2.4.4 The Multiplier Flashcards
What is the relationship between aggregate demand and circular flow of income
An increase in any of the components of AD will lead to a rise in the circular flow of income
What is the multiplier process
- occurs when an initial change on spending leads to a larger final impact on an economy’s total output
- when an individual increases spending, the recipients of that spending then have more income which they then spend on goods and services
- this creates additional demand, which prompts businesses to increase production and hire more workers, resulting in higher factor incomes
Define the multiplier effect
Occurs when an additional injection into the economy, or circular flow of income, causes a larger final increase of real national income/output
How does the multiplier effect come about
The multiplier effect comes about because injections of demand into the circular flow stimulate further rounds of spending- because one persons spending is another persons income
This leads to a bigger final effect on the level of national output and total employment in the labour market
Define the positive multiplier effect
When an initial increase in an injection ( or decrease in a leakage) leads to a greater final increase in the level of real GDP
Define the negative multiplier effect
When an initial decrease in an injection (or an increase in leakage) leads to a greater final decrease in the level of real GDP
Define the marginal propensity to consume
The change in consumer spending arising from a change in disposable income
Why is the value of the marginal propensity to consume important
When the government is considering cutting direct taxes to stimulate consumption, the impact of the tax cut depends on the MPC
What must the MPC + MPS always equal
1
What is the marginal propensity to save
The change in savings following a small change in income
What is the formula for MPC and MPS
MPC=change in total consumption/change in income
MPS= change in total savings/ change in income
What is the formula for the multiplier effect
1/MPS+MPM+MPT
Or
1/1-MPC
Or
1/MPW
What factors affect the value of the multiplier
The MPC
Leakages
Degree of spare capacity
Time frame
Explain how the MPC affect the multiplier effect
A higher MPC leads to a larger multiplier effect because a greater proportion of any initial increase in income is spent, leading to multiple rounds of increased spending and output
Explain how leakages affect the multiplier
Leakages from the circular flow reduce the size of the multiplier