2.4.4 - The multiplier

Question 1

What jobs would be created if HS2 were to be built?

Answer 1

• Architectual jobs
• Builder
• People to transport goods
• Ticket people
• Cleaners
• Train drivers
• Sales manager
• Maintenance people

Question 2

What is the link between aggregate demand the activity in the economy?

Answer 2

The higher the level of aggregate demand in an economy, the higher the level of economic activity.

A large part of government economic policy is designed to stimulate the various components of aggregate demand

Any increase in C + I + G + (X - M), will shift the aggregate demand curve to the right, and consequently will increase the level of real national output

An increase in any of the components of aggregate demand will lead to a rise in the circular flow of income.

Question 3

What is the definition of aggregate demand?

Answer 3

The total demand for all goods and services in an economy at any given price level over a period of time.

Question 4

What’s the formula for aggregate demand?

Answer 4

C + I + G + (X - M)

Question 5

Which parts of aggregate demand are injections?

Answer 5

Investments, government spending and exports.

Question 6

What parts of aggregate demand are withdrawals?

Answer 6

Imports

Question 7

What does MPC stand for?

Answer 7

Marginal propensity to consume.

Question 8

What is MPC

Answer 8

The proportion in any change in income that is spent rather than saved.

If income increases by £100 and the MPC is 0.7 then £70 of the increase in income will be spent on consumption.

Question 9

What does MPW stand for?

Answer 9

Marginal propensity to withdraw

Question 10

What is the multiplier formula ?

Answer 10

K = 1 / MPW

Question 11

What’s the other formula for calculating the multiplier?

Answer 11

K = 1 / 1 - MPC

Question 12

What is the multilplier effect?

Answer 12

This is when an initial injection occurs into the economy, or circular flow of income, causes a larger final increase in the level of real national income/output.

Question 13

Why is the multiplier so significant for shifts in AD?

Answer 13

By targeting those individuals with a high MPC the government can increase AD dramatically. This implies that, in times of low demand, focus should be on
increasing the income of those with a high MPC.

Question 14

What is MPS?

Answer 14

This is the marginal propensity to save.

If interest rates are high, then consumption may not rise significantly as additional income may be saved rather than spent.

Question 15

What is MPT?

Answer 15

This is marginal propensity to tax.

Taxes are a withdrawal from the circular flow, if tax rates are high then consumers will be deterred from spending or simply have less disposable income with which to consume goods and services.

Question 16

What is MPM?

Answer 16

This is marginal propensity to import.

In the UK, we have a high propensity to consume imports. If we receive increases in disposable income, but this is spent on imported goods, then this would count as a withdrawal or leakage from the circular flow of income and national income would not rise as much as anticipated.

Question 17

What is the multiplier determined by?

Answer 17

It’s determined by the size of the leakages from the economy – MPS, MPT and MPM.

Question 18

Name 2 things that have an effect on the economy and explain

Answer 18

• If there is very little spare capacity in the economy, then any increase in aggregate demand may not be able to be met by firms
• Unemployment
• Economic growth
• Inflation
• Exchange rates
• The size of the multiplier is almost impossible to measure as it takes into account numerous factors
• It is likely that those on low incomes will have a higher MPC so AD will shift further to the right if government prioritise these

Question 19

What graph can be used to show the effects of the economy on the multiplier?

Answer 19

LRAS curve

Question 20

Draw a LRAS curve

Answer 20

• Y axis labelled as “Price Level”
• X axis labelled as “Real National Output”
• LRAS Curve
• AD Line
• “P” on the Y axis to show current price
• “FE” at the point where LRAS stops curving and goes into a straight line
• “Y” or “Y1” labelled on the X axis to show a new equilibrium