2.4.4 The Multiplier

Question 1

What is the relationship between aggregate demand and circular flow of income

Answer 1

An increase in any of the components of AD will lead to a rise in the circular flow of income

Question 2

What is the multiplier process

Answer 2

• 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

Question 3

Define the multiplier effect

Answer 3

Occurs when an additional injection into the economy, or circular flow of income, causes a larger final increase of real national income/output

Question 4

How does the multiplier effect come about

Answer 4

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

Question 5

Define the positive multiplier effect

Answer 5

When an initial increase in an injection ( or decrease in a leakage) leads to a greater final increase in the level of real GDP

Question 6

Define the negative multiplier effect

Answer 6

When an initial decrease in an injection (or an increase in leakage) leads to a greater final decrease in the level of real GDP

Question 7

Define the marginal propensity to consume

Answer 7

The change in consumer spending arising from a change in disposable income

Question 8

Why is the value of the marginal propensity to consume important

Answer 8

When the government is considering cutting direct taxes to stimulate consumption, the impact of the tax cut depends on the MPC

Question 9

What must the MPC + MPS always equal

Answer 9

1

Question 10

What is the marginal propensity to save

Answer 10

The change in savings following a small change in income

Question 11

What is the formula for MPC and MPS

Answer 11

MPC=change in total consumption/change in income
MPS= change in total savings/ change in income

Question 12

What is the formula for the multiplier effect

Answer 12

1/MPS+MPM+MPT
Or
1/1-MPC
Or
1/MPW

Question 13

What factors affect the value of the multiplier

Answer 13

The MPC
Leakages
Degree of spare capacity
Time frame

Question 14

Explain how the MPC affect the multiplier effect

Answer 14

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

Question 15

Explain how leakages affect the multiplier

Answer 15

Leakages from the circular flow reduce the size of the multiplier

Question 16

Explain how the degree of spare capacity affects the value of the multiplier

Answer 16

If an economy is operating close to its full potential, the multiplier effect may be limited

Question 17

Explain how the time frame affects the value of the multiplier

Answer 17

In the short run, factors like capacity constraints can limit the multipliers size.
In the long run, adjustments in production capacity, investments and resource allocation can lead to a larger multiplier effect

Question 18

When is the value of the multiplier high

Answer 18

Level of spare capacity is high
MPW is low
MPC is high

Question 19

When is the value of the multiplier low

Answer 19

Level of spare capacity is low
MPW is high
MPC is low

Question 20

How can the government increase AD dramatically

Answer 20

By targeting individuals with a high MPC, so should focus on increasing their income