+MPT+MPM
Define multiplier
A calculation of the degree to which injections into the circular flow of income cause changes in final national income.
Multiplier (k) = change in real GDP (Y)/change in injections (J). The formula used to calculate the size of any change in final national income that results from an increase in injections. The formula is 1/mpw where mpw is the marginal propensity to withdraw, or alternatively the formula 1/1-mpc can be used
multiplier formula
1/MPW or 1/1-MPC
MPW formula
MPW = MPS + MPM + MPT
State three basic effects of an increase in AD
1) higher output (higher econ growth)
2) higher employment due to an increase in firm’sneed for labour
3) higher inflation if economy is not in recession (increase in AD above the bend)
What is the effect of a change in AD in general
In general, the multiplier will have a big effect when there is plenty of spare capacity in the
economy and the MPW is low/MPC is higher. It has little effect on output when there is little
spare capacity in the economy so the rising demand only creates rising prices.
Effect of a change in AD with relation to multiplier
●The multiplier leads to an increase in AD higher than the original increase but to have the desired effect, must be sufficient spare capacity in the economy (i.e.
it cannot be at full output) for extra output to be produced.
● If the AS is perfectly inelastic, like on the classical LRAS curve, then the only impact
of the multiplier will be to increase price; it will not affect output in the long run,
although it will in the short run. The more elastic the curve, the smaller the effect on
price but the bigger the effect on output.
● Therefore, as with any increase in AD, the effect of the multiplier depends on the
shape of the AS curve and whether it is short run or long run. The size of the
increase in AD will depend on both the size of the initial increase in AD and the size
of the multiplier
What are the effects of the multiplier on the economy
The multiplier means that growth can occur quicker, as any injections lead to a bigger increase in national income. Injections can be targeted at those with the biggest MPC in order to increase the size of the multiplier.
- but there’s a time lag between income increase and full of effect of increase
- effect in economy depends on change in AD and elasticity of AS curve
What is negative multiplier effect
A negative multiplier effect can also occur i.e. a withdrawal from the economy could lead to an even further fall in income, decreasing economic growth and possibly leading to a decline in the economy. This means that government plans to cut deficits will lead to an even further decrease of the economy
What is the effect of the marginal propensities
-Value of multiplier depends on the MPs
- MPs can change value if other variables in economy change
- change in interest rates will affect the MPC
- higher the MOC, the bigger the multiplier as this means more of the money in of income is spent so more is transferred through CF and less is withdrawn
