3) The Multiplier And The Accelerator - MMT Flashcards
Injections increase AD, if Dyson were to build a new £1 bn base in the UK it would…
increase and so would AD
If the government committed to building a new high speed rail link (HS2) from London to Manchester (G), at a cost of £100 bn, then that £100 bn would add at least…
£100 bn to the economy, however the key phrase is “at least”, when the government spends £100 bn on something like HS2 it expects a big return, it expects the £100 bn to grow the economy by more than £100 bn… this is due to the multiplier effect
What is the multiplier sometimes called?
National Income Multiplier or Fiscal Multiplier
Definition of the multiplier effect
When an initial change in AD has a greater final impact on the level of equilibrium national income
How does the multiplier effect work? Eg NHS
1) government decides to spend an extra £10 bn on the NHS then this is £10 bn of expenditure that wasn’t previously there
2) quite likely government borrowed money or simplistically could have got the Bank of England to create it for them
3) the different trusts that run the NHS (eg Worcestershire) now have extra income of £10 bn, spending most of this on materials, new equipment and services
4) producing this, increases national output; the companies supplying the materials/ services now have extra income, the workers in the NHS, workers in the factories making the materials, workers in the firms providing the services are also going to earn new income, money they make then spend in their local shops, restaurants, cafes etc, again generating extra income, extra expenditure, extra output
If the government injects £10 bn into the economy, what could it cause?
1)It could inject an extra £20 bn into the economy , ie a £30 bn increase from scratch (£10 bn G and an extra £20 bn new income/ product/expenditure
2) the Multiplier effect is 3 - £10 bn injection leads to a £3o bn increase in National Income
Why can’t the multiplier apply to other injections, eg I and X?
There is the same logic however the multiplier theory is most commonly used to justify increasing G, hence the term fiscal multiplier (G + T), the accelerator is a far narrower concept, the accelerator effect applies specifically to I - investment by firms
Definition of the accelerator theory:
The accelerator theory states an increase in real GDP will often lead to a proportionately higher increase in private sector investment (I)
What can an increase in I be explained by?
Resulting from higher real GDP is explained by the greater levels of business confidence that economic growth will generate, this increased I will in turn accelerate economic growth, for example, an increase in RGDP of 3% might increase C by 3% but actually increase I by 10%
Why could an increase in I be more extreme than the increases in RGDP and C?
I is by far the most sensitive/volatile component of AD, it responds very positively to improved economic performance -far more so than C which is often pretty stable (this also works in reverse)
Why could an increase in I be more extreme than the decreases in RGDP and C?
If the economy goes into recession (eg -0.5%) C might fall by around 0.5% but I might fall by 20%, whatever the change in RGDP, the change in I will accelerate away beyond that change and then quickly make the overall economic position consequently better or worse, depending on whether business confidence is booming or falling
Why do economists use the multiplier theory?
To propose the active involvement of government in increasing economic growth, however other economists dispute the effectiveness of a “fiscal” (ie G) multiplier, however even the opponents of G agree that injections create new income/ expenditure/ product - ie that there is a multiplier effect
