2.4.4 - The multiplier Flashcards
What is the Multiplier effect.
● The multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.
- The multiplier effect arises because one agent’s spending is another agent’s income.
Example : - 2012 olympics in uk.
- Gov spent 8.8bn and and around 10bn was generated back into the uk economy.
- The initial invested decreased unemployment, increased, consumption,which increased sale rev which lead to an increase in tax rev ect.
What’s the effect of the multiplier on AD.
AD will increase.
Blurt all the effects of the multiplier on the economy
● The effect of the multiplier can be shown using the diagram:
o The initial injection (either increased government spending, investment or export revenue) causes an increase in AD (AD1 to AD2).
o This causes an increase in the price level (P1 to P2) and an increase in Real GDP (Y1 to Y2).
o This injection then creates income for someone else e.g. workers. Those who receive this increased income will then spend a proportion of it in the economy and the rest will be withdrawn from the circular flow.
oThe proportion of the extra income withdrawn** from the economy will determine the overall multiplier effect.
- This is because if less is withdrawn then more will be spent and therefore consumer spending will increase by a larger amount than if a high proportion of the money was withdrawn.
- (Calculations of the multiplier using the formulae).
o Unless the proportion of the extra withdrawn is 100%, there will always be a further increase in AD/multiplier effect**. This
is because the proportion of extra income spent causes an increase in consumer spending which then increases AD from AD2 to AD3.
oThe multiplier effect** causes the general price level to increase from P2 to P3 and real GDP to increase from Y2 to Y3. Therefore, although the initial injection only causes an increase in Real GDP of Y1 to Y2, the multiplier means that the overall increase ends up being from Y1 to Y3. This brings the economy much closer to the full employment level (YFE).
Marginal Propensity to Consume (MPC)
● The proportion of extra income that is spent,
Marginal Propensity to Save (MPS)
● This proportion of extra income that is saved.
● The bigger the MPS value is, the smaller the multiplier. This is because more of the extra income will be withdrawn from the economy rather than being kept in the circular flow of income. Therefore, the second increase in AD will be small compared to if the MPS value was small.
Marginal Propensity to Tax (MPT)
● This is the proportion of extra income that goes to the government in the form of taxation.
● The larger the value of MPT, the smaller the multiplier effect will be. This is because taxation is one of the leakages in the circular flow. Therefore, the larger the proportion of extra income that gets taxed, the more of that extra income is going out of the circular flow.
The marginal propensity to import (MPM)
● This is the proportion of extra income that is spent on imports.
● The larger the value of MPM, the smaller the multiplier effect will be. This is because instead of the majority of that extra income being spent in the economy, it will be injected into the circular flow of the country that the domestic consumer is spending their extra income buying imports from.
Blurt everything you know about the significance of the Multiplier in Shifting AD
Blurt everything you know about the downward multiplier effect.
