4.1 The Multiplier - The Multiplier Process Explained with Macroeconomic Models Flashcards
How would you illustrate the multiplier process with the AD-AS approach?
Assume an initial event of value $Xm ==> equivalent increase in AD ==> firms employ more FOPs to produce more output ==> $Xm is paid to the FOPs ==> national output/income increases by $Xm.
Increase in NY by $Xm ==> a rise in consumption (on domestically produced goods and services) of $Xm x MPC (multiplier).
Income-induced consumption of $Xm x MPC ==> AD rises again ==> firms employ more FOPs to produce more output ==> $Xm x MPC is paid to the FOPs ==> national output/income increases by $Xm x MPC (repeat this statement twice).
This repeats until the sum of the total withdrawals is equal to the value of the initial increase in demand and the total increase in national income is $Xm x k.
What assumptions are made when analysing the multiplier effect?
- There are no capacity constraints/abundance of idle resources
- Contant general price level
- Constant technology
How would you illustrate the multiplier process with the circular flow of income approach?
Assume an initial injection of value $Xm ==> firms will receive this injection as revenue ==> firms redistribute the money to households as income (in return for the FOPs) ==> not all the income is spent on consumption by households ==> $Xm x MPC is spent on consuming (domestically produced goods and services) ==> $Xm x MPC flows back to the domestic firms (repeat the explanation again).
Eventually all the initial injection $Xm is withdrawn (total withdrawals = initial injections) ==> Induced consumption falls to zero ==> multiplier process ends
